How We Evaluate a DST Before We Recommend It

With a DST, you are purchasing a beneficial interest in a trust that owns a specific property or portfolio of properties. The property’s location, asset class, tenants, financing, and other material details are identified in the Private Placement Memorandum (PPM), an offering document delivered under the SEC’s Regulation D rules. The sponsor and its affiliated property management team are responsible for operating and managing the real estate on behalf of investors.

Income is generally generated from the property’s rental or lease revenue, less operating expenses and debt service, if applicable. The sponsor underwrites projected income and expenses in advance, and those assumptions can be reviewed in the PPM. As part of our due diligence, we evaluate items such as lease terms, rental assumptions, occupancy, operating expenses, debt service, and other factors that support the projected distributions. We focus on whether the assumptions supporting the projected income appear reasonable, not simply on the stated distribution rate.

Leverage varies by offering and is disclosed in the PPM. For 1031 investors, leverage may also play a role in replacing debt from the relinquished property. We evaluate the property’s loan-to-value ratio, interest rate, whether the debt is fixed or floating, the loan term, and the maturity date.

We also consider what would need to occur operationally and from a valuation standpoint for the property to support a successful exit at or before the anticipated debt maturity.

Distributions can be affected by many factors, including, but not limited to, changes in occupancy, tenant performance, rental income, operating expenses, property taxes, insurance costs, repairs, capital expenditures, debt service, interest rates, and broader real estate or economic conditions.

Projected distributions are not guaranteed and may increase, decrease, or be suspended depending on property performance and other circumstances.

Risks can include, but are not limited to, loss of principal, reductions or suspension of distributions, tenant or occupancy issues, changes in property values, economic downturns, interest rate changes, operating cost increases, leverage, illiquidity, sponsor-related risks, and the inability to sell the property at the anticipated value or within the projected timeframe.

Each offering has its own specific risks, which are described in detail in the PPM and should be reviewed before investing.

DST investors are passive owners and generally do not participate in day-to-day property management or operating decisions. The trustee, sponsor, and designated property management team are responsible for managing the property in accordance with the DST structure and offering documents.

This passive structure is one of the reasons DSTs may appeal to investors who want continued real estate ownership without the responsibilities associated with directly managing a property.

DSTs generally cannot make capital calls requiring investors to contribute additional funds after their initial investment. For that reason, the sponsor typically establishes reserves at the beginning of the investment to help address anticipated repairs, capital expenditures, leasing costs, and other property needs.

As part of our due diligence, we evaluate the amount of reserves established for the property and whether they appear reasonable relative to the property’s age, condition, tenant structure, and anticipated capital requirements.

The anticipated exit strategy depends on the offering.

A traditional DST generally contemplates the eventual sale of the underlying real estate, at which point investors may receive their proportionate share of the sale proceeds and, if eligible, evaluate another 1031 exchange.

Certain DST strategies are specifically designed with the potential for a future Section 721/UPREIT transaction, in which the property may be contributed to a REIT operating partnership in exchange for operating partnership units.

Traditional DSTs often target holding periods of approximately five to seven years, although the actual hold period can be shorter or longer depending on market conditions, property performance, financing, and sponsor decisions. Some DST offering documents also provide flexibility for a potential future 721 or UPREIT transaction, but investors should not assume a 721 transaction will occur unless it is a defined part of the investment strategy.

When a traditional DST property is sold, investors generally receive their proportionate share of the net sale proceeds after the repayment of debt, transaction costs, and other applicable expenses.

Investors may then choose to recognize the applicable tax consequences or, if they meet the requirements of Section 1031, pursue another qualifying 1031 exchange. Because individual tax circumstances vary, investors should work with their qualified intermediary and tax professionals before the sale occurs to evaluate their options.