1031 Rental Property Gain into Delaware Statutory Trust Vehicle

[Christopher Smith]

I'm contemplating rolling several very large SFR property gain amounts (via 1031) into a handful of DST Vehicles. I really like the concept of being able to utilize 1031 to defer my very substantial SFR gains by reinvesting in fractionalized property interests managed by DSTs in larger Multi Family and Commercial properties. I have PMs for my current properties so they are generally pretty passive already, but the DSTs would be totally passive, for better or for worse.

The outfit I have been speaking with represents that they do greatly enhanced due diligence (e.g., multiple site visits on an anonymous basis), apply analytical stress testing to pro forma financials and avoid certain categories of properties altogether (Senior Housing, Oil & Gas, etc) to ensure that all underlying properties held by the respective DSTs are prudent investments for folks who are not experts in making risk assessments for these larger operations. 

What I would like to know are BP Community Member personal experiences with DSTs directed at accredited investor classes. Specifically, were projected returns fully realized, were fees and other charges excessive, were holding periods predictable, etc?

[Dave Foster]

Thanks for the shout out @Mike Jacobson. If now's the time to make that leap from active into a passive role (whether fatigue, age, or changing priorities) then the DST can be a great way and still preserve all of that hard earned gain and have to pay back the depreciation you've received @Christopher Smith. In the world that I live in so many investors have successfully built up piles of tax deferred gain that is working for them. If they go into something like .a REIT, or a LP syndication, or out of real estate into a passive market then they lose a substantial amount of that gain to the tax man so it's no longer working for them. Since every 100K of tax you have to pay can represent a very real $8k - $10K of lost income depending on your normal return.

So for the 1031 investor keeping tax deferral is a huge priority. The DST has the advantage of being 1031 compliant as do the Tenant In Common (TIC structure), and for the most part any NNN stand alone or land lease.

Some of the nuanced differences - In a DST you do not own the underlying real estate and instead own an interest in the trust. They usually have non-recourse debt requirements so that a mortgage on a 1031 property can be absorbed easily. And while non- recourse cannot come back on you personally it's still an additional risk to the property. They also continue your depreciation schedule.

The TIC are more often debt free. And since you actually own a deeded % of the real estate itself, if it's debt free that's one more layer of risk eliminated. Less administrative and legal levels can make returns higher. And the time horizons for these can be shorter so easier to buy into and sell out of - even using a 1031.

NNN are the gold standard but not all can purchase solely owned (or want to for what their price point will buy). Slightly less passive but commercial management representation is not difficult to find. Unless your coffers are extremely full then you'll add debt to purchase a NNN. And in a late market rising interest rate environment debt is what kills the returns on NNN properties.

The key to all of these that so many real estate folks forget is that the property itself is really of secondary importance - very counter intuitive to folks who have been focused on the right property and find tenants.  In these it's the company, or tenant that is the key.  You need to vet them extensively.  Site visits? Sure, but ultimately if you've got a Toys R Us building it don't matter if it's the nicest building in town.  It's not making you money unless the lease also protects you corporate wide and in receivorship.  

So the Tennant and the lease are where you focus your time.  It is interesting that so many can carry the label of "accredited investor" and yet a company like the one you're talking to now speaks of providing you their information to protect those... "folks who are not experts in making risk assessments on these larger operations.  The lesson is what...?  Don't let "accreditation" or the folks selling products "only accredited investors can buy" lull you into a false sense of security.  Accreditation really just means you've got a fat red target on your wallet..   

There are some other intriguing and lessor known applications for turning 1031 from active into passive.  Vacation rentals in buildings managed by central reservations (think ski areas or other large resort areas) can be enticing.  With the consolidation in the winter sport industry central management has gotten very greedy indeed.  But there can still be room if you've got the right units to make a comparable return.

Oil and Gas and mineral rights are also 1031 compatible.  And the very interesting trend there is that Oil is starting it's resurgence towards what many think of as the latter stages of this real estate cycle.  When these two cycles are running contra to each other it can be possible to exit real estate at a high and enter Oil working or royalty interests  on the upswing and ride that till the next real estate correction.  

I've got one client doing exactly that - sold oil two years ago and purchased waterfront vacation rentals with 1.8 mil.  Now selling and will be going back into an oil royalty program, this time with around  $3 mil  that projected 7% last year and returned 11%.  No tax because of the 1031.  Now that guy fits the exact description of what my grandpappy used to say, "I'd rather be lucky than good!"

All high level thinking but the key at ground level is that all of the above keep your tax dollars making a return for you and don't have to leave your pocket.