A Delaware Statutory Trust (DST) ownership structure offers the accredited investor an opportunity to own a fractional interest in institutional-grade commercial property beside other investors, where each investor is a separate owner within the Trust. Each owner receives his or her percentage share of the potential cash flow income, tax benefits, and any appreciation of the property, without the headaches and burdens of hands on management responsibilities.At Fortitude, we pride ourselves on our comprehensive knowledge of DST’s and our experience with helping investors manage a DST transaction. A big part of this process is our responsibility to conduct thorough due diligence for every investor, and on every potential transaction BEFORE we present a DST investment opportunity to clients.
This extensive analysis includes systematic reviews of three critical parts of every DST, which are explained in detail below.
1. SPONSOR REVIEW
A Sponsor is a person or entity that identifies and purchases properties to be held in a DST and typically arranges for a master tenant to lease the assets. They then offer these investments to accredited investors via beneficial interests through financial advisors and/or registered representatives. Here a just a few things we look at when reviewing a Sponsor:
- Sponsor history & track record
- Executive team experience
- Local market knowledge
- Fees and Mark-ups
A successful securitized real estate transaction starts with selecting the right sponsor. Once the sponsor is identified, we then begin to evaluate the opportunity itself, including deal structure and property details.
2. DEAL STRUCTURE REVIEW
The next phase of due diligence involves reviewing the structure of the deal, which includes all of the agreements related to the DST. These include purchase agreements, loan documents and tax structure.
This information includes disclosures on each offering l and can be found in a Private Placement Memorandum (PPM), which is a legal document produced by the real estate sponsor. The PPM contains a detailed description of the property, the sponsor, the financial details of the investment, the projected return on the investment, and the specifics of the DST structure. It also contains third-party due diligence reports, all pertinent leases, agreements and contracts.
3. PROPERTY REVIEW
During the last phase of due diligence, we analyze the individual properties within the deal portfolio. Some of the areas we evaluate are:
- Number of Buildings in Portfolio
- Percent (%) occupancy
- Cost per square foot
- Length of Lease Term
4. ECONOMIC REVIEW
Fee analysis is a large component of both the Deal Structure Review and Property Review. Besides looking at fee sources and uses, we also look at many metrics that we evaluate to determine if a property is a viable investment. Here are just a few important ones:
Net Operating Income (NOI)
For investors interested in commercial real estate property, it is important to look at the net income of the property. The NOI is the remaining value AFTER you calculate and remove operational expenses (i.e.: taxes, management expenses and repairs costs). NOI is considered positive when income exceeds operating expenses. Evaluating the NOI will help determine if the property is a “good” investment. A positive NOI is a good indicator that the property may be well positioned to continue to produce a solid income stream.
Exit Capitalization Rate (CAP Rate)
The exit capitalization rate, also known as terminal capitalization rate, refers to the rate used to calculate the resale value of a property by capitalizing the expected Net Operating Income (NOI) at the end of the planned holding period. Cap rate is computed by dividing the NOI by the sales price of the property. This determines what your return would be if you paid for everything with no mortgage (debt) involved. The cap rate is also used to determine the worth of a property. It considers factors such as vacancy, credit losses, operating expenses, as well as other income sources.
For commercial real estate to increase in value, the NOI on the property needs to increase, or the market needs to increase, in the form of cap rate compression. That is why we prefer that the breakeven exit cap rate is higher than the sponsor’s purchase price. This way there is room for cap rate compression over the holding period. It is important to keep in mind that the breakeven exit cap is dependent on the sponsor hitting their financial projections.
Cash-on-cash return is a rate of return in real estate transactions that calculates cash income earned on the cash invested. It is calculated by taking the annual pre-tax dollar income and dividing it by the total dollar investment. Simply put, investors need to make sure they are getting their money back fast in order to invest in other properties. Evaluating the cash-on-cash return may be one factor to determine if a property has the potential to be a great long-term investment.
A replacement cost is the cost to replace the property at the same or equal value. It is important to always compare sales price to estimated replacement costs when doing an analysis on the property.
As with any real estate investment, DST’s have potential risks. It is always important to hire a team of professionals – in addition to advisors – that includes a Qualified Intermediary, a CPA and a Real Estate Attorney to help facilitate the process. In fact, as mentioned in other posts, the most experienced advisors in DST transactions have already assembled their ‘circles of expert’ to assist their clients in every area of the y DST investment process.
Do you have any questions? Feel free to contact our team!
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