Investing in real estate through a Delaware Statutory Trust (DST) offers a compelling opportunity for investors seeking portfolio diversification and potential tax advantages. Central to evaluating DST investments is understanding how property-purchase loans, or debt, impact investors. As a reminder to some and new information to others, a DST can benefit an investor who may not want to obtain a new loan, wants to be debt free or doesn’t want the headaches of property management and liability. This guide delves into the intricacies of DST debt to help prospective investors make informed decisions.
Impact of DST Property-Purchase Loans on Investors
DSTs commonly utilize loans to finance real estate acquisitions, typically ranging from 30% to 55% of a property’s value, and occasionally up to 85% in specific cases. For investors leveraging a 1031 exchange—an IRS provision allowing tax deferral on capital gains—the debt incurred by the DST plays a pivotal role. For instance, if an investor commits $100,000 to a DST with a 50% loan-to-value (LTV) ratio, the IRS recognizes the total investment as $200,000: $100,000 in debt and $100,000 in equity. It is important to note, however, an investor must replace their debt from the sale/relinquished property in the next purchase to avoid a boot/taxable event. It is misconception that you just have to reinvest the cash in the exchange and forget about the loan that was paid off at closing.
Navigating Loan Acquisition
Investors don’t need to apply for DST property-purchase loans themselves. Typically, DST managers secure financing using the trust’s property as collateral before inviting investors to participate. This proactive approach by the manager shields individual investors from the complexities of loan procurement. In addition, investors don’t have to service the debt, it does not appear on their credit report and they don’t have to fill out a loan application.
Qualification and Ownership
The DST/Trust and the property/tenant financials are what qualify for the debt, and the DST manager signs for any recourse liability. In other words, the financing structure is managed by the DST entity itself. This setup dissociates the loan from investors’ personal credit reports and obligations, ensuring accessibility regardless of individual creditworthiness. Some investors may not qualify for a loan (purchase) or don’t want the liability. A DST allows an investor to replace the debt on a non- recourse basis without liability and loan qualifications. This can be of benefit to the investor who does not want to get a loan, cannot qualify or may not want the hassle of obtain one. And investors do not have to go through a traditional loan qualification process for a DST.
Loan Management and Responsibilities
Investors are relieved of direct loan management responsibilities. Instead, the DST manager handles all financial obligations, including collecting rent and servicing the debt from tenant payments. This arrangement safeguards investors from the intricacies of loan repayment.
Liability and Default Considerations
In the event of loan default, investors typically bear no personal liability beyond their initial investment. DST loans are predominantly structured as non-recourse debt, wherein lenders cannot pursue investors for repayment. However, investors may face the risk of losing their principal investment if the DST defaults and the property is foreclosed.
Loan Repayment Dynamics
Upon selling the property, the DST manager uses the proceeds to settle the loan. After covering final expenses, any remaining equity is distributed among individual investors, reflecting their proportional ownership. It should be noted that once the property sells and loan is settled, the investor must replace their debt/loan in their next purchase based upon their percentage of ownership.
Tax Implications
Interest payments from DST loans may offer tax benefits, subject to individual circumstances including that loan interest is deductible against income as an expense. Consulting with tax advisors is advisable to optimize tax advantages based on specific investment scenarios.
Summary of Investor Responsibilities
Investing in a DST enables investors to leverage the trust’s structured debt framework without undergoing loan applications or affecting personal credit scores. Investors generally assume minimal liability for DST loan obligations, reinforcing the appeal of this investment vehicle for those seeking passive real estate exposure.
Conclusion
Delaware Statutory Trusts present compelling opportunities for investors seeking to diversify and gain tax advantages through real estate investments. Understanding the nuances of DST debt—its acquisition, implications and management—is essential for making informed investment decisions. By grasping these fundamentals, investors can navigate DST investments confidently, guided by their financial goals and risk tolerance.
Diversified Investment Strategies is a team of experienced and trusted professionals specializing in real estate investment and services – including buying, selling, leasing, retirement planning and wealth growth and management through strategic, informed investment choices and a meticulous real estate investment analysis. As knowledgeable replacement property professionals, we help clients build a customized strategy that identifies suitable investments pursuing successful completion of a 1031 Tax-Deferred Exchange. Visit us at www.diversified1031.com or call 949-379-2080.
*Example portfolio is hypothetical and for illustrative purposes only. Individual results will vary and are not guaranteed. Because investor situations and objectives vary this information is not intended to indicate that an investment is appropriate for or is being recommended to any individual investor. This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk. There are material risks associated with investing in private placements, Delaware Statutory Trusts (“DSTs”) and real estate securities including the potential loss of the entire investment principal, illiquidity, tenant vacancies impacting income and revenue, general and real estate market conditions, lack of operating history, interest rate risks, competition, including the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and investors should read the PPM carefully before investing paying special attention to the risk section. DST 1031 properties are only available to accredited investors (typically defined as having a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last two years; or have an active Series 7, Series 82, or Series 65). Individuals holding a Series 66 do not fall under this definition) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney. Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Diversified 1031 is independent of CIS. FOR ACCREDITED INVESTOR USE ONLY.