Help me decide between a 1031 DST vs. a syndication.

[Matt W.]

Hi BP, 

I'm considering selling off my small portfolio of 3 SFH's and moving the money into either a Delaware Statutory Trust via a 1031 or just selling and paying the tax and then reinvesting the money in a syndication. I probably have an average of $150k of equity in each house. I live in NC, I'm 41, my wife is a high W2 earner, and we don't plan on touching this money for 12-15 years. Selling because I'm a little burnt out as a landlord and I see that my return on equity is pretty low. Yes, I know that in 10 years the houses will be worth more and will cashflow more, but that can apply to almost any investment, especially since the FED only knows how to print money.

I should note that I did a 1031 INTO 2 of the 3 houses, and did a cost segregation study and took accelerated depreciation on all 3 to offset 2022 taxes because I had a very profitable flip that year and I am a real estate professional per the IRS. I know all this deferred tax must be repaid if I were to sell without a 1031, so that tips the scales in favor of the DST option.

So the pros and cons of each option as I understand it:

1031 DST: Pro: start the investment with a bigger chunk of money because I didn't have to pay taxes on it. Not guaranteed, but very safe and boring national level companies that will not go out of business anytime soon. Con: lower returns (@7%) and higher fees. I'm not sure if my income is offset by depreciaton?

Syndication: Pro: higher (projected) returns, most seem to be around 15-20%. Cons: take a big tax hit up front, so I start with less money invested. Possibly riskier because the businesses are less established (of course I must do my proper due diligence.)

With my long time horizon before I plan to use the money, it's possible that the higher rate of return for syndications would offset the initial higher tax hit. I think both options can be rolled over with a 1031 indefinitely. I'm not smart enough to work out the math of which option would be best, or how long it would take for the syndication option to overtake the DST option.

Anyone who can help me think this thru, please chime in. Thanks!
 

[Victoria S.]

Carlos Ptriawan Yes, that option of using it with your primary is definetly a good one! I am considering breaking up my 1031 into a few pieces. At the moment, your suggestion is one of them. I was going to ask you about the STR aspect that you mentioned above. In terms of quality SF houses, nothing beats a property that would be attractive as STR, but that model seems whoefully overdone, and is currently suffering. Also, personally, as a rental model it has a lot of moving parts. Has anyone considered transitional housing model?

[Victoria S.]

@Dave Foster I have noticed that IRR is not talked about much. Any more thoughts you might offer regarding using IRR in the context of deciding how to 1031. Applying to DSTs? Or your own expample?

[Victoria S.]

With all this talk about 1031 and individual situation(s) being the key component....Since this is a common analysis, there must be a comprehensive analysis tool already in existence. Im trying to not reinvent the wheel as is my tendency! lol 

Any suggestions out there. A beautiful excel tool would help a lot (along with #s from a CPA) 
Where / how can I get my hot hands on something like this? I could then modify to suit.

[Dave Foster]

@Wilson Pereira,  And that is exactly what I did.  If I had done a 1031 on that property I would have been able to compound both the tax and the remaining profit.  And that's why I've used them for myself all this time since as well.

Refinances through helocs or conventional are strategic tools to use when you have a good performing property that you don't want to sell but has equity trapped in it.  This lets you leverage into another property and again keep the compounding going.  You're absolutely right.  If the rates don't support you don't borrow to buy.  Look at what Buffet and Apple are holding in cash right now waiting for good acquisition targets.  Same thing here but with real estate instead of companies.

It's not talked about nearly enough by real estate investors, because it requires analysis way beyond the "buy low and sell high" that everyone initially thinks about. The Internal Rate of Return is my holy grail of analysis.  Because it accounts for every way I make money on my real estate.  Appreciation, depreciation, amortization of the loan, and cash flow (and laundry machine or soda machine or parking money if applicable :) all blended to create my actual return on ownership of the asset. 

[Dave Foster]

@Victoria S., Yah the IRR sadly does not get enough attention paid to it. But in my world it is the only metric that can comprehensively evaluate a real estate investment opportunity.

Of course, the thing that boosts your IRR to the moon is debt. So you also need to create a way to add risk from debt into your underwriting. But debt is where DSTS can potentially boost your returns significantly. Since most DSTS have institutional debt on them. You assume your pro rata share of that debt. So it is conceivable to sell a real estate asset that you own with little or no debt. And purchase a DST (or several) that are leveraged. The leverage is buying you amortization of the loan and additional depreciable basis. Both components of the IRR.

Sell an asset for $500K cash and you could buy a DST that is 66% leveraged. You are actually buying $1.5 mil in DST. That is an additional $1 mil in depreciation. And another $1 mil in debt that is being paid off. The kicker in this is that the debt you assume is all non-recourse to you. So there is no personal risk for the debt. Your risk is only the cash investment in the asset. Not that that is insignificant. But it's less risk than personally guaranteeing the entire loan.

[Ameet Mehta]

Hey Matt! I understand your dilemma and let me lay down a few points here that will help you decide amongst the two.

So, 1031 DST is a great option and safer of course, but the returns on this type of investment are potentially low. Even if you are looking at a time frame of 12-15 years later, the initial investment you would make may not provide you with big returns. And considering that the asset will most likely appreciate in value, you might feel you could have got more returns.

On the other hand, syndications have a track record of offering greater returns, sometimes even more than 20%. Yes, the risk factor is higher but considering the possible returns, syndications provide a more attractive return, making it one of the most sought-after options. And not to mention, syndications also offer some good tax benefits. For this you can speak to a professional real estate agent or check out ongoing syndication deals.

The biggest question here is your risk tolerance. 1031 DSTs are perfect for investors who want low risk investments while Syndications are more popular amongst investors with high risk tolerance. My advice will be to do proper due diligence for both options and understand your investment goals thoroughly.