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A little clarity for your next decision.
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Investor WorkspaceA little clarity for your next decision.
By Jerry Baker
There is no single right number of Delaware statutory trusts, or DSTs, to own. A useful mix depends on your finances, the size of each investment, the risks behind the properties, and the rules of your 1031 exchange.
When someone asks me how many DSTs they should buy, I want to understand why they are asking. Are they worried about one tenant leaving? Do they need monthly income? Are they trying to avoid putting a lifetime of savings in one investment? Those are different problems. A longer list of offerings does not answer all of them.
The SEC explains that an asset mix should reflect your goals, time horizon, and ability to accept loss. It also draws a useful distinction between spreading money across asset classes and spreading it within one asset class. Several DSTs may broaden your real estate holdings while leaving much of your wealth tied to real estate. [1]
Start with your full financial picture. Include cash, retirement accounts, a business you own, other rentals, and debts. Keep your home separate from the money you expect to spend in retirement. Then ask what share of your resources you could leave in an investment that may be hard to sell.
A 1031 exchange adds tax rules to that discussion. Keeping some sale proceeds for yourself can create taxable gain. That does not mean full tax deferral must outweigh every other need. Have your tax adviser compare the tax cost of keeping cash with the risks of committing money you may need soon. [6]
A DST is an ownership structure. The name does not tell you how many buildings, tenants, or markets sit inside it. One offering might own a single property. Another might hold a portfolio. The trust agreement, property schedules, and private placement memorandum, or PPM, should explain what you would own.
Consider two hypothetical choices. One portfolio has three DST interests backed by 24 properties. Another has six DST interests backed by six properties. The second has more trust names. The first has more properties. Neither fact tells us which portfolio is better.
The 24 properties could all serve the same tenant. The six could have six separate tenants but sit near the same major employer. Either group could depend on one management team. Look through each trust to the factors that could affect its rent, expenses, debt payments, and eventual sale.
FINRA warns that holdings can share risks through the same sector or region. It also identifies concentration in investments that are hard to sell as a separate concern. Different labels do not remove those links. [2]
I would make a map before choosing a target count. List each property, its use, its major tenants, and its share of the offering. If that information is missing, mark the gap. An unknown exposure should not quietly become a zero in your analysis.
Four investments do not create four equal risks unless you invest equal amounts—and even then their risks can differ. A portfolio split 60%, 20%, 10%, and 10% still relies heavily on its largest position. An equal split would put 25% in each. Those are different decisions despite the same count.
Here is a simple cash-flow stress test. Assume a $1 million portfolio, with each investment paying a hypothetical 5% annual distribution on invested equity. That would produce $50,000 a year before personal taxes. The rate is an illustration, not a quote or forecast.
With 60% invested in one DST, that position supplies $30,000 of the annual cash. If it stops paying while the others keep paying at the assumed rate, cash falls to $20,000. With four equal positions, one pause would reduce annual cash to $37,500.
The equal split performs better in this one test. It does not prove equal weights are always best. Two or more investments could struggle at once. An apparently small position might have more leverage or weaker tenants. A distribution can also include money that is not current operating profit.
Use this exercise to connect a portfolio to your budget. Could you still cover essential expenses after a large distribution cut? For how long? Do you have funds outside the exchange to bridge that gap? Testing lost income often reveals more than comparing a blended target yield.
Also test a loss of principal. A portfolio that sends enough cash this year can still sell for less than you invested. Income needs and the ability to bear a capital loss deserve separate answers.
When assumed distribution rates differ, calculate the share of cash coming from each position too. Suppose two investments each receive $200,000. One is shown at 4% and the other at 8%. The illustrated annual payments are $8,000 and $16,000. Each holds half your equity, but the second supplies two-thirds of the illustrated cash.
Those rates are made-up numbers chosen to show the math. They do not describe available investments or the return you should expect. The larger payment may depend on different risks or sources of funds. Review those sources before treating either payment as reliable income.
