Delaware Statutory Trust DST 1031 Difficulty Giving up control

43 Replies

Looking to get feedback from others that have 1031 into DST Delaware Statutory Trust.

We have tons of equity, low debt, fully depreciated, and I have been dealing with toilets, trash, and tenants, for 20 years...I often fantasize about passive income, because owning a 90 year old apartment building, is not passive at all. I tell people that I start my day with a list of 100 things to do, and by the time i finish the first 10, the list is already back up to 120 and I'm lucky to end the day back at 100.

Maybe this is a moment of weakness, but, it sure seems like I have them more and more often and that lifestyle of a passive investor analyzing DST's every 5-7 years, and checking on quarterly reports keeps seeming more and more attractive!

Am I missing something? I know fees are high, but, the passivity is worth it, to me, as long as the cash flow and appreciation are consistent. Hell, even just not loosing equity and steady cash flow would be fine.

@Isaac S. , Everyone hits that wall at some point or another.  Sometimes it's age, increasing work on aging properties, or an increasingly unfriendly landlord environment (Hello CA!!!).  But everyone gets there.  You've had a great run.  No shame in wanting to simplify.  I think you're right, the lack of control is probably going to be your biggest emotional hurdle.

There may be some middle ground that softens that blow up.  Certainly DSTs can get you where you're wanting to go.  I'm not a fan of their debt when I'm not in control.  Even non-recourse debt still leaves the asset at risk.  I'm much more willing to let control go if there's no debt involved.  And there are some DSTs and several TICs (same concept but actual ownership of the real estate asset opposed to membership in the trust) that are debt free.

You may also be a good candidate to simply own your own NNN property. Quality of lease and tenant are critical at this point in a market. And if risk is the biggest consideration then you'll be wanting to focus on quality of tenant more than quantity of tenant.

In all cases, the TIC and wholely owned NNN are going to give you more actual and perceptual control even though both are passive. You still make some decisions, can exit again at will again using the 1031 rather than being tied up for 7-10. And these two are actual real estate ownership.

In any of these you can utilize a 1031 exchange so you don't get trapped into that depreciation recap and tax on gain.  CA in particular would extract a nasty tax on the gain side.  

Many of my clients are selling multifamily properties and transitioning through 1031 exchange to STNL properties and leveraging their exchange funds. Some are selling CA properties at very low cap rates, then replacing with STNL or 2-4 tenant NNN retail properties in Midwest or Southeast markets at much higher cap rates. Depending on the tenant and remaining lease term, we are borrowing at 10-year fixed interest rates that 175-225 basis points below the going in cap rate on the replacement property. The client achieves improved cash flow and rids themselves of the management headaches!

@Isaac S. You are right, DSTs have their positives.  The biggest detractor is limited control and timing of exit.

Regarding your low debt position today, it puts you in an odd spot with DSTs that have either no debt or 50+% LTV. The balance is blending different DSTs to achieve an efficient LTV.

If they were not working well for investors, DSTs would not continue to attract the capital they are year over year....something is working right.

@Dave Foster points out other structures as well with more control, yet still produce attractive passive income.  Again, all of these options are available to be used in concert to match every last dollar in your exchange.

Good Luck with next steps!

hey everybody, thanks for chiming in!

Yeah, I have definitely been analyzing NNN lease properties for the last 12 months, along with reading and researching as much as I can about them. It is my initial reposition instinct for all the reasons @Dave Foster and @Kevin Sellers point out.

I just don't like the idea of so many of my proverbial eggs in so few baskets, or not being as familiar with the asset class, and the looming recession we are over due for, combined with not necessarily having much location knowledge, if buying in a secondary/tertiary market that I have no direct experience in.

Also, it seems like the primo NNN lease assets, get snatched up before they get posted on loopnet or crexi. Although I have gotten on quite a few NNN brokerage mailing lists, I am nervous about the 45 day timeframe and lining up a great up leg(or two) that actually completes the 1031 and ends up being a stable safe move.

Enter DST's and diversification of location and asset type, combined with their 5-10 year cycle timing, that seems to line up with the usual ebb and flow of the economy(if timed right). Always a bunch available at any given time to pick from, along with some unlevearged offerings, but, Just can't bring myself to have zero control of exit. I do like that they are usually managed by really smart and experienced people with lots of impressive titles and credentials, but just don't like that they get paid even if losing money.

