No investment is completely safe, and a Delaware Statutory Trust (DST) should not be treated as a guaranteed or low-risk investment. A DST can be useful for investors who want passive real estate ownership or a potential 1031 exchange replacement property, but investors can lose part or all of their principal. Whether a DST is appropriate depends on the specific property, sponsor, debt, tenants, fees, market conditions, and the investor’s own goals and liquidity needs.
A DST is also not the same thing as a real estate investment trust (REIT). A DST is a trust structure that can hold title to real estate. Under IRS Revenue Ruling 2004-86, an interest in the specific DST structure described in the ruling may be treated as an interest in real property for federal tax purposes when the other requirements of Section 1031 are satisfied. That potential tax treatment does not make the underlying investment safer.
What risks should DST investors consider?
Before investing, consider several important risks:
- Loss of principal: Property values can fall, tenants can default, expenses can rise, and investors may receive less than they originally invested when the property is sold.
- Limited liquidity: DST interests generally do not trade on a public exchange. Selling an interest before the sponsor sells the property may be difficult or may require accepting a lower price.
- Limited investor control: DST investors are passive beneficial owners. Major property, financing, leasing, and sale decisions are generally handled by the trustee or sponsor rather than individual investors.
- Sponsor risk: Investors depend heavily on the sponsor’s property selection, financing decisions, asset management, and eventual exit strategy.
- Property and tenant risk: Vacancy, tenant financial problems, changes in local real estate conditions, and weakness in a particular property sector can reduce distributions and property value.
- Debt and interest rate risk: Leverage can magnify losses. Loan maturity, refinancing conditions, and changing interest rates can also affect the eventual sale or value of the property.
- Fees and expenses: Offering, acquisition, financing, management, and disposition costs can reduce the investor’s net return.
For a deeper review of these issues, see our guide to Delaware Statutory Trust risks.
Are DSTs regulated investments?
Many DST interests are offered as securities through private placements. If an offering relies on an exemption from SEC registration, that does not mean the investment is unregulated or approved by the SEC. Private placements remain subject to federal securities laws, but they may provide less public information and can be much harder to resell than publicly traded securities.
Accredited-investor requirements also depend on the particular offering. For example, Rule 506(c) offerings are limited to verified accredited investors, while Rule 506(b) can permit a limited number of financially sophisticated non-accredited investors. Investors should confirm the eligibility requirements of the specific DST they are considering.
How should you evaluate whether a DST is appropriate?
Review the offering documents carefully, especially the risk factors, fees, debt terms, tenant information, projected hold strategy, sponsor history, and assumptions behind projected distributions. Pay particular attention to what could happen if occupancy falls, a major tenant leaves, financing becomes difficult, or the property must be held longer than expected.
It is also important to separate investment risk from 1031 exchange qualification. A DST may satisfy the requirements to serve as replacement property in a 1031 exchange without necessarily being a suitable investment for a particular investor.
Instead of asking whether every DST is safe, evaluate the Delaware statutory trust pros and cons of the specific offering. Investors should consider their need for liquidity, tolerance for real estate risk, concentration in other investments, and ability to hold the investment if market conditions change.