1031 Rental Property Gain into Delaware Statutory Trust Vehicle
Investor · brentwood, CA · Member since 2016 · 1k+ posts · 730 votes
1031 Rental Property Gain into Delaware Statutory Trust Vehicle
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votesThanks 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.
The 1031 Investor5137 Reviews
12 Replies
- Rental Property Investor · Rochester MN · Member since 2018 · 64 posts · 106 votes7y
I have been in 1 year. I love it so far. Search in BP DST and you will find many posts. Check out #davefoster he is extremely knowledgable and I really like his posts on the pro's and con's of dst's.
- Investor · brentwood, CA · Member since 2016 · 1k+ posts · 730 votes7y
Originally posted by @Mike Jacobson:
I have been in 1 year. I love it so far. Search in BP DST and you will find many posts. Check out #davefoster he is extremely knowledgable and I really like his posts on the pro's and con's of dst's.
Thanks Mike, I did briefly have an exchange with Dave. I like most things about the DST, except the relatively high load charges to get out of my stuff and even more so into the DST.
He acknowledged they are pretty high as a rule so if my stuff is running very well currently without excessive personal involvement on my part, I might hold off to avoid those costs and reevaluate the DST again at a later date.
- 7yDave FosterBusiness MemberQualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
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.
The 1031 Investor5137 Reviews - Investor · brentwood, CA · Member since 2016 · 1k+ posts · 730 votes7y
Thanks for the additional information @Dave Foster. My properties are mostly in a pretty attractive bedroom county of both the San Jose and San Francisco metro areas where the underlying growth just never seems to stagnate, my managers carry 95% of the work load (I set annual rate increases, approve major repairs and do the taxes) and my cash flow on my original cost is about 10%.
With this fact pattern, its tough contemplating losing maybe up to 20% of my initial capital in load charges to sell and buy just to effectively annuitize what I have. Although I haven't decided to hold these properties indefinitely, there isn't really a reason I can't just let them pass through my estate and then under current law all the taxable gain goes away and no significant transactions cost are incurred. Plus I hate the notion of selling one over-priced asset just to turn around and buy another overpriced asset given I have no faith in my ability to select counter cyclical asset classes.
If I had a shaker operation or I was just sick and tired of the landlord process (even as passive as mine is) I might feel a bit different.
@Christopher Smith I'm in a similar situation. I own 5 small prime buildings in San Francisco. Tons of appreciation, but still a decent cash on cash return > 5%, and IRR of 15-19%. I manage them myself, and since most of my renters are model tenants, it's not too bad. Plus I also live very close by...and it gives me something to do ;) As long as I don't get too stressed by the usual repair calls, tenancy changes, etc. it's really sort of like a giant game, and my goal is to be as fast and effective with every decision. A quick, cheap and elegant solution earns a psychological brownie point. A classic brain fart/path of most resistance outcome can be frustrating, but at least I learn a "I'll never do that again in that specific situation" lesson.
I'm inclined to keep all my stuff for now, as I still think there are one or two good appreciation cycles to be had in the next 10-20 years. But I'm sure at some point I'll tire of this, or I'll find a new hobby/passion/obsession, and then I'll be happy to rid myself of the active RE. At that point I'll either get a PM in place, or I won't mind incurring the sales transaction costs, and either set returns of NNN, or the vagaries of DST's fees and reliance on their management team not to f**k up the project returns ;)
So how has your experience been with property management (PMs)? I always hear how they tend to slack off, never do a great job, overcharge, etc. (to be fair I’m comparing them to a very high bar- the way I manage my own properties.) How are you able to deal with that disparity? And how many homes are they managing for you/are the homes all nearby?