We sold our hotel in the spring of 2018. We had 2.2 million cash and had to replace with debt over 4.1 million. I attempted to find quality NNN properties to purchase. I had been looking for several years prior to the sale. Research 2016, 2017, 2018. I have not had commercial rental experience.

Cash flow, Freedom and not wanting to loose what I had gained were high priorities.

My goal was exceed $100,000 per year cash flow.

I was being shown high quality NNN properties with 15 year leases backed by top companies like Gander Mountain, Shopko, Many Dollar stores in some small communities with higher enticing cap rates. ( as you know they have all failed) I pictured myself making a $35,000 per month payment with no tenant. Then I thought I could diversify and get several in the 1 to 2 million range. There is much competition in that range and lower cap rates. I figured a closing fee when I sell would be a one time 6%. Then an ongoing annual management fee would be 4%ish, and more if you get a class C apartment with lots of work needed. (but higher cap rate) Limited diversification.

Freedom was very high on my list so I did not want to deal with this. I thought about taking cash but was unwilling to give the government 850K. I thought even if I did DST's and lost 30% of the equity, It would be the same as giving it to the government. (Probably not technically accurate). Doing a 1031 allowed me to invest $850,000 more whether a NNN or DST. Money you can collect cash flow from for years to come.

I looked at financial adviser's who promised 30-40K per year return on the cash after taxes.  I felt sick about that number.  They charged a .75 to 1.25% management fee.  This is 10% over 10 years.

I had been looking at DST's. Up front assembly fees about 10%. So I looked at it like 10% management fee up front that covers the assembly of the product and sales of the product to people like me. Very comparative to purchasing something myself, yet total freedom.

I now have properties in Florida, Texas, Missouri, Washington.  I have Apartments, Mini Storage, Hotel, Sr. Housing.  Checks come in ACH monthly and I love it.  I hope it continues.

Not all the money went into DST's however we did not pay any boot. Every dollar was reinvested.

We now exceed $10k per month in DST cash flow. DST's have met my goals as far as cash flow, freedom, diversification and lowering taxes. I have been in DST's less than one year. I do not know the outcome long term. I have invested with DST providers like, Moody, Inland Capital, Passco and Bourne. As you can tell by my writing I am not a financial wizard. I am impressed with the many people on the Bigger Pockets forum and I am learning from all of you. Thank you.

Thanks @Mike Jacobson for your input. We are in very similar situations and priorities. It's not so much the cost, since I am ok with paying people that really add value and don't just go through the motions. It's more of the lack of control and having complete faith in someone else...

These companies have professionals beyond my abilities. My worry has been, are they creating the DST's to keep the up front money in their pockets and just hope that it comes back to break even or better at around the 7 year mark. I just felt that even the big providers of DST's who have been doing it for years get a track record. The bad ones, no one will invest with them in the future. I think think there were a lot of winners who set them up from 2009 to 2014. Good time to buy. The problem is my property did not sell until the peak. But I got top dollar also. The guy I purchased the DST's has been doing it since 2004. He has vetted the companies that put them together and each project they put together. (They all say that) But at some point you have to go with your gut.

@Mike Jacobson and @issac singer- great discussion. Although I'm still a few years away from exchanging my San Francisco properties, I can relate to your experiences. I too have a hard time with giving up control for DST's although I see their value. I am concerned that newly forming DST's are basically buying at top of market now, so who knows how successful they will be 7-10 years from now. It seems that the ones formed 2012-15 are in a safer place. Also, I don't believe that their management has any direct equity (correct me if I'm wrong). So they will keep forming them, as there is a market for them, in spite of market cycles. Is this being mitigated in any way to reduce risk to DST current buyers??

