Delaware Statutory Trusts (DSTs) have earned a rightful position among 1031 exchange investors as a popular and efficient way to reinvest the proceeds from an investment property sale while deferring capital gains taxes on any property appreciation.
Many investors, however, are not aware that they can make direct cash investments into a DST without using a 1031 exchange. While this investment approach may not offer the immediate tax advantages of an exchange, there are several compelling reasons why a cash investment might make sense for certain investors. We consider those potential advantages in this post.
Unlike most privately owned real estate investment properties, a DST is structured so that investors each own a passive interest in a property (or properties) that is professionally managed. That means the investor is not responsible for collecting rent, keeping up the property or dealing with insurance, taxes, or loan obligations. Instead, this passive investment is designed to provide regularly scheduled income potential to the investor, without the headaches of property management.
Investors may own shares of a publicly traded REIT (Real Estate Investment Trust) or a mutual fund that invests in many different REITs, but private real estate ownership offers a way to further diversify one’s portfolio with this asset class. While there are obviously certain risks to consider with a DST investment, the fact that DSTs are not publicly traded often means they are not subject to the same volatility and market movements that public securities are.
Investors interested in owning potential income-producing privately owned real estate are frequently confronted with the hard truth that it may take a large investment to own a property. Since DSTs are structured in a manner where multiple investors can participate with each owning a fractional interest, minimum investments can be as low as $50,000 for accredited investors.
Since DSTs are permitted to have several hundred investors, the cumulative investments within a single DST can be $50,000,000 or more. This enables the sponsor to pursue and purchase large, institutional quality real estate that would generally not be available (or attainable) by a single individual investor. Higher quality real estate may provide more favorable income potential compared to lower quality properties.
It is a very common practice for investors in privately owned real estate to secure loans on their investments so that they can purchase properties of the highest value possible. But, as with any investment, risks need to be considered and default risk on a loan is always a concern, especially if tenants fall behind or are unable to make rent payments. With DSTs, however, the properties have already been purchased and leverage already secured by the sponsor. Since the DST is the sole borrower, loans are considered non-recourse for the individual investor.
Since the DST structure confirms to 1031 Exchange regulations, cash investors in a DST can enjoy the same tax-deferral benefits upon the sale of the DST property. In other words, if the property has appreciated in value, the investor is permitted to use a 1031 exchange to defer any capital gains tax that would apply, by purchasing another like-kind property or investing in another DST.
Recent market volatility caused by the COVID-19 pandemic and ultimate shutdown of the economy, naturally has many investors nervous about where they should have their money invested. Publicly traded REITs were not unscathed by the market downturn and it may take some time for those investments to recover in value. For investors who understand the importance of diversifying beyond just stocks and bonds, private real estate just might prove to be an effective way to do so, and if suitable, DSTs may be an attractive way to participate.
If you would like to learn more about direct cash investing in a DST, do not hesitate to contact our team.
NOTE: Mutual Funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing in Mutual Funds. The prospectus, which contains this and other information about the investment company, can be obtained directly from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.