DST Investors: What Do You Wish You Knew Before Your First 1031 Exchange?

Question

I'm researching DSTs as a potential destination for a future 1031 exchange and recently came across several investor discussions involving suspended distributions, sponsor issues, and communication problems.

For those who have actually invested in DSTs (especially those who have gone through a full hold period and sale), what do you wish you knew before your first investment?

Specifically:

* What red flags do you look for in a sponsor?

* How much weight do you give sponsor quality versus the actual property?

* Have you ever experienced a distribution reduction or suspension?

* What metrics do you focus on (LTV, DSCR, occupancy, debt maturity, etc.)?

* What questions do you ask before investing that most investors forget to ask?

* Looking back, what mistakes did you make that you'd avoid today?

* If you had to build a DST portfolio again, how would you diversify across sponsors, property types, and geographies?

I'm less concerned about maximizing yield and more concerned about preserving capital, maintaining reliable income, and avoiding unpleasant surprises.

Interested in hearing both positive and negative experiences.

Stuart Udis · Answer

DSTs are frequently promoted at my local REIA meetings, and I’ve generally found both the projected returns and the underlying investment strategies to be underwhelming. In my view, many investors place too much emphasis on tax preservation and too little emphasis on the quality of the investment itself. That often leads them into DSTs or poorly vetted 1031 exchange opportunities that they might not otherwise consider on their own merits.

My suspicion is that many DST sponsors understand this dynamic and intentionally market these offerings to a captive audience of investors who are primarily focused on avoiding taxes rather than maximizing risk-adjusted returns. I'm sure there are DSTs that perform well, but the ones I've personally reviewed have not been particularly impressive, and the structure is not something that appeals to me as an investor.

Dave Foster · Answer

@Fidel Aviles, " I'm less concerned about maximizing yield and more concerned about preserving capital, maintaining reliable income, and avoiding unpleasant surprises."

Good on you for approaching this realistically. Chasing returns, and trying to make a DST something it was never intended to be (a high paying syndication) is exactly what gets DSTs into trouble. And with the myriad of limitations and requirements placed on these it takes an extremely unusual situation (or inexperienced sponsor) to fail to a great extent.

Stick with known names who have many offerings that have gone full cycle.  Treat these as first real estate investments (and underwrite them as such).  And then rest knowing that you still have a lowly leveraged asset to work with if something does go south.

Brett Henricks · Answer

Relying on "known" name Sponsors is no guarantee that a DST investment will be a good one. I bought a DST from Cantor-Fitzgerald thinking that and I am sorry I did. They have cut the distribution by over half. This particular DST was sold with an UPREIT potential which could be seen as a good future ending. Turns out their REIT sucks. Problem was I trusted the broker/dealers to have done the due diligence to know.

So, you are asking the right questions but the "source" of your data to calculate things like DSCR and other metrics can't come from the Sponsor's "projections" in the PPM. Huge mistake trusting the Sponsor's projections because you don't know what they were built from.

If you would like to send me a PM I can help steer you in the right direction. Would appreciate the opportunity to help someone not make the same mistakes I did.

Chris Seveney · Answer

@Stuart Udis you hit the nail on the head. This space, according to some of the broker-dealers I speak with, has taken a huge hit over the last few years because they're real estate-based and they're not making any money. This is especially because of the heavy fee load, where the broker-dealer was making 5-8% off the top and throw in  management fees and all the other fees on top of it. In many instances, less than 90% of the capital raised actually gets invested. Far too often, people focus on tax strategy rather than the asset or the investment itself. for example one I saw had a $69m acquisition and $10M in fees to the sponsor - so raise $80M to buy a $69M property

then Throw in they got 1% asset management fee and 3% disposition fee - the sponsor on 69M was making over 12M (or 20% acq price) - what do you think is left for investors ??

Ashish Acharya · Answer

@Fidel Aviles, I'll speak to this mostly from the tax side, not sponsor vetting or DSCR analysis. DSTs qualify as 1031 replacement property under Revenue Ruling 2004-86, that's the whole reason they exist as a category, but that tax qualification says nothing about sponsor quality or whether distributions hold up, those are separate risks entirely.

Worth knowing that DSTs pass through depreciation similarly to direct ownership, but once you're in one, you can't add capital or make decisions on the property, so if a distribution suspension happens, you have far less ability to respond than with direct ownership. That same rigidity, the trustee's limited ability to renegotiate debt or raise capital under the ruling's seven-point test, is often exactly what causes the communication issues you're seeing discussed elsewhere.

Since you care more about capital preservation than yield, also worth knowing you can split a single 1031 exchange across multiple DSTs as long as value and debt requirements are met overall, so diversifying sponsors doesn't mean giving up the tax deferral, it's a structuring decision worth modeling with a CPA before you're locked into a timeline. Happy to connect!

John M. · Answer

@Brett Henricks

Long term capital gains are about 20% for me here in virginia.  15% federal/5.75 state.  I.E. it's easy to make up that tax hit in a few years with the higher returns.  You have to run your numbers, but remember it's not always about the math.  Access to liquidity, diversification, and passive returns without going through the hassel and fees of an upreit or another 1031 down the road.

John M. · Answer

You can chase yield and have stable income!  Have you looked at PPR capital or7E investments?  These mortgage note funds perform 9-12% year over year.  You can also look at private equity or private credit with yields in the 10-15% range. Better than a bond or DST.  The problem with deferring the tax into a DST is that you miss out on yield, liquidity, and diversification.  This was not the case 10 years ago but now the market has more options!!!

Brett Henricks · Answer

Explain more please. If you don't 1031 you pay in excess of 40% of what you sold a property for. So to buy these other high percentage returns do you first need to take a 40%+ tax hit? Sounds too good to be true.

Brett Henricks · Answer

You would hope your Broker/Dealer would know all the fees and percentages being paid out. Most all of them don't. This should be part of the due diligence process they are supposed to be doing for you. Discovering what's actually happening will need more talent than most BD's will have.

At any given time, there are almost 100 DST's being marketed. Your BD will likely show you what they are being told to sell so you will likely see only a fraction of the entire market. 45 days goes quickly and you're limited to what's currently on the market and your BD is selling at the time.

DST's are full of monies skimmed off the funds investors are giving them. So, since the average DST investor is over 70 years old and are typically doing a 1031, they fall prey to BD's offering them a way to get income and avoid the tax hit. Which can be in excess of 40%.

DST Investors: What Do You Wish You Knew Before Your First 1031 Exchange?

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