The Benefits of Delaware Statutory Trusts
It is challenging for many investors to gain exposure to institutional quality real estate investments. There are not very many options for investors who want to invest a small amount of money into larger projects. Forming a syndicate with other investors can be confusing, so most investors choose to invest alone in REITs or individual properties. In this case, many investors can only manage a smaller portfolio of listed stocks or funds or buy a single investment property. Therefore, some investors may face challenges related to exposure and diversification.
One potential solution for investors is a Delaware Statutory Trust. A Delaware Statutory Trust is a real estate investment vehicle that allows investors to own a percentage of the trust’s assets. A DST sponsor creates the trust and leaves it open to additional investments until enough individuals take full ownership of the trust. This structure can be very beneficial for someone who wants to invest a relatively smaller amount, such as $100,000, in a larger project that they otherwise might not be able to afford. Furthermore, many people choose to invest in these products because of the unique offerings and favorable tax benefits. Moreover, many investors are not willing to invest larger amounts of money in a single project.
The Advantages of a Delaware Statutory Trust
The Delaware Statutory Trust Market has been growing rapidly as more investors have expressed interest in passive investment vehicles. Moreover, Delaware Statutory Trusts have also been gaining popularity because of the numerous tax benefits, which allow investors to defer paying capital gains taxes.
Eligible for 1031 Exchange: A 1031 Exchange allows investors to avoid capital gains taxes when they sell an investment property and replace it with a similar property. However, the benefits of 1031 Exchanges also apply to investments in Delaware Statutory Trusts, even though the investor only purchases a small percentage of the investment project.
Example: An investor decides to sell a $300,000 investment property because he does not want to deal with actively managing a property. However, he is worried about paying capital gains taxes on this property, as he originally purchased it for $140,000. In this case, the investor could invest a similar amount in a qualified opportunity zone and not have to pay capital gains taxes on the $160,000 gain.
Unique Types of Investments: One of the benefits of Delaware Statutory Trusts is that you can invest in a pool of unique real estate assets. These investments can include projects like healthcare, retail, multi-family, and commercial real estate projects. While many of these projects are out of reach for most investors because of the higher capital requirements, Delaware Statutory Trusts allow investors to access these projects.
Flexible Timing: It is not time-consuming to initiate an investment position in a Delaware Statutory Trust. Moreover, the investment term of the project can be flexible, at ten years or less, allowing you to pick an investment that fits your timeline.
Passive investment: One of the benefits of investing in this type of property is that you do not need to worry about issues associated with actively managing an investment property. The Delaware Statutory Trust hires a property manager who is responsible for all aspects of managing the property. It became increasingly difficult to deal with processes, like eviction, following the coronavirus pandemic, and the combination of rising rent and inflation has made defaults on rental payments more common. A DST can be a less stressful option that offers similar returns.
Leases are often long-term: Most of the DST’s tenants are long-term tenants, who sign 5-20 year leases. These properties are easier to manage and it is less likely that landlords will run into issues found in shorter-term residential leases. Many of the investment categories, such as healthcare real estate, tend to be more stable relative to other types of real estate investments.
Portfolio Diversification: Investing in a Delaware Statutory Trust can allow you to have more cash to invest in stocks, bonds, municipal bonds, or other types of investments, instead of having a higher percentage of your net worth invested in the illiquid real estate.
Management Quality: Delaware Statutory Trusts have extensive experience managing commercial real estate properties. In many cases, it may be best for investors to rely on DST’s experience in this area, rather than spending their time actively managing investment properties.
Risks or negative factors
However, investing in Delaware Statutory Trusts may not be the best option for every investor, and these investments still carry certain levels of risk. Moreover, not all investors are eligible to invest in these products.
Only accredited can participate: One important factor to note is that only accredited investors are eligible to invest in Delaware Statutory Trusts. Accredited investors typically earn more than $200,000/year to receive this classification. However, some people who work in finance may be classified as accredited investors, even if their income is below $200,000/year.
Harder to sell early: Although there is not an official lockup period when you invest in a Delaware Statutory Trust, it can still be difficult to sell your investment early. Not all real estate investors are willing to invest in Delaware Statutory Trusts, and you can only sell your investment to an accredited investor. Therefore, it is best to only invest in a Delaware Statutory Trust if you are certain you can hold it for the entire period.
Control over investments: If you invest in a Delaware Statutory Trust, you will not have any control over how the investments are managed. Therefore, it is best to choose an investment style you are comfortable with and spend as much time as possible researching the DST before investing in it.
Income streams are not guaranteed: Even though the leases are usually long-term, you face some of the same risks as other real estate investments. If there is an issue, it will be up to the manager of the DST to address it, as owners of DST investments have no say in the management of the properties.
Lack of flexibility in some areas: Delaware Statutory Trusts have to follow set guidelines, and have very little flexibility in some areas. All of the cash received either has to be redistributed or held in liquid short-term investments. These trusts can’t take advantage of new trends in the market and enter into new leases if other investments are profitable. If you are an investor that values leverage and altering strategies based on market conditions, then it is probably best to consider other investment options.
1031 exchanges can be complex: It may be harder for you to successfully implement a 1031 exchange, as you will need to finalize a purchase of a new property shortly after exiting your DST investment. Any delays could make you ineligible for the 1031 exchange or require you to file amended tax returns. There are also financial penalties if you do not correctly execute a 1031 exchange.
Who Can Invest in a Delaware Statutory Trust
Many restrictions can prevent you from investing in these products, but DSTs are accessible for most accredited investors. Unfortunately, there are no exceptions to the accredited investor rule, even if you have sufficient funds and experience investing in real estate.
The minimum investments for these projects are typically high, at around $100,000, although this is still much cheaper than most real estate investments.
Once you decide to invest in a Delaware Statutory Trust, you will need to search for a DST sponsor on your own. Because of SEC regulations, many of these companies are unable to market their services effectively, and you will have to search for them on your own and request additional information from the sponsor.
There is limited liquidity in the market, as only accredited investors can participate, and not all accredited investors are willing to invest in Delaware Statutory Trusts. However, if you do decide to sell your investment early there is no penalty or lock-up period, and you can still sell it early and receive all of the 1031 exchange benefits. However, this can be rather complex, as you will need to make sure that you time the sale correctly and purchase a similar property shortly after. In most cases, it is better to be committed to the time period initially stated, as selling a DST investment early can be complicated because of low liquidity and other legal factors.
If you are not eligible to invest in a Delaware Statutory Trust, or do not feel like this product is best for your investment objectives, there are plenty of other options out there that can offer you similar benefits.
REITs for Non-Accredited Investors: REITs are companies that own and manage different types of investment properties. Individuals can invest in these real estate products on public stock exchanges and receive dividend income from these investments. The main relative benefits of these products are that any investor can invest in this product, the initial investment requirements are extremely low, and they are highly liquid. Investors can invest as little as $100 in these products and exit their position instantly.
Forming Syndicates: If you want to take a more active role in managing a real estate project, it may be best to form a real estate syndicate. A real estate syndicate allows a group of investors with common interests and objectives to collectively invest in a real estate project.
There are a plethora of benefits available for people who want to invest in real estate, but many of these benefits are for people who invest large amounts of money in real estate and actively manage the properties. Investing in a Delaware Statutory Trust is one way to gain exposure to a diversified portfolio of institutional quality real estate without having to make a larger bet on a single property. An investment of $100,000 is enough to invest in a portfolio of properties in strategic investment areas, like healthcare real estate.
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This post was written by Sean Allaband