Delaware Statutory Trust Pros and Cons
September 13, 2024 • 6 min read
Delaware Statutory Trusts (DST's) have become a popular option for real estate investors, especially for those seeking passive income and tax advantages through a 1031 exchange. While DST's offer several compelling benefits, they are not without their problems. Below, we'll discuss the pros and cons of Delaware Statutory Trusts in detail to help you decide if this investment vehicle aligns with your financial goals.
What is a Delaware Statutory Trust (DST)?
A Delaware Statutory Trust (DST) is a legally recognized entity that holds title to one or more investment properties. Investors purchase a fractional interest in the DST, and these interests are considered "like-kind" property for purposes of a DST 1031 exchange, allowing investors to defer capital gains taxes when selling a property and reinvesting in a DST.
Pros of Investing in a Delaware Statutory Trust
1. Tax Deferral through 1031 Exchange
DST's are frequently used in 1031 exchanges, providing a powerful way to defer capital gains taxes. By reinvesting proceeds from the sale of an investment property into a DST, investors can defer taxes while maintaining the benefits of property ownership. DST's are also a perfect fallback option when a direct replacement property isn’t secured within the strict 1031 exchange timelines. Investors can easily choose a DST to ensure they don't lose the tax deferral benefit.
2. Consistent Monthly Cash Flow
DST's typically provide consistent cash flow distributions, often in the range of 4-5% annually, paid out monthly. This makes DST's particularly appealing to those seeking passive income. These payouts can help investors maintain a reliable income stream without the hassles of active property management.
3. Property Appreciation
In addition to monthly cash flow, properties held in a DST can appreciate over time, leading to potential gains when the property is sold. Investors can benefit not only from the passive income but also from long-term value increases in the property, providing a dual income and growth opportunity. This is one of the key advantages of DST investments.
4. Matching Loan-to-Value (LTV) Ratios
DST's allow investors to blend different DST properties with varying loan-to-value (LTV) ratios. This makes it easier for investors to perfectly match the LTV of their 1031 exchange requirements, ensuring they meet the necessary debt-replacement rules while tailoring the overall risk and return of their investment portfolio.
5. Skin-in-the-Game from Management
The management teams behind DST's often have skin in the game, meaning they are financially invested in the success of the properties. This alignment of interests ensures that the management team is motivated to make sound decisions that benefit both the property and the investors, as their own capital is on the line.
6. Professional Management
One of the most attractive features of DST's is the fully passive nature of the investment. Investors are not responsible for managing the properties; instead, they rely on professional management teams with experience in handling all aspects of property operations, from leasing to maintenance. This allows investors to focus on other areas of their lives while still benefiting from real estate ownership.
7. Use of DST's as a Capital "Filler"
In situations where an investor cannot find a replacement property that perfectly matches the value required for a 1031 exchange, DST's serve as an excellent solution for investing remaining capital. Investors can use a DST to fill any gaps and ensure they fully deploy the proceeds from their property sale, which helps them meet the requirements of the exchange and maximize their deferral benefits.
8. Continued 1031 Exchange Opportunities
Once a DST completes its cycle (typically 5-7 years), investors can roll the proceeds from the sale into another DST 1031 exchange, allowing for continued tax deferral. This ability to reinvest in another DST or other like-kind property helps investors maintain their tax-deferral strategy over the long term and potentially grow their wealth tax-free for decades.
Cons of Investing in a Delaware Statutory Trust
1. Illiquidity
One of the significant drawbacks of DST's is their illiquidity. Typically, DST investments have holding periods ranging from 5 to 7 years, during which investors cannot easily liquidate their shares. There's no active secondary market for DST interests, so investors should be prepared to hold their investment for the full cycle. For those who may need quick access to capital, this illiquidity can be a major downside.
2. Lack of Control
When investing in a DST, investors give up direct control over the management of the property. Key decisions, such as leasing, financing, and property improvements, are made by the sponsor or trustee, not by the investors. While this hands-off approach is ideal for those seeking passive investments, it can be a disadvantage for individuals who prefer a more active role in managing their assets.
This, however, can be seen as a benefit in some contexts. For example, in a Tenant in Common structure investors may disagree on how to proceed with the investment which can cause serious issues. Imagine that one investor wants to sell (because of personal reasons) while all the others wish to remain. Well, all investors must agree for decisions to be made.
3. Not Suited for High-Risk, High-Reward Investors
DST's are designed for income generation and preservation of capital, rather than for high-risk, high-reward growth. For younger investors or those with a high tolerance for risk looking for substantial short-term returns, DST's may not be the right investment vehicle. The focus is on steady, predictable cash flow and long-term appreciation rather than rapid growth.
4. Minimum Investment Requirement
One of the key barriers to investing in DST's is the relatively high minimum investment requirement, which typically starts at around $100,000. This can limit access for smaller or first-time investors who may not have such substantial capital readily available. For those who are not prepared to commit a large sum of money, this may be a significant disadvantage.
5. Must Be an Accredited Investor
DST investments are generally only available to accredited investors, as defined by the Securities and Exchange Commission (SEC). To qualify, an individual must meet certain financial criteria, such as having a net worth of over $1 million (excluding the primary residence) or an annual income of $200,000 (or $300,000 with a spouse) for the last two years. This restricts access to DST's for many investors who don’t meet these requirements, further narrowing the pool of potential participants.
As a reminder for real estate property owners who think they might qualify based on their real estate, that would be $1 million in equity, not price.
6. Reliance on the DST Sponsor
Investing in a DST means you are placing significant trust in the DST sponsor, the entity responsible for managing the property. The sponsor makes key decisions regarding leasing, maintenance, financing, and the eventual sale of the property. If the sponsor lacks experience or makes poor decisions, it could negatively impact the investment's performance. Additionally, there may be limited transparency or oversight, meaning investors have little say in how the property is managed, increasing the risk of mismanagement.
However, DSTs are regulated by the Securities and Exchange Commission (SEC), and brokers involved are overseen by FINRA (Financial Industry Regulatory Authority), ensuring that sponsors adhere to strict securities laws. Additionally, DST sponsors often hold a significant ownership stake in the project, aligning their interests with those of the investors, providing some reassurance despite the lack of direct investor control.
Conclusion: Are DSTs Good Investment?
Delaware Statutory Trusts offer a unique opportunity for real estate investors to enjoy passive income, tax deferral, and property appreciation. They are particularly useful in DST real estate for 1031 exchanges, either as a primary option or as a fallback when a traditional replacement property cannot be secured within the required timeline. DST's allow investors to blend LTV ratios, maintain consistent monthly payouts, and benefit from professional property management.
However, the illiquidity of DST's and the lack of direct control may make them less suitable for some investors. If you are looking for an entirely passive real estate investment with long-term growth potential and the ability to defer taxes through multiple DST 1031 exchanges, DST's can be an excellent choice. Just be sure to fully understand the nature of the investment and your own financial needs before committing.
By carefully weighing the DST 1031 pros and cons, and working with experienced financial advisors, investors with due diligence can decide if DST's are a good fit for their portfolio and long-term investment strategy.
Would you like to talk about DST's and learn more?
Jeffrey Lemoine
Jeffrey is a real estate advisor focused on finding creative ways to solve problems.
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