As for STNL NNN properties, you certainly have more control, which is great- the issue I have is two fold. One, you really have to choose well- both the location and "the lease" are super critical to long term success. It used to be that large retail companies were almost "totally safe" as NNN. Well tell that to the owners of Toys are Us and Sears! Having that sh!t go dark must be a major pain point...unless you have several other STNL's going strong. So given that "Amazon effect", STNL is far from a no brainer, and buying in markets I have no idea about (suburbs in states I've never visited) is a huge step into the unknown. The second issue I have with STNL is that if it functions like a bond, then isn't this a terrible time to buy? You're basically paying high prices at low, compressed rates. Isn't the time to buy STNL is when rates are higher and the bldg prices are lower? I'd like someone with consistent STNL selling experience to weigh in about purchase timing- how was buying STNL in 2004-2007, vs 2012-2015, vs today? @Joel Owens or @Dave Foster any thoughts on this?

BTW Mike, great analogy of how paying the high DST fees or potentially loosing some equity if they close out in a bad market is mitigated by cashing out and paying the cap gains taxes a priori.

Yet another option I’d consider is just keeping my properties and turning them over to a full time property manager. Yes it’ll cost something, the PM will never manage it as well as I can, and I’ll still need to “manage the manager.” But if the properties are in a prime location that is still appreciating (as are mine), that may be a way to go. But I guess when both the mortgage interest and depreciation finally run out, then that’s another milestone to consider...though for me I’m still years off from that! Again, great discussion.

@Amit M. , The mantra is you make your money buying at high cap rates and selling at low. On the market curve that does indeed mean that this is not the optimal time to be buying NNN properties. But the right leases and tenants can mitigate some of that over long time with rent escalations, renewals, etc. As with anything the right time to buy or sell is when it's right for you. Sometimes good defensive investing is moving from stellar to mediocre when you still can. So I wouldn't totally give up on STNL. And even in receivorships like with some of the bigger chains it's not a given that just because a store goes dark the landlord gets nothing. There's a pecking order for payment that sometimes provides some recoup. But vetting both lease and tenant and especially tenant is huge. And that's easier with national credit tenants than with regional companies with fewer locations. Too much cash chasing too few deals is having an effect.

Timing seems to be a critical thing. The only option I had when using 1031 was the time frames allowed when I sold my property. I sold at what I believe to be the peak. So like the rising tide, other properties are at their peak. Had I sold in 2010, 11, 12, I would have sold for 30 to 40% less. But I could have rolled into some good deals at 30% less than they are now. I guess I just rolled with it because I had 45 days to play the game or call in my chips with a +30% payout to the government. I bet on the DST people to at least break even and give me cash flow. More is a bonus. I am also thinking that if they sell off between 4 and 10 years, the second round I will start buying in different time periods spread over several years. I will also split investments that have $600k in them into 2 or 3 to diversify even more. If they all do poorly I will roll them out and go back into hands on. This is just my simplistic way of justifying/risking everything! :) Trust the government with my money? or DST's? That is the Question.... by not paying the government the $850,000 and keeping it in the (DST) market, I will get a return on that money monthly as long as I don't touch it. I can live with that.

 I just got back from a 3 week Australian/New Zealand cruise.  Deposits were in my account.  I love it!  So far.

Here is my take on it.

I have 2 buckets.

Clients I work with nationally that buy STNL and MTNL and I am the principal commercial broker as it's my firm and I work with them as the broker.

Second bucket is I syndicate value add retail deals where I am the sponsor.

1031 money unless buying directly needs to be DST or TIC model. I have also seen some UPREITS before and also opportunity zones.

Not a fan of the TIC model. Dave mentioned control in the TIC but alot of times that is an illusion. You get a voting share with a TIC but the problem is so do the other investors so you can have a lot of infighting on when to sell, refinance,etc. It can become a really big mess and lot's of them failed the last downturn. I have seen some smaller TIC's with just a very small amount of investors work.

High cap rates and STNL simply do not go together. Think of it this way. I am a developer and my breakeven is a 9 cap rate to cost. After resale costs of commission, legal fees, and capital gains if the sale is in the 6's I might make 200 basis point spread profit. If some buyer comes up and wants a 7.5 to 8 cap I would tell them to pound sand. I can convert the construction loan to permanent and have  a national tenant with a long term lease  with a high cap rate and hold for a better time to sell. Many buyers simply do not understand the economics of commercial retail properties.

