DST's seem like serious rip-offs - here is analysis of an offer

[Daniel Scott]

I've been shopping for DST's - got a typical one sent to me, and analyzed the numbers, and compared it to simply buying a totally well-managed replacement residential income property. The difference? One immediately seems to lose 14% of one's investment the moment the investment is made. Here is the analysis I sent to the broker, and I would love to hear from brokers, financial investment advisers, and investors on their response to this:

I'm doing some digging into the sample DST you sent me. Let me run some thoughts and questions by you for your response.

Property was bought for $68M. There were added costs –

Closing and title cost - $188,000 (that seems excessive, but whatever)

Lender and acquisition finance costs – $1,189,000 (maybe that’s mostly points – doesn’t say)

3rd party reports and due diligence - $118,000 (again, whatever)

Legal costs – 402,000 (really?)

“Acquisition fee” - $1,360,000 (no explanation – what is this?)

Anyway, total acquisition costs were $1,189,000. I won’t quibble.

So total cost of acquisition is $71,257,956

From there, they then offer it to clients like me for $77,540,619 (via shares). Main added costs are:

$2,294,000 – 6% commissions (I assume that’s to brokers like you as you sell to clients like me)

$535,000 – “dealer fee” (no explanation)

$478,000 – “placement agent fee” (no explanation)

Etc., etc., etc. The property is bought for $68,000,000 then the sponsors sell it to investors (in shares) for $77,540,619. Again, I won't quibble. Sponsors need to eat. The main number to a client like me is the "cash-on-cash" return – 4.25% (although proforma). Not a bad rate, very comparable to the cap rate I would get if I just 1031 into good residential property that is fully managed (although I would still have to "manage the manager" – DST's save me that trouble).

But let's look more closely at that return. Correct me if I'm wrong, but DST's are normally held for a medium turn (in this case, I believe it's 7 years – the length of the loan). At that point, being super conservative we'll assume the only cost to the investors is a 6% sales commission.

The property is worth $68,000,000. When fees are added in, it’s immediately resold to clients like me for $77,540,619 (an increase of 14%).

To keep things simple, and compare apples to apples when comparing buying this DST to buying a well-managed nice residential income replacement property, let's assume that neither one has rent increases or appreciation of value over 7 years (we can also compare apples to apples by assuming that both would have similar increases in rent and similar appreciation – either way the numbers work out the same).

If I buy a replacement property for $1,000,000 at a 4.25% cap rate and sell it in 7 years (no rent increases, no appreciation – and assuming that same 6% sales commission), over that 7 years, I will have collected $297,500 in rent ($42,500 per year). When I sell in 7 years, I will pay $60,000 in sales commission. My profit over the 7 years comes to $237,500. This is a 23.75% profit on my $1,000,000.

Now, compare this to this DST, with the same assumptions (no rent increases, no appreciation, 6% sales commission after 7 years). I invest $1,000,000 into this DST. I collect the same $42,500 in rent each year for 7 years - $297,500 total. Then after 7 years, the sponsor sells the property – for $68,000,000, minus the 6% sales commission. My share of the sales commission is the same $60,000. (6% of my $1,000,000 share). This reduces my profit to the same $237,500, again a 23.75% profit on my $1,000,000 over 7 years – same as if I had bought a replacement property myself – without the hassle!

BUT – when I invested, the total purchase price wasn’t $68,000,000 (in shares), it was $77,540,619 (in shares). There’s that 14% bump up between what the sponsor paid and what the clients paid. On my $1,000,000 investment, this comes to a $140,000 premium that I paid – which reduces my 7 year profit from $237,500 to $97.500 – a 9.75% profit over 7 years.

What am I missing?