Reposition Your Active Management Real Estate To Passive Income Institutional Quality Real Estate to

Updated: Nov 18, 2021

By Dan Werry, JD, MBA

Invest In Or Trade Your Investment Real Estate For Professionally Managed Investment Grade Property.

Many of my clients use to find themselves busy managing their investment real estate, or struggling to find investments to balance out their portfolio. In both cases those clients may have desired passive income private real estate to meet their goals. The first client generally would like to sell his labor intensive real estate, defer capital gains, and find a reasonable passive income replacement property. The second client generally has invested in most other asset classes and would like private real estate to provide portfolio diversification.

The solution for each client may be the same. Delaware Statutory Trust properties, also known as, DSTs. DST investment properties or fractional interest options have been the choice for thousands of similar clients since 2003, and through 2016 the equity invested into DST properties was approaching $1.5B*.

DSTs can enable a client to complete an IRS Section 1031 exchange and reinvest their proceeds into passive income real estate. Investors not completing an exchange may also choose DSTs as a means of finding professionally managed real estate because commercial real estate is an asset type that is not correlated to the stock market.

Both client types benefit from the typical attributes of real estate; tax benefits from depreciation and deductible mortgage interest. Subject to market conditions, and depending on the acquisition price, costs, and if there is increasing net operating income the property could have the potential to appreciate. Again, although passive incomes, DSTs are investments in real estate and therefore they have the same real estate risks. Those risks generally are related to; 1 – the tenant (vacancy … etc.), 2 – the market (supply/demand), 3 – property management (under managed) and 4 – potential unforeseen events or disasters.

To appropriately consider and evaluate the exposure to these risks, just as you would in purchasing any real estate, extensive due diligence is required. Due Diligence is our firm’s core and most important function we can provide to our clients. We invest significant resources evaluating and analyzing each available offering and investment property (DST) for our clients. We encourage our clients to participate in a 30 to 90 meeting to review each offering and how we go about analyzing available properties to help them make the appropriate reinvestment and investment decision.

Understanding DST Investment Properties

DSTs are syndicated real estate investment vehicles, also known as co-ownership.

The average number of investors per property has generally been from 12 to 24 investors, and 24 to 48 for larger DST offerings. The co-investors are directed by a trust agreement. Each investment property averages in value from $20 to $60 million and typically has a loan packaged with it for at least 50% of the value. There are some properties that have no debt at all. Importantly, if there is a loan you should look for “non-recourse” debt. Generally DST investment sizes could be for as little as $100,000 dollars. Understanding that you don’t need to invest millions of dollars to own part of a multi-million dollar property offering. With these investment amounts clients use DSTs as a means to diversify their portfolios. They are generally seeking an asset type that has a low correlation to the markets, and they are investing for long term performance.

Some clients with larger 1031 exchanges or at least $5,000,000 of equity choose our Wealth Management Program which enables these investors to buy and own properties just like any major real estate company would without requiring them to have a large institutional infrastructure.

The property types that investors can invest in include Medical Office, NNN triple-net long term lease portfolios, Multi-Family (Apartment), Industrial, Office, and Retail. The properties are located throughout the country enabling investors to diversify geographically and possibly invest in stronger markets. Each asset class has its pros and cons. Multi-Family can be a hedge against inflation because as you renew leases you can adjust them upward accordingly. However, if interest rates decrease low enough there is the concern of losing groups of tenants that could purchase their own homes. In general, management companies look for properties that have long-term leases so the DST properties can weather uncertain economic times with minimal impact to investor cash flow.

Conceptually, the DST structure is designed to allow investors to invest in passive income institutional quality real estate. Therefore investors rely on management to operate these properties within annual budgets. In addition, management negotiates leases, handles tenant issues, fills any vacancy, and takes care of capital improvements. If done correctly co-investors can expect to receive forecasted annual returns distributed monthly. Because investors do not expect to make additional contributions after their initial investment adequate reserves are required to cover re-leasing expenses such as tenant improvement costs and leasing commissions. Reserves are also required in the event of necessary capital improvements. Most DSTs start with significant upfront reserves and through operations additional funds are accrued to avoid future investor contributions. The investor goal is to have the management take care of all property and financial details in order to receive monthly distributions, quarterly reports with some DSTs holding quarterly conference calls and close the year with an annual operations summary.

Lastly, because transaction expenses such as commissions, legal fees and marketing expenses are built into each DST offering these investments are not short terms in nature. Investors do receive their monthly cash flow based on the amount of equity that they invest. Just as with any investment that has transaction costs, with real estate, you look for increasing net operating income to compensate for initial expenses. Also, because there is a limited secondary market for these investments the client should plan on waiting for the property or properties to resell before they can access the equity invested. This is another reason why these investments are generally considered long term investments.

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