- Investor · brentwood, CA · Member since 2016 · 1k+ posts · 730 votes7y
Originally posted by @Amit M.:
Hello Amit
Your situation sounds pretty close to mine in a whole lot of ways. One thing I do use 2 property managers, 1 local and 1 long distance. My experience with them has been pretty good. The local outfit first had me assigned to one of the owners and he was originally reasonably good but had health issues so I requested to be reassigned about 4 years ago to a younger guy who has been really great. Very much on top of things and very easy to work with when necessary (e.g., casualty issues, miscellaneous complaints, etc.). My long distance manager is solid as well, although he generally only managers a couple of mostly lower maintenance properties (although one may need a new roof soon).
From all the horror stories I have heard I guess I have been pretty lucky with PMs which is really good for me since I'm not the active landlord type. I like the acquisition part, the setting of rents and the devising of an exit strategy (like you I haven't decided upon one yet), but direct tenant interaction isn't for me. I haven't met a single tenant in 20 years, and have no desire to start :).
Also like you holding tight works for me currently, and perhaps I will even hold indefinitely absent some unforeseen future event that might dictate I dispose of them. With good PMs (Knock on Wood) there really isn't much that needs to be done by me other than Federal and State tax reporting, and I can handle that fairly easily (was once a CPA in a couple of larger tax practices). So like you I will just continue to explore things and size up my options as they arise.
Good Luck with your activities.
@Christopher Smith Thanks for writing back. it’s interesting to hear about your positive experiences with PM’s, which is an area I need more exposure to. If you don’t mind, I’d be interested in your perspective on the following aspects:
1- did you choose formal PM firms, or more of a realtor who does it on the side?
2- are these larger (formal) multi locations PM firms, or more small and local boutiques?
3- during tenant turnover, do they select the new tenants all on their own? Or do they forward you candidates that they like, and you review the applications too?
4- for a capital expense like a new roof, water heater, etc., do they manage the entire process and bill you on top of the contractors bid for the work?
5- do you mind sharing their fees and structure? Is it monthly management fee, plus an extra fee for tenant turn overs?
6- how often do you visit your properties?
Appreciate your perspectives, thanks.
- Investor · brentwood, CA · Member since 2016 · 1k+ posts · 730 votes7y
Originally posted by @Amit M.:
@Christopher Smith Thanks for writing back. it’s interesting to hear about your positive experiences with PM’s, which is an area I need more exposure to. If you don’t mind, I’d be interested in your perspective on the following aspects:
1- did you choose formal PM firms, or more of a realtor who does it on the side?
All of my PM's are realtors: My CA PM is with BestPropertyManagement and they sell property (I bought one property from them), but the major part of their business is Property Management; My OH PM is with BetterHomes&Gardens and they do a lot of both.
2- are these larger (formal) multi locations PM firms, or more small and local boutiques?
BestProperty is an established Local; Better Homes & Gardens is National of course
3- during tenant turnover, do they select the new tenants all on their own? Or do they forward you candidates that they like, and you review the applications too?
They call to give me what is generally a relatively brief run down of already screened candidates and we go back and forth until I'm satisfied with the Tenant and the we will charge them Rate. I guess you would say I always have veto authority, but they do all the detailed screening.
4- for a capital expense like a new roof, water heater, etc., do they manage the entire process and bill you on top of the contractors bid for the work?
They call me and I screen who they are going to use and what the charge will be. Like 3. I have veto authority, but they do all of the detailed work. For smaller stuff its pretty quick, and as the price goes up for major repairs I screen more closely and get more price sensitive. I had a few issues in the beginning with being charged retail rates (especially by CA HVAC folks), but after a discussion about how that needed to change, it has. The PMs now have reliable contractors who know I will scrutinize very carefully what they do if needed. I will tell them to meet me on site if the price seems unreasonable, and they know this now so its always been unnecessary.
5- do you mind sharing their fees and structure? Is it monthly management fee, plus an extra fee for tenant turn overs?
8% on gross rent actually collected, nothing else, which has worked well. I've had other PMs bid for my properties with some offering as low as 3% which at first impression seemed pretty attractive. But I went on to YELP to see their reviews and they always seemed to be in the middle of a tenant revolt with many 1 and 2 ratings and lots of very hateful and threatening comments. My guys have a 4+ rating, and as I don't want to deal with tenant issues (e.g., complaints, lawsuits, etc.) I've decided a flat 8% is fair for what they do.