At the bottom of the market say 6 to 8 years ago there were some higher cap rates for STNL. Cost of land and construction was dirt cheap so cap rate to cost was higher for resale spreads. Now to get those high caps you need leases with shorter primary terms left that are almost all cash deals. I will do those on the sponsor side but NOT the broker side.

For instance a property where it is 700k and then can double with a reposition I might make 15k or 20k going in to the buyer making upside of 500k. I would rather syndicate and get half as the sponsor. There is a deal I am looking at for 1 million right now that looks good for value add. Again I will syndicate it because I make a great profit. Finding the one in a thousand to make 25k commission for someone else to make a large return has no interest to me. If they are buying 3 million where I make close to 100k then different situation.

I am an investor also so looking for highest returns as well................ : )

If an investor is looking at STNL 1,500,000 and below they are going to be looking at a lot of crap. I look at about 1,000 properties a week so I know what is out there state to state. To get strong suburban core with a good B to A location typical is 2 million and up in price. Some buyers just want to pay all cash as they are leverage adverse. That's great if they have 2 to 3 million we might can do something. If it's like 1.2 million all cash it's a waste of time. They will be looking at crap dollar store type properties and other junk not worth anything.

DST's can give some diversity. Most tend to breakeven at best over time. With a DST not much upfront work to select and can relieve some stress with a 1031. You have to give up control, pay high junk fees front loaded, potentially have money trapped for a long period of time, etc. DST's can be good if say someone is selling off 10 properties for 100k profit each for 1 million but will not have it all at once.In that situation if they had the whole 1 million then they could likely find a very nice STNL or MTNL property for 3 million price range. When they get just 100k at a time what they could buy for 400k would be junk. With the DST they can plow 100k into a larger property in the many millions to tens of millions.

The better STNL deals tend to be in the higher price points. One of my clients right now is looking at a Red Lobster for about 6 million and cap rate about 6.5 going in. Absolute NNN with 2% annual increases and you do nothing and has 20 years left on primary with parent corp. guarantee.

Lot's of investors want to have their cake and eat it too. That doesn't exist folks. What does exist are CHOICES of various ways of doing things with pluses and minuses to each. The investor has to decide which ones they can live with and which ones are deal breakers to meet their goals and give them peace of mind. Most of my clients buying STNL or MTNL stay in certain price ranges. It doesn't make sense for an individual investor to buy single large box tenant for a really high price. The REIT's and funds can buy those and average out if a few go dark for a year to re-tenant again long term. The small individual investor it is too much risk to take on. Most of my individual buyers stay at 10 million and under for MTNL and STNL purchases.

   

@Joel Owens wow, thats alot of information. I understood 90% and agree with it all. It really came down to a time in my life where I want to enjoy it rather than continue to chase it. As an amateur at this I was to nervous to go for the 8 millionth dollar deal. (Doubling down) on my sale price. One day I went into my business and spent four hours dealing with a customer's debit card. The customer thought we took their money, because they didn't understand how debit cards work in a hotel environment. I went home and had lunch and thought is this what I'm going to do till I'm 70? I was 55 at the time. It was then I decided to enjoy life and reduce stress. Going for the 8 million dollar deal would have put way too much stress on me. I am still learning from all the people on BiggerPockets in case I decide to go back into something. But now I am very careful what I give up my time for. These discussions and thoughts will hopefully help other people make decisions about what they want to work toward and when they want to enjoy the fruits of their labor.

Hi Mike,

Yes I am 44 now. I have my plan I stick to now and say NO a lot these days to things that do not fit into my plan. The older I get the more I value those seconds,minutes,hours,days and what I want to do with them.

@Joel Owens so can we walk through a NNN scenario? Take the red lobster example. What I'm trying to understand is, what capital appreciation that property would have 10 years from now. We know the rent goes up 2% every year, ok. I don't think that you can just capitalize that increase over 10 years do get the resale value? Even assuming the lease is still solid, it'll have 10 years left at that time vs 20 when purchased. Also, what about interest rates at that time? That will have an impact.

That was my point about buying today with compressed rates vs buying years ago when rates were higher.

Maybe you have some clients that brought before the GFC for a historical perspective. In 2004-2007 interest rates were around 6%. The market was hot (like today.)  

