All Forum Posts by: Matyas A. S.

I have reviewed several PPM-s for DST-s. I wonder what do others look at closely? I usually do look at:

* Property location, business plan, environment. Main employers? Is it a growing area? Personal prior knowledge or ask family friends, or google. Weather, other risks.

* Sponsor's prior experience, results.

* Forecasted cash flow. If they plan x% rent increase yearly, is that feasible?, etc.

Btw this is for a list of DST-s that my financial advisor already selected. I definitely could not look at all of them...

Recently I ruled out a DST that was a NNN lease on a medical use facility. It was a small property (compared to others I looked at) with 4-5 million valuation. Monthly rent was just under 300k. The expenses included 4200 bank fee per month and 15k asset management fee per month. I thought that these are unnecessarily high for a NNN property. (There is a single rent payer!)

I had a conversation with a friend about real estate DST investments. We invested recently into DST-s as part of 1031 exchange. I educated myself on the risks and read the PPM-s. I am comfortable and I think it was a good choice for 1031 exchange funds. But for new money to be invested the consideration is slightly different. (Deferring of taxes is a significant motivator.)

One particular risk that came up has to do with the fact that the multifamily DST-s we looked at typically have 45%-55% loan to value ratios with 10 year fixed rates. Most DST sponsors indicate that they will sell in 7-10 years. I assume the main reason for that is so that the investors could get out. Those who want continued real estate exposure can reinvest into another DST etc. The loan term seems to be engineered accordingly.

The concern that was raised is that what if there is a recession or a credit crisis and so it is hard to get loans. That would reduce the market for the properties since fewer investors can get loans. The fact that the DST has to sell is a liability in that case. It seems that the consequence is that the market would set a lower price. On the other hand if you invest into a multifamily property via say a partnership, there is no similar pressure to sell within a time period. The partners can and probably will decide to try to hold until the crisis eases and sell when they can get the proper market price.

Do you agree that the limited holding period is a concern?

The PPM-s talk about the option of turning the DST into a Springing LLC when things do not go according to plan. I assumed that such conversion would enable a refinancing of the loan (say if sale is not possible or unattractive and the loan terms are such that extension is not possible).

I know that there are many other risks. The above was something I did not consider myself until I talked to my friend.

We bought into DST-s this year as part of 1031 exchanges. I liked the process and I am hopeful that this will work out long term. Ask me in 10 years! I am a mathematician with actuarial background and I do not mind reading the 250+ page private placement memoranda documents. I got lucky that I found a financial advisor who is a fiduciary. He was available for lots of conversations and helped our selections. We are diversified across geography and sponsors. We considered commercial and storage sector but ultimately we stuck to multifamily.

We invested in 2 multifamily deals using partnerships prior to going to the DST route. One of the multifamily deals was a great success in 1.5 years (originally planned for 4-5) the other is still ongoing in its 2nd year and it is performing somewhat below plan/expectation (but no a major concern).

Initially, we wanted to 1031 into another such multifamily deal, but I quickly learned that is a no-go, because partnership interest is 'not like' real estate ownership. With the 45 day deadline coming up I gave myself a crash course on DST-s and invested with Inland.

Then, shortly after a second single family home had a similar issue: the tenants separated and we let them out of the lease early. Considering that the 10/1 ARM mortgage on it with the ultra low 2.5% interest rate was in its last year, we decided to 1031 this as well into DST-s.

Here are the pros and cons as a I see them:

PROS:

* Quick closing (3-5 days!)

* Better diversification can be achieved (with little work). (A single family home can suffer one bad tenant incident which could tank your returns. Harder to own in multiple markets.)

* Completely passive investment. No calls regarding broken water heater. No need to deal with dog chewing up the place etc. No hassle over finding tenants.

* Simpler record keeping. DST sends replacement 1099 at end of year. No need for you to keep track of handyman, legal, travel, etc. expenses. No need to send 1099-s to contractors.

CONS:

* Intimidating PPM documents. Some may never get comfortable reading these. I found in one a disclosure stating that a broker who was selling shares has been convicted a few years prior for operating a ponzi scheme. I can totally see that after reading that some investors just run the other way.

* While record keeping is simpler for operating expenses, depreciation must be tracked by investor and can be a challenge to some. (I intend to tackle this myself, because I do not trust others with my money, but if I have to, I will hire an accountant to help.)

* You need to file state tax return in each state you own that has state tax!! (This is what makes Florida, Texas etc. favorite locations for DST-s.) Make sure you have your taxes very much in order prior to doing this, because refiling taxes in multiple states will be a pain.

* You probably can get better return with other multifamily investments that focus on improvements and value-add. DST-s cannot make significant improvements to the property (per the IRS private letter ruling). DST-s will never offer an investment to buy land and build on it and sell for example. Of course, new appliances and carpet, wood floor, countertop is allowed. (This is my understanding.)

* DST-s are new and not well tested in (tax) court. Lot's of other risks, see the PPM where they discuss these risks over several pages. DST-s started in 2009 and so they did not live through a proper recession. However, the companies sponsoring them (some of them that is) were in real estate before and that can give some guidance. I will post a separate message regarding risks.

* Illiquid investment. You have no control over timing of the sale. You better not need the money. (This is almost the same for a partnership interest in a multifamily property.) There is a secondary market, but it is very recent and untested.

* One has to be an accredited investor (1M assets without primary residence or 300k+ income.) However, note that this is not actually verified. At the same time, I totally agree with the accreditation requirement.

Finally, I thought first that the broker fees/commissions are crazy high for DST-s. These are around 8.75-9.5%! I always thought that 6% real estate commission is too high, especially true for the Bay Area. (Should be capped by a small multiple of the amount of real estate taxes, which is 1% in CA but 2.5-3% in Texas for example. That would take care of the problem!)

But then I realized that the 9% commission is only on the funds invested. When you buy a single family home with a loan, you pay commission on the loan amount you take on! Advice: do not pay full commission for getting DST-s. It is negotiable.