Real estate investors exploring tax-deferred investments often find themselves navigating a landscape dotted with an overwhelming variety of options, one that frequently comes up but rarely examined in detail is the DSTs (Delaware Statutory Trusts) to 721 UPREIT. These vehicles have seen a surge in popularity as investors look to optimize tax advantages and real estate investments utilizing the 1031 Exchange while planning for their estate plan and lifestyle.

This post aims to illuminate the nuances and implications of these investment strategies. Dive in as we unpack DSTs, 721 UPREITS, and the different options available to investors.

What is a DST?

The Delaware Statutory Trust (DST) is a legal entity created and often used in real estate investing that allows multiple investors to pool money together and hold fractional interests in the trust's holdings and assets. Typically, a sponsor organizes a DST by acquiring an institutional-quality property, putting a management team in place, organizing financing, and providing investors with a turnkey investment in a professionally managed property. More information on DSTs can be found here.

What is a 721 UPREIT?

DST’s typical exit strategy is to sell the property and distribute the proceeds to the investors. However, some sponsors allow investors to elect to roll their proceeds into a REIT through a 721 UPREIT (Umbrella Partnership Real Estate Investment Trust).

A pure 721 Exchange transaction would involve a direct contribution of the investor's real property into the operating partnership in exchange for an interest in the operating partnership. This usually never happens because the REIT managers are generally not interested in most real estate an investor has to offer. As such, most 1031 Exchange investors need to follow a two-step process.

The first step is to sell the relinquished property and structure a 1031 Exchange into fractional ownership institutional-quality real estate, such as a DST. This step completes the 1031 Exchange portion of the transaction.

The second step is for the sponsor to contribute the fractional interest into the operating partnership after a holding period for a certain period, which varies from sponsor to sponsor via a 721 Exchange (tax-deferred contribution into a partnership). As a result, the investor receives an interest in the operating partnership in exchange for his or her contribution of the real estate and is now effectively part of the REIT.

The above description needs to be more concise but should give readers the general idea of how a 721 UPREIT may be utilized. Below is an overview of some of the pros and cons of this strategy:

Pros

·    Suitable for investors worried about the future of 1031 Exchanges and want to defer their capital gains taxes.

·    Potential diversification once the DST is converted into a UPREIT and added into the REIT Portfolio, which typically has other properties.

·    Potentially more liquid, since the investor can sell their shares to the sponsor who purchases at the market price.

Cons

·    Since the investor's share in the property is part of a REIT, they can no longer 1031 Exchange out of the UPREIT into other "like-kind" real estate.

·    A sale of their interest in a UPREIT will result in a taxable event, including the recognition of previously deferred capital gain and any depreciation recapture.

RIA Versus BD Models and the Impact on Total Fees

DSTs with 721 UPREIT strategies are sold in two ways: through Registered Investment Advisors and Broker-Dealers. Understanding these models is particularly important for investors considering the complexities of 721 UPREITs and DSTs, where fees and the investor's best interest become crucial factors. The total cost of these investments, often made up of management fees, acquisition fees, and performance fees, can add up quickly. For example, an RIA typically charges a fee for Assets Under Management (AUM), typically around 1% to perpetuity. If the client plans to Exchange into a DST with a 721 UPREIT, they can expect to pay 1% every year as long as they are in the REIT.

Alternatively, Broker Dealers charge an upfront commission of about 5%. So, if an investor plans to hold the investment for longer than five years, it may make sense to go through the broker-dealer channel as they don't take on going fees, especially when there's little to no advisory value added once you're in the UPREIT since any sale of interest may trigger capital gains tax.

Investors should compare the total fees associated with the different models and assess whether a potential conflict of interest exists and what that might mean for their investment returns and long-term financial goals. Many RIAs only have one or two DSTs available, which may present concentration and diversification risks if the Advisor can only place their client's 1031 Exchange proceeds into one or two programs. For 1031 investors, exploring alternate routes, such as working with specialized firms with a broader range of DST offerings, could be the key to genuine diversification without compromising quality or tax benefits. Many sponsors offering DSTs with a 721 exit strategy include ARES, Cantor Fitzgerald, Exchange Right, JLLX, Apollo Asset Management, Inland, Hines, and many more. Just like no one would advise someone to invest all their equity in one stock, no one should invest all their 1031 Exchange proceeds into one DST from one sponsor.

Conclusion

While navigating through 1031 Exchanges and evaluating DSTs with 721 UPREITs, investors should exercise diligence in considering the costs and the broader picture of diversification and conflict of interest. With many DST sponsors, engaging with specialized firms that offer a more comprehensive selection of DSTs can pave the way for a more diversified and strategic investment approach. Investors are encouraged to seek expertise and support in making informed decisions aligning with their financial objectives. 

Consider contacting a Fortitude Representative who specializes in 1031 Exchanges and DSTs. We can provide personalized guidance and help you explore various options to meet your needs. 

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Important Disclosures

This is for informational purposes only and does not constitute as individual investment advice. There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Past performance is not a guarantee of future results.  Potential cash flow, returns and appreciation are not guaranteed. IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular situation. This is not a solicitation or an offer to sell any securities. DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney.

PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS
The case study does not reflect actual clients. Any reference to securities is based upon historical data that is public sourced. No statement made herein is to suggest stock market performance or future performance, and no case study is used to imply future performance. The case study is intended to illustrate services available through the adviser. They do not necessarily represent the experience of any clients. Fortitude Investment Group does not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Diversification does not guarantee a profit or protect against a loss in a declining market.  It is a method used to help manage investment risk.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services through Concorde Asset Management, LLC (CAM), an SEC-registered investment adviser. Insurance offered through Concorde Insurance Agency, Inc. (CIA). Fortitude Investment Group is independent of CIS, CAM and CIA.

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