Out with the Old (TICs) and In with the New (DSTs)
April 10, 2017
Authors: Robert Straton, NW 1031 Planning Inc.
Publishers: HFO Apartment Investor Newsletter
For purposes of 1031 exchange, TICs or Tenant-In- Common programs are dying and almost obsolete. Their user-unfriendly format – requiring unanimous investor approval of fundamental property management decisions like refinancing, re-tenanting, and sale – hastened their demise. No one was ever on the same page.
DSTs or Delaware Statutory Trusts – a legal entity that is used to hold title to investment real estate – have taken their place. Here are some of the potential advantages and risks of the DST structure:
Potential Advantages
No Active Management Burden. All management authority in a Delaware Statutory Trust vests with the property manager/sponsor. Unlike TICs, the DST structure takes all decision making out of the hands of investors and places it in the hands of the sponsor-affiliated trustee. Therefore, in times of crisis, DSTs are much more agile decision makers than TIC programs. With DSTs, crucial property management decisions are made in a timely manner.
Unique Ownership Structure. In a Tenants-In-Common deal, each investor owns a fractional interest in the underlying real estate through a special purpose entity, usually a limited liability company (LLC). This was cumbersome and expensive. Investors also had to pass muster with the lender and formally become borrowers under the loan agreement. In a DST offering, there is only one signatory trustee on the loan, the property sponsor. DST investors may have limited liability to their personal assets due to the bankruptcy-remote provision of the DST.
Lower Ongoing Fees. Investors in DSTs experience lower ongoing fees than a traditional TIC investment. In a TIC, annual Single Purpose Entity (SPE) maintenance fees are required. They are eliminated in a DST because an SPE is not required.
Greater Diversification. DST programs can achieve scalability and diversification. Because the IRS limited the number of investors in any single TIC program to 35, these properties were smaller (less than $25 million in total value). They also required a higher minimum investment which tended to concentrate assets. DSTs, however, are permitted to have up to 2,000 investors. Thus, DSTs can own properties with aggregate values much greater than any TIC deal. This allows for the potential for more diversification of investment across multiple DST programs in much smaller increments. DSTs usually have minimum investment amounts of $100,000.
Potential Risks
General Real Estate Risk. As with any real estate investment DST properties may lose value. Various economic cycles can affect the performance and value of any property. Real estate investing is speculative and involves a high degree of risk. As such, investors should be able to bear the loss of their investment.
No Guarantee of Income or Performance. The projected income distributions of DST properties are not guaranteed and may fluctuate depending on occupancy and revenue. Past performance does not ensure or indicate future earnings, and property appreciation is not guaranteed.
Non-Liquid. A DST investment is an investment in real estate and considered illiquid. Although investors have the right to sell their interest at any time, there is no established secondary market. Investors should be prepared to hold their interests until disposition of the property.
Fees and Expenses. The cost of acquiring a DST may be more than purchasing a property entirely on your own. In some instances, costs associated with the transaction may impact returns and outweigh the tax benefits of the investment.
Why DSTs? Many owners of investment properties are turning to DST properties as a potential solution for their 1031 exchange. DSTs allow multiple investors to pool their funds to purchase one or more institutional-quality, income-producing commercial real estate properties without the burden of active property management, thus simplifying their lives. DSTs can potentially provide the investor with monthly income with a portion that can be sheltered from tax by using depreciation and interest deductions.
Although not for everyone, I believe Delaware Statutory Trusts (DSTs) are a step up for real estate investors in terms of simplicity and flexibility. It’s definitely appropriate to say, “Out With The Old (TICs), In With The New (DSTs)”
Robert Straton is the President and Founder of NW 1031 Planning Inc., a Portland-based company that specializes in identifying DST (co-ownership) properties eligible as replacement properties for tax-deferred 1031 exchanges. He can be reached at (503) 720-7674 or bob@nw1031planning.com.
NW 1031 Planning, Inc. and DFPG Investments, Inc. do not provide tax or legal advice, as such advice can only be provided by a qualified tax or legal professional, who all investors should consult prior to making any investment decision. NW 1031 Planning is a branch office of DFPG Investments, Inc. Securities offered through DFPG Investments, Inc. Member FINRA/SiPC.