Inevitably at some point, real estate investors reach a point where they’d like to ‘retire’ from managing real estate and receive consistent monthly income without the need to be a landlord or manage properties. Usually, they’ve used tax-deferred exchanges along the way and have deferred what is now typically a very sizable capital gains tax liability. With this significant incentive, property owners typically intend to “swap till they drop”. This allows them to continue to defer this tax until their death because at that point their heirs inherit the real estate at a “stepped-up” cost basis – which essentially eliminates the tax liability altogether.
Often at this point, property owners often know they’re looking for real estate investments that provide secure monthly income without management responsibilities but aren’t very familiar with their investment options. Where should they turn to explore options? Their financial advisor or real estate agent? Their CPA? 1031 exchange investments are quite a niche, so very few advisors and agents are well-equipped to help exchangors find investment options for a 1031 exchange. The result is many turns to the internet to find solutions.
Non-Accredited Investor Dilemma
Online searches for 1031 property options will inevitably lead to the Delaware Statutory Trust or DST for short. While it’s today’s most popular investment format for 1031 exchangors seeking passive real estate investments, it’s not always the best fit and furthermore, not everyone is able to invest in DSTs. DSTs are securities products like a stock or bond and the Securities and Exchange Commission (SEC) has determined that DSTs only be sold to “sophisticated” or “accredited investors”. Is this your first time hearing the term? You’re not the only one.
This becomes an even bigger issue for people because, due to the popularity of DSTs, most will have a hard time coming across any other viable options. Needless to say, today, non-accredited real estate investing can be challenging for those looking for passive real estate investments. Before we get into what options are available for those who find themselves as “non-accredited” investors, let’s discuss what an “accredited investor” is exactly.
What Is An Accredited Investor?
In order to qualify to invest in a DST investment, you must be an “accredited investor”. This term applies to less than 3% of Americans so limits access to DSTs for many interested parties. The term “accredited investor” is defined in Rule 501 of Regulation D of the U.S. Securities and Exchange Commission (SEC). There are eight potential ways to qualify as an accredited investor but #6 and #7 listed below are usually the most applicable:
- a bank, insurance company, registered investment company, business development company, or small business investment company;
- an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
- a charitable organization, corporation, or partnership with assets exceeding $5 million;
- a director, executive officer, or general partner of the company selling the securities;
- a business in which all the equity owners are accredited investors;
- a natural person who has an individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, or has assets under management of $1 million or above, excluding the value of the individual’s primary residence;
- a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
- a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.
DST Alternative Investment Options For Non-Accredited Investors
A common dilemma: what if I’m not an accredited investor but want the benefits of alternative investments like a DST? This is a scenario we come across quite often. Exchangors like the fact that they can invest their proceeds into investment-grade properties and have no management responsibilities. The good news is – there’s hope. There’s another investment format that proceeded DSTs called tenants-in-common or TIC for short. Like DSTs, TICs allow exchangors to invest in investment-grade properties with as little as $100k (and sometimes even less). Unlike DSTs, the TIC properties that we connect clients with are not securities and thus, are open to investment from non-accredited investors.
TICs actually preceded DSTs in qualifying as ‘like-kind property‘ for 1031 exchanges. They were incredibly popular in the early 2000s but in more recent years, DSTs have become a far more common choice. While some would use this to discredit the TIC format, the primary reason for DST’s popularity is due to the fact that over 90% of TIC/DST deals were and are leveraged (i.e. have a loan over the property) and DSTs make it far easier for the deal sponsor to leverage and also much easier for investors to take on their portion of the leverage upon investing. So although TIC deals are harder to come by these days, it by no means changes the validity or benefit of quality TIC investments. Our team has decades of experience working with both TICs and DSTs and would love to help you explore what options are available to you. Contact us and we’ll provide you with current options.