*how did they fare, selling in the last few years?*

And let's forget value added, etc. I'm talking about straight up buying a quality NNN, getting your yearly 2% rent increases, no major drama wrt to tenant or the location's intrinsic value changing due to outliers. Under that scenario, what can one expect for capital appreciation? And how sensitive is that to interest rates changes (the rate you brought at vs the rate the new buyer can get in the market when you want to sell?)

That’s the big question in my mind...

The key with the NNN is to make sure rent per sq ft is not above market. With new builds you have to watch for developers building in TI's with inflated rents on the resale. The older buildings which have been reimaged and sale leasebacks in great locations the rent tends to be market or below. In those cases the restuarants generally set at 7 to 8% sales ratio for rent number.

10 years from now development costs are higher with inflation which dictates higher rents for new builds. When there is only so much land in an area the county or city tends to relax zoning to allow higher density levels over time. So you can see instances where redevelopment and land value over time blends upward. With STNL if you have about 10 years left on the primary lease you tend to still get good debt on the property. Alot has to do with LTV and amount down.

Some STNL buyers do not need cash flow today but want to reduce tax basis in their businesses. Some clients make seven figures a year and do not need anymore cash. General goal I see with most buyers is to generate a cash flow return, build equity, and have tax savings. If it breaks even and preserves equity on resale then that is hopefully worst case scenario. With the interest rates cash flow with rent increases blends up and mortgage amount blends down. So in 10 years even if interest rates are higher close to the same cash flow might be obtained. With a Red Lobster at 6.55 rate in 10 years with increases you would be right at an 8 cap. You could model out in 10 years that loan balance would be paid down to XX and NOI would be XX. So you then you could extrapolate what interest rate would be needed at that time to hit your minimum targeted return if you did not want to sell but refi.

I find with STNL 3 million and below lot's of cash buyers so they are not as affected by interest rates in the market as the buyer is not using debt for the purchase. The higher amount properties even if someone has all cash they tend to want to diversify and use some debt so interest rates going up can have somewhat of an effect on resale. That is why value creation and upward increase of rents is important.

This is why I do not like Dollar Generals. 15 year flat rent and an inferior building in junk locations. People buy them because sub 2 million it's about the only thing NNN absolute that gives a 7 cap. Usually it is retirees that are looking at is for an income stream to live off of before they kick the bucket. That is all they are usually thinking about.

Nobody knows the future or at what point a cycle will be in and what interest rates will be. You can model out and find your own comfort level. 

@Mike Dymski

Haha...I hear ya and have thought about it.

If i would  pay management company to manage this place it would kill the profitability. The 4-8% management fee,  and getting charged for every basic maintenance task, they are not motivated to get you best cost on bids and usually add a percentage for supervising, did i mention its a 90 year old building?...2/3 of the units are singles/studios, so generally higher turnover, causing higher fees for clean outs and lease ups, etc, etc

Recently had to get a "fire rated" door to the roof replaced from some city inspection, the first  bids were $3800-$4500, but with the right contractors and a little of my own time and motivation, i got the job done for less than $1500 and 12 hours of my time, and it had 2x the fire rating than the city required. Lets not forget the management company would have piled on a few hundred on top of the bids for a supervising fee. I'm not saying they shouldn't, I just can't afford to leave that money on the table if I'm not making more than that somewhere else. 

I guess that's kind of my point, I could easily see loosing 10-15% of my profitability using a management company, so it makes the DST fees more palatable when I factor in how much more time I would get back from passive investing vs. vetting/managing a management company and possibly still being active at times.

Just having no control or ability to fire managers or jump in and help out when the asset needs it, or time your exit, means you have to really really really trust the DST sponsor.... no pun intended(OK maybe a little pun)

@Joel Owens

Joel you rock! Your answers are always thoughtful and well articulated and you really are a great contributor on BP. We have talked on the phone, in the past and you were really helpful and generous with your time.

@Dave Foster

You are another BP rock star, too! Basically a "ditto" of what I said about Joel, but, we haven't yet had a chance speak directly.

Thanks to both of you for the pro advice and input.

Also, thanks to the other two investors for chiming in!

