Understanding DSTs: An Investment Option for Passive Income and Long-Term Growth Potential

If you have the financial resources, buying a commercial property can be a strong investment for generating income. Properties such as office buildings or shopping malls, which are leased to businesses or corporations, often come with long-term leases that provide stable income over several years. Typically, tenants cover most costs, including any non-essential construction or improvements within their own spaces.

However, commercial properties require a large amount of capital to purchase individually or with others. Delaware Statutory Trusts (DSTs) offer an alternative that gives investors a fractional interest in a trust that already holds a property or properties. This is useful for investors interested in deferring capital gains through a 1031 exchange when looking to purchase a new investment property.

What is a Delaware Statutory Trust?

A Delaware Statutory Trust is an ownership structure in which investors each hold interest in the property in the trust. The trust is established by the DST sponsor who purchased the property originally. As individuals continue to invest, their investments eventually overtake the original capital used to purchase the property until they fully own it.

In a DST, the investors act as beneficiaries, while the legal title and management duties are handled by the DST sponsor or trustee. This structure allows investors to gain passive ownership in a commercial property investment at a relatively low cost.

Benefits of a Delaware Statutory Trust 

DSTs eliminate the usual responsibilities of managing investment properties. As a passive investment, often referred to as an "armchair investment," a DST allows individuals to own fractional shares in institutional-grade properties without the hassle of day-to-day management. Investors have no management or day-to-day responsibilities related to the property or properties. This can be attractive to investors who are looking to take less direct responsibility in relation to their investments. 

Properties within a DST often tend to be larger and more expensive properties, like industrial properties. This allows investors to diversify their portfolios with properties that could be too expensive to buy in full. They can also spread their funds across different investments instead of placing all funds in one property.

Investors are also not liable directly in case of a default on the property, as the debt is non-recourse. This offers a level of protection to those interested in investing. However, a DST may not be suitable for investors looking for short-term property investments, as these investments are generally intended for holding periods of two years or longer.

Considerations Before Investing in DSTs

Although DSTs can offer many benefits, there are some potential considerations before deciding whether a DST is right for you. For example, as previously mentioned, DSTs are a longer-term investment. This means they are illiquid assets and cannot be utilized as cash or funds as easily as other investment types. 

The lack of management ability may be a downside for some investors, as individuals have no authority related to strategic decisions. So, if the sponsor is making decisions that investors don’t agree with, they can’t do anything about it. In addition, there is the risk, as with all real estate properties, that market fluctuations can cause a downturn in the investment’s profitability. 

Note that DSTs are designed for accredited individuals as defined by the SEC. Those interested in a DST should conduct their own due diligence on the sponsor, property, and other aspects of the trust.

DSTs and 1031 Exchanges

1031 exchanges require the sale of a relinquished property and the purchase of a replacement property. DSTs qualify as direct property ownership; therefore under IRC Section 1031, they qualify for a 1031 exchange.  Individuals can invest in a DST as the replacement property or sell it as the relinquished property. Like other replacement properties, DSTs can be the entire investment, or funds can be spread through multiple DSTs or other properties that qualify.

The Bottom Line

DSTs offer a unique opportunity for investors seeking passive income and long-term growth potential, especially for those looking to defer capital gains through a 1031 exchange. By providing fractional ownership in properties without the burden of day-to-day management, DSTs can be an attractive option for investors who prefer a hands-off approach.

For accredited investors, DSTs can be a valuable addition to a diversified investment portfolio, offering both stability and the potential for growth. As with any investment, careful consideration and due diligence are essential to ensure that a DST aligns with your financial goals and risk tolerance.