How to Evaluate a DST Before You Invest

Most DST investors focus first on the property. But before you invest, it is worth asking a more fundamental question: Who are you trusting with your money?

A Delaware Statutory Trust (DST) lets investors own a fractional beneficial interest in institutional-quality commercial real estate that a sponsor acquires and operates on their behalf. DST offerings span a range of property types, including multifamily, self-storage, senior living, student housing and single-tenant net-lease buildings.

Many investors start by asking whether a DST is a good investment. That question is too broad to answer, because no two DSTs are alike. More useful questions are: Who is behind the investment? What are you actually buying? How is it financed? What assumptions are being made? What are the risks? And does the investment make sense for you?

Start With the People Behind the Investment

When you invest in a DST, the sponsor is responsible for important decisions about the investment, including acquiring the property, arranging financing, overseeing the investment and ultimately determining when and how the property is sold. That makes the sponsor more than just another item on a due-diligence list. You are putting your money in the hands of the people and organizations behind the investment.

Experience matters, but years in business and the number of offerings completed do not tell the whole story. Look at the experience, backgrounds and track records of the key people and firms involved in the investment. This should include looking for regulatory or disciplinary matters, personal bankruptcies, tax liens, judgments or significant litigation that may warrant further investigation.

FINRA’s guidance for private placements specifically calls for reasonable investigation of the issuer and its management and emphasizes independent research, regulatory and litigation history, and following up on red flags rather than relying solely on an issuer’s representations or a firm’s past experience with the issuer. Personal bankruptcies, tax liens, judgments or significant litigation are the types of red flags that warrant further investigation.

This review should include the sponsor and its principals, the managing broker-dealer and its principals, the registered representative recommending the investment, and the broker-dealer that employs the representative and its principals. Depending on their role, other key participants may warrant review as well.

The point of these questions is not to assume a problem exists or that any single finding automatically rules an investment out. It is to uncover information that may raise questions you want answered before investing.

Much of this information can be researched from multiple sources. FINRA BrokerCheck provides information on registered representatives and broker-dealers, while the SEC Action Lookup can provide information on individuals involved in SEC actions. The PPM should provide information about the sponsor, its management and the structure of the investment, and the broker-dealer’s due-diligence materials may provide additional information about the sponsor and key people involved. Investors can also use general internet searches and other reputable research services to look for additional information that may warrant further investigation.

The managing broker-dealer deserves particular attention because it plays an important role in the offering process. It is the firm the sponsor engages and pays to review the offering, assemble the group of broker-dealers whose representatives sell it, and process subscriptions. It is not the firm you deal with directly.

Also consider the history and culture of the organizations involved, including their track record through different market conditions, how they communicate with investors, how transparent they are, and how they approach compliance. The registered representative and broker-dealer may also provide insight into the sponsor’s culture, leadership and history, particularly through their experience working with the sponsor.

Also look for potential affiliations or conflicts of interest among the parties involved, including shared ownership, common management or financial interests.

Look at the Real Estate

Next, understand what you are actually buying.

Consider the property type and location, its age and condition, occupancy, the quality and stability of the property’s income, and the market in which it operates.

Ask a simple question: What makes this property likely to perform well?

A strong property in a market with sustained demand may have a very different risk profile from one whose projected performance depends heavily on aggressive rent growth, unusually high occupancy or other favorable assumptions in the PPM.

Understand the Income and Debt

A property’s income is central to the investment. Understand how that income is generated, how dependent it is on individual tenants or other sources, occupancy levels, lease or resident terms, and the underlying demand.

Then look at the debt. Consider the amount of leverage, interest rate, whether the rate is fixed or variable, loan maturity and debt-service requirements.

Leverage can enhance potential returns, but it can also magnify the effect of lower property values or weaker operating income. Consider what could happen if income declines, occupancy falls or a major tenant leaves. Also understand when the existing loan matures and the potential implications for the investment at that time.

The projected distribution should be evaluated carefully. It is a projection, not a guarantee, and distributions can be reduced or suspended. A higher projected distribution often reflects greater risk, so it should not be viewed as evidence that one DST is a better investment than another.

Review the Offering Documents

Review the offering documents to understand the fees, expenses and other costs associated with acquiring, financing, managing and eventually selling the property. The goal isn’t simply to find the DST with the lowest fees. It is to understand what you are paying and whether the economics make sense for the investment being offered.

The Private Placement Memorandum, or PPM, is an important source of information. Pay particular attention to the risk factors, financing, conflicts of interest, fees, distributions, tax considerations, management and the sponsor’s role.

You don’t need to be an attorney to read a PPM, but you should understand the important risks and ask questions about anything that is unclear.

Understand the Hold Period and Exit Strategy

Understand the expected hold period and exit strategy. A DST is generally a long-term, illiquid investment, and the projected sale date is not guaranteed. The property could be sold earlier or later depending on market conditions, property performance, financing and other factors.

If the property is sold, understand what happens to your investment proceeds, including whether the proceeds can be used in another 1031 exchange and what would be required to do so.

Does It Fit Your Objectives?

After looking at the people, property, income, debt, costs, risks and potential exit, step back and consider whether the investment fits your objectives.

Think about your income needs, risk tolerance, diversification, liquidity needs and time horizon. A DST should not be chosen simply because it has the highest projected distribution or because the 45-day identification deadline is approaching.

The goal of a 1031 exchange is not simply to identify a replacement property before the deadline. It is to find replacement property that makes sense for your overall investment objectives.

The Bottom Line

Start with the people behind the investment. Understand the real estate, income, debt, costs, risks and potential exit. Read the important parts of the PPM and ask questions about anything you don’t understand.

The right DST isn’t necessarily the one with the highest projected distribution or the most attractive property on paper. It is the investment you understand well enough to decide whether the opportunity and its risks make sense for you.

This article is provided for general educational purposes only and does not constitute tax, legal, or investment advice. DST investments involve risk, including illiquidity and potential loss of principal, and are suitable only for accredited investors. Tax treatment depends on individual circumstances. Consult your tax advisor regarding your individual situation. NexTrend Securities is not a tax advisor and does not provide tax advice.