6- how often do you visit your properties?
Well I live within 3 miles of all my CA properties so I usually find a way to cycle or drive by them probably at least 3 times a week (e.g., on the way to a local lunch). I haven't seen my Ohio properties in 20 years (one just turned 20 this year), and one I have not seen ever. I used my OH PM to represent me at closing on that one and he was also my representative during the negotiations.
All has worked out really well with my OH properties. I can see recent pictures of them on the internet at any time and they are all in excellent locations (upper middle class areas of Springboro on the Cincinnati to Dayton corridor, which believe or not is actually flourishing incredibly well, despite Dayton itself being essentially a total dump). My OH PM has nearly 40 years of experience so he knows the area like the back of his hand.
@Christopher Smith thanks for all those details. Looks like your PM selection turned out rather well. That’s encouraging to hear. I guess one needs to be prepared to pay ~ 8% of gross, and reading reviews also helps in the final selection. Plus your properties attract quality tenants, which I think is a critical factor. Easier for the PM to manage and less chance of bad incidents. All contributing factors to a good solution. I’ll keep them in mind.
- Investor · brentwood, CA · Member since 2016 · 1k+ posts · 730 votes7y
Originally posted by @Amit M.:
@Christopher Smith thanks for all those details. Looks like your PM selection turned out rather well. That’s encouraging to hear. I guess one needs to be prepared to pay ~ 8% of gross, and reading reviews also helps in the final selection. Plus your properties attract quality tenants, which I think is a critical factor. Easier for the PM to manage and less chance of bad incidents. All contributing factors to a good solution. I’ll keep them in mind.
You could pay less. As I indicated I have had numerous offers to pay less, and initially I was seriously considering switching to get something probably in the 5 to 6 percent range. However, my background is as a totally passive securities investor and the thought of active rental properties duties was in the beginning a total non starter - way to much personal involvement, way to much risk, way to much visibility.
What I have found with a truly dependable PM (very hard to find what I have I think) all those problems go away, plus I have a moderately good cash flow generator, quite strong underlying appreciation and very good tax benefits. Including the underlying appreciation my managers probably take about 5% of total income, and probably do 95% of the work. They also act as a very significant and very important risk and privacy buffer over and above the work component. It may sound a little like overkill, but for me overkill probably isn't possible given where I want my level of involvement to be in performing active field duties and tenant interfacing, which is ZERO.
That is all very valuable to me as it allows me to focus on my professional work and securities investment which is what I prefer to do. The actual performance of landlord duties is something I would never do, so these guys are really my right and left arms. I actually think they earn what they charge, and that is after some substantial reflection and hearing all the horror stories of other folks PM relationships.
@Christopher Smith given your predilection for avoiding tenant involvement, it sounds like you found a solid solution. In my case I actually kind of like a limited amount of property management. Here in SF the professional tenants are top notch, and it’s interesting meeting all the people and understanding their motivations. I’ve gotten pretty good at predicting behavior, so it’s easier to select good tenants. I’ve never had anything remote to bad ones. So it’s a game of seeking the 9’s or 10’s tenants versus the mere 7 or 8’s. Plus it gives me something to do. Every once in awhile I’ll try to fix something too, just to see if I can do it. Sometimes it’s the small things in life that are rewarding :)
But back to property management, given my set up, I’d be hard pressed to find a decent PM that would meet my standards. So in that sense, when I’m ready to move on, I’ll probably look for a PM similar to yours. On the one hand I’d lean towards a small shop that would be willing to do things the way I specify. OTOH I don’t want to be too dependent on a primary owner/operator. I’d still want a PM shop with a management staff and systems and processes in place, so if someone leaves, another can be trained to replace them. I actually think it’s a tricky thing to find the right PM fit, especially as a long term solution. So it’s good seeing others that have had decent success with this.
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