Are DSTs a Good Investment? What to Know Before Investing

Delaware Statutory Trusts (DSTs) are a structure for commercial real estate investment. They offer individuals a way to invest in real estate assets, often appealing to those seeking passive ownership. DSTs function as a legal entity designed to hold title to real estate, providing a framework for investor participation.

Understanding Delaware Statutory Trusts

A Delaware Statutory Trust is a legally recognized entity established under Delaware law that allows multiple investors to hold fractional beneficial interests in a single property or a portfolio of properties. Investors own a percentage of the trust, which holds the real estate title on behalf of all beneficial owners.

Ownership in a DST is passive; investors acquire a beneficial interest rather than direct property ownership. Investors benefit from income and potential appreciation without involvement in day-to-day management. A designated trustee holds the property title and oversees trust operations according to the trust agreement.

A professional property manager handles daily operations, including tenant relations, maintenance, and rent collection. This relieves individual investors of direct management responsibilities, distinguishing DSTs from direct real estate ownership. This passive management structure allows investors to participate in real estate without the burdens of active property management.

DSTs are utilized in Internal Revenue Code Section 1031 exchanges, allowing investors to defer capital gains taxes by reinvesting proceeds into “like-kind” property. Internal Revenue Service Revenue Ruling 2004-86 clarified that a beneficial interest in a DST can qualify as like-kind property for a 1031 exchange.

To qualify under Revenue Ruling 2004-86, DSTs must meet certain conditions, known as the “five no” rules, to be treated as a grantor trust for tax purposes. These rules restrict the trustee’s ability to negotiate new leases, renegotiate existing leases, make capital expenditures, or sell the property without unanimous consent from all beneficial owners.

Key Investment Characteristics of DSTs

DSTs provide investors with passive ownership, meaning they have no operational control or management responsibilities. Investors acquire a fractional beneficial interest in the trust, which holds the property. A property management company handles all aspects of property operation, from tenant acquisition to maintenance and financial reporting.

The investment horizon for DSTs typically ranges from five to ten years. Investors should anticipate a multi-year commitment, though hold periods vary by property and market conditions. The exit strategy involves the eventual sale of the property, with proceeds distributed proportionally to beneficial owners.

DSTs are illiquid; beneficial interests are not traded on public exchanges, and there is no active secondary market. Selling an interest before the property is sold can be challenging, often requiring a private buyer and a lengthy process. Investors should commit capital they do not anticipate needing in the short term.

Many DSTs use non-recourse debt to finance real estate acquisition. Non-recourse debt limits the lender’s claim in default to the property itself, not extending to investors’ personal assets. This structure limits financial risk to the investor’s equity contribution and their pro-rata share of the loan, protecting against personal liability.

Investors in DSTs typically receive regular distributions, often monthly or quarterly, from the rental income generated by the real estate. These distributions represent a portion of the net operating income after expenses and debt service, providing a predictable cash flow. Frequency and amount depend on the property’s performance, occupancy rates, and lease agreements.

Beyond income distributions, DSTs offer potential for appreciation of the real estate asset. As property values increase due to market demand, improvements, or favorable economic conditions, the beneficial interest value can rise. This capital appreciation, coupled with regular income distributions, forms the dual return potential for DST investors.

Investor Considerations for DSTs

Investing in a Delaware Statutory Trust typically requires meeting specific financial criteria, often as an “accredited investor.” This designation applies to individuals with a net worth exceeding $1 million (excluding primary residence) or an annual income exceeding $200,000 individually ($300,000 jointly) for the past two years, with the same expectation for the current year. DSTs are offered under Regulation D of the Securities Act of 1933, which governs private placements and limits participation to accredited investors.

Before committing capital, investors should align a DST investment with their overall financial goals. This includes assessing how it fits into their broader portfolio and whether its characteristics, such as passive income and potential appreciation, complement their long-term objectives. The investment should serve a specific purpose within the financial plan, whether for income generation, capital growth, or tax deferral through a 1031 exchange.

The investment horizon of a DST must align with an investor’s personal liquidity needs and time frame. Given the illiquid nature of DST interests, investors should ensure they do not require access to their invested capital for several years. Understanding the projected hold period of the property is important for managing personal financial planning.

An investor’s personal risk tolerance is a consideration when evaluating DSTs. While DSTs offer passive ownership, they are subject to real estate market risks, including vacancy, declining property values, and economic downturns. Investors should assess their comfort level with these inherent risks and understand that investment returns are not guaranteed. The potential for loss of principal exists, similar to other real estate investments.

Diversification is key to any investment strategy, and DSTs can provide exposure to different types of commercial real estate or geographic markets. Investors should consider how adding a DST impacts their overall portfolio diversification, rather than relying on a single DST as their sole investment. Spreading investments across various asset classes and real estate types can help mitigate concentration risk.

Regulatory Framework and Due Diligence

The regulatory environment for Delaware Statutory Trusts involves oversight from the Securities and Exchange Commission (SEC), as DST interests are considered securities. Offerings must comply with federal securities laws, typically through exemptions like Regulation D. Broker-dealers distributing DSTs are regulated by the Financial Industry Regulatory Authority (FINRA), ensuring adherence to conduct rules and disclosure requirements.

Thorough due diligence is important before investing in a DST. The Private Placement Memorandum (PPM) is a primary document for review, providing detailed information about the investment, including the property, sponsor, fees, risks, and terms. Investors should examine the PPM to understand the proposed investment.

Evaluating the property’s financials is a key step in due diligence. This includes analyzing historical and projected income and expenses, lease agreements, occupancy rates, and any existing debt. Understanding the property’s financial health and its potential for consistent cash flow is important for assessing investment viability.

Assessing the sponsor’s track record and experience is important. The sponsor identifies, acquires, and manages the real estate within the DST. Investors should research the sponsor’s history with similar offerings, financial stability, and expertise in the specific real estate sector. A reputable sponsor with a proven history of successful projects provides confidence in the DST’s management.

A detailed evaluation of the property’s location and current market conditions is necessary. This involves researching local economic trends, population growth, supply and demand dynamics for the property type, and comparable property values. Understanding the market context helps assess the potential for property appreciation and stable rental income. Seeking advice from financial advisors, tax professionals, or legal counsel is recommended to navigate DST investment complexities and ensure due diligence.