@Mike Jacobson 

@Amit M.

I am so thankful for Bigger Pockets and all the really good people(including any that didn't get mentioned) that use it!

Originally posted by @Isaac S. :

@Mike Dymski

Haha...I hear ya and have thought about it.

If i would  pay management company to manage this place it would kill the profitability. The 4-8% management fee,  and getting charged for every basic maintenance task, they are not motivated to get you best cost on bids and usually add a percentage for supervising, did i mention its a 90 year old building?...2/3 of the units are singles/studios, so generally higher turnover, causing higher fees for clean outs and lease ups, etc, etc

Recently had to get a "fire rated" door to the roof replaced from some city inspection, the first  bids were $3800-$4500, but with the right contractors and a little of my own time and motivation, i got the job done for less than $1500 and 12 hours of my time, and it had 2x the fire rating than the city required. Lets not forget the management company would have piled on a few hundred on top of the bids for a supervising fee. I'm not saying they shouldn't, I just can't afford to leave that money on the table if I'm not making more than that somewhere else. 

I guess that's kind of my point, I could easily see loosing 10-15% of my profitability using a management company, so it makes the DST fees more palatable when I factor in how much more time I would get back from passive investing vs. vetting/managing a management company and possibly still being active at times.

Just having no control or ability to fire managers or jump in and help out when the asset needs it, or time your exit, means you have to really really really trust the DST sponsor.... no pun intended(OK maybe a little pun)

Got it.  Well said.  This apartment community is not really an investment (said differently, the non-management portion of the returns are limited).  You are running a micro property management business instead and getting paid for your time and want to retire from that work.

@Thomas Rutkowski may be able to help with a monetized installment sale...just another option.

Glad that you posted...this is a meaningful post.

Updated 10 months ago

"limited" meaning similar to what you could get investing passively

I appreciate this thread though I admit a lot of it is over my head. The world of DST's, TIC's and NNN properties is all new to me. I'm in a similar position of selling off some rental property and not wanting to give more than necessary to Uncle Sam, but my taxable boot is more likely to be in the $400k range. From this thread, I gather that's not enough to work with for NNN properties so I'm also looking at DST's. However, like others here, I don't like the longer term commitment especially when getting in at this economic cycle. Are there any DST's with a shorter term commitment? 2 years or less?

Originally posted by @John Semanchuk :

I appreciate this thread though I admit a lot of it is over my head. The world of DST's, TIC's and NNN properties is all new to me. I'm in a similar position of selling off some rental property and not wanting to give more than necessary to Uncle Sam, but my taxable boot is more likely to be in the $400k range. From this thread, I gather that's not enough to work with for NNN properties so I'm also looking at DST's. However, like others here, I don't like the longer term commitment especially when getting in at this economic cycle. Are there any DST's with a shorter term commitment? 2 years or less?

Usually DST's are designed for 5-7 year cycle, with maximum of 10 years because of the underlying financing for project being 10 year term.

Not having clearly defined time lines and being at the mercy of the offering management and their exit strategy, is one of the biggest negatives of this type of investment, in my opinion.

Some have shorter cycles, and you don't have to position all $400k in one, you can spread the money over 4 different offerings and they ideally will have staggered maturity dates...or you may want it all in one if you plan to 1031 out of the DST back into real property.

@Isaac S. so you know what the options are once a DST matures? Is it usually a cash out, and you pretty much have to buy into new DST's to defer your gains again? Or maybe they offer the option to roll over and stay in it, if they were able to add value, increase cashflow, etc., making the long term return is favorable?

I ask because the benefit of diversifying into several DST's is mitigated in the future if you need to roll gains over, as now you're chasing different maturity dates and smaller amounts. I'd be harder, for instance, to roll over to a prime NNN property with your assets diversified over several DST's.

Anyone else, also feel free to chime in!

@Amit M. , Good point about diversification into multiple DSTs. Of course diversification is also the king of risk mitigation. You options are the same as any 1031. At the maturity you can take the cash and pay the tax. Or you can roll it into any other type of investment real estate. Or you can invest in another DST using the 1031 exchange. It would be no problem to re-consolidate them as long as the 1031 calendars are compatible.

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