Sell for More Trivia is a weekly blog series that playfully presents a trivia question about commercial real estate.
DST is an acronym for Delaware Statutory Trust. DST’s are a fractional ownership structure used to purchase commercial real estate.
A DST is an ownership model through a separate legal entity that allows co-investment among sponsors and accredited investors to purchase interest into either a single asset or across a portfolio of properties. The most notable characteristic of DSTs is that they are tax-deferred 1031 exchange-friendly.
Fractional ownership structures, such as DSTs, limited liability companies (LLCs), limited liability partnerships (LLPs) and crowdfunding, continue to attract a wide cross section of investors from newcomers to sophisticated high-net-worth individuals and family offices.
Pre-COVID, syndications and fractional interest were at highs, perhaps not all-time highs, but highs for this cycle.
Investors are drawn to the benefits of direct real estate ownership that include steady cash-on-cash returns, potential value appreciation, tax advantages and portfolio diversification. Although investors did push pause during the early weeks of the pandemic, interest in fractional ownership is once again picking up.
Investors who are wary of the volatility in the stock market are looking at fractional ownership as a stable addition to balance investment portfolios.
There is a perception that real estate is a little more of a predictable and durable investment. It might not get the same maximum returns as the stock market over time, but it is something that does have more predictability.
Recently, the DST activity has picked up pretty dramatically, because people are concerned that the 1031 laws may go away if Biden becomes the next US President. So, there are people who are trying to get ahead of that potential change.
1031’s fuel interest in DST’s
The primary reason people choose the DST structure is that it qualifies as a like-kind property for use in a 1031 exchange.
The one and only reason investors go into a DST is to defer their capital gains taxes. Otherwise, you would invest in an LLC or LLP that gives you the ability to have control.
DSTs are attractive in a supply constrained market as it allows the investor to easily split capital gains into multiple investments rather than trying to find one property that is the right price point.
Another key difference between a DST and an LLC or LLP is that a DST has a defined exit strategy. They usually take on 10-year debt with a plan to sell the property in five to seven years, whereas ownership in an LLC or LLP can go on indefinitely.
DST is the new TIC
DSTs stepped into a gap left by tenant-in-common (TIC structures). TICs were a popular fractional ownership structure in the last cycle prior to the Great Recession.
However, the TIC industry imploded for a variety of reasons. In part, it was a frothy market where some syndicators were charging high fees and were overpaying for assets.
In addition, the cumbersome structures became problematic. In some cases, there were more than 20 fractional owners and a unanimous or majority vote was needed to make even minor decisions, such as agreeing to a lease with a new tenant or committing to a capital improvement project.
TICs are still being done today, but typically with only three or fewer investors.
Lack of liquidity
The long-term nature of fractional ownership structures brings up one of the biggest downside risks—lack of liquidity.
Real estate in general is a more illiquid asset, and that is even more true with fractional ownership structures. Oftentimes, the only option for an early exit is for an investor to be bought out by another co-owner.
Liquidity is probably the most significant thing for investors to assess when we are looking at these types of investments.
Although DSTs do have a more defined exit, fractional ownership in LLPs, LLCs or even TICs can end up being generational investments that pass on to heirs.
In fact, a business model exists to take advantage of this liquidity problem.
QuickLiquidity’s business model is to buy out fractional owners in syndications and partnerships to provide an exit strategy and liquidity for investors. For example, it bought out a limited partnership interest in a 199-unit apartment building in Fairfax, Va. that was more than 40 years old. The original owner had died, and the estate opted to sell. Typically, QuickLiquidity acquires those fractional ownership interests at a discount to the current value.
The firm also has introduced a new platform that provides financing for investors with fractional ownership as collateral.
There are plenty of examples of fractional owners that no longer want to be there for a variety of reasons. For some people, maybe their circumstances have changed, or perhaps that property isn’t performing as had hoped.
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About Beau Beach, MBA CCIM
Beau is a tenacious Commercial Real Estate Broker, author and adoring father of four. His clients appreciate his no-nonsense demeanor and his legendary work ethic.
Beau leads Beachwood which is a commercial real estate broker for sellers in the Nashville, Milwaukee and South Florida markets.
He’s the author of the books The 3 Reasons: Why Most Commercial Properties Don’t Sell and True Wealth: What Every Seller Should Know About 1031 Exchanges.
Beau can be reached at 800-721-3287, click to schedule a call or Beau@BeachwoodSells.com