Will DSTs Gain Momentum During Credit Crunch?

The credit crunch that has gripped the U.S. and the world during the last 18 months seems to be giving momentum to a property investment vehicle, the Delaware Statutory Trust (DST), that allows as many as 100 investors, and sometimes more, to buy commercial real estate and reap the benefits of a 1031 exchange. Many tenant-in-common, or TIC, sponsors are increasingly turning to the DST model to buy properties, according to Grant Conness (pictured), president of 1031 Alternatives Group, L.L.C. “We’ve seen an uptick in this (DST) activity,” Conness told CPN, and today’s capital constrained environment is the major reason why. In a TIC structure, which permits up to 35 investors, each investor has to qualify for a pro-rata share of the mortgage. But, in a DST, the real estate sponsor firm that organizes and puts together the deal usually serves as the managing trustee of the DST. The investors own a beneficial interest in the trust, which in turn owns a fee simple interest in the underlying real estate. In a TIC, the investors each own a piece of the real estate. With each investor in a TIC having to qualify for their pro-rata share of the mortgage, putting TIC deals together in today’s capital constrained environment can present stiff challenges. In a DST, however, the lender makes only one loan to the sponsor, who operates the property. “It’s the difference between getting one loan, or 35 loans,” Conness said. The DST structure presents both positives and negatives, Conness said. A DST can contain numerous properties, so it offers ready-made diversification to an investor, he said. Also, since the DST contains many more investors than a TIC, an investor can enter into a DST for a significantly smaller dollar amount than a TIC. But the DST does present some drawbacks. Conness notes that the normal risks of real estate investing, such as vacancy increases and the need for a property to cover its debt service, still exist. And, the investor is truly in a “backseat” role compared to their TIC counterpart, who does have a say in how a property is run, or to a sole investor. Also, refinancing the property or altering the management agreement is prohibited in a DST. DSTs are gaining popularity with baby boomers and seniors who are looking for passive real estate investments, who can defer capital gains taxes on their investment in a DST when the property is sold, which they are not able to do by investing in REIT stocks or acquiring a property through a straight syndicate or partnership, Conness said. Properties that sell in the $20 million to $50 million range are the typical target for DST investment. Apartment buildings and single tenant retail properties are the most favored property types for DSTs he said, while multi-tenant office buildings, with their great amount of lease rollover, are least attractive to DST investors.