Sponsor and operating team. List the firm running each offering and any common parent company. Then identify the property manager and key service providers. Two sponsor brands may still depend on the same people. Multiple sponsors can also use the same local operator.
Property use. Apartments, warehouses, retail properties, and other assets earn money in different ways. Study those differences rather than treating each sector name as a shield. A rent increase plan, a tenant renewal, and a lease-up plan each require something to go right.
Location. State names are a starting point. Ask whether properties depend on the same employers, face similar storm risks, or compete with similar new construction. Buildings across a state line can share a local market. Buildings within one large state can face very different conditions.
Tenants. Combine exposure to the same tenant across offerings. Check which legal entity owes rent and whether a parent has guaranteed payment. A familiar brand on the building is not enough to establish who must pay under the lease.
Financing and timing. Put loan maturities, major lease expirations, and planned sales on a calendar. A portfolio can look varied today while several major events cluster in the same year. Planned sale dates remain estimates, so test delays as well as the sponsor's base case.
These checks are a way to organize due diligence, not a formula that measures every risk. Shared exposures may be acceptable if you understand them and size them deliberately. The problem is discovering them only after several investments face the same setback.
An equity allocation shows where your invested cash goes. It does not fully describe the property value and debt tied to that cash. Different loan-to-value ratios, or LTVs, can change the picture.
Suppose you put $200,000 into an all-cash investment and $200,000 into an investment with 60% LTV. For this simplified example, ignore fees and assume LTV uses the same property-value basis throughout. The all-cash position represents $200,000 of property value. The leveraged position represents $500,000: $200,000 equity plus $300,000 debt.
Together, you have $400,000 of equity, $300,000 of debt, and $700,000 of property value. Combined LTV is $300,000 divided by $700,000, or about 42.86%. Averaging 0% and 60% would give 30%, which is not the combined result.
Real offering prices, costs, values, and allocated debt require careful review. Use matching definitions and figures from the same date. A reported property-level LTV may use a different denominator from the figure used to plan an investor's exchange.
The example explains why I want both views. Half the equity went into each investment, but the leveraged position accounts for more of the gross property exposure. It also has loan obligations. The all-cash position avoids that loan risk but still faces property, tenant, expense, and sale-price risk.
For the exchange itself, have your adviser and qualified intermediary confirm the replacement value, cash investment, and debt treatment. A portfolio risk calculation is not a substitute for the tax calculation.
Each offering sets its own minimum investment and may have other limits or required increments. Do not treat a commonly advertised minimum as a rule for every DST. Read the subscription terms and confirm what the sponsor will accept.
If you have $300,000 to invest and every suitable offering on your short list requires at least $100,000, that menu allows at most three positions. That is arithmetic, not a recommendation to buy three. You might find only two that meet your standards. Fees, availability, debt needs, and required increments can further affect the plan.
Now consider a larger exchange that could meet the minimum for ten offerings. Buying ten creates more documents to review and more investments to follow. The next addition should have a clear role. What risk does it reduce? What useful feature does it add? What new risks and costs come with it?
I do not want an investor buying a weak offering because there is an empty slot on a five-investment worksheet. First decide which opportunities merit consideration. Then decide how they work together. The count should emerge from that work.
Confirm availability again before committing funds. A place on a marketing list is not the same as an accepted subscription or a completed purchase. Build a plan that fits the actual closing process.
Compare fees at the proposed dollar amounts as well. Several investments may each have costs embedded in their offering price, ongoing charges, and sale expenses. Count the dollars and understand what services they pay for. Buying more positions does not, by itself, prove that total costs are higher or lower. The actual terms decide that.
Keep rejected choices out of the plan even when time is short. A backup should be something you would be willing to own after a full review. It should not be an offering you already ruled out, revived only because it is still open.
A diversified investment plan still has to meet the exchange rules. In a typical deferred exchange, replacement property must be identified within 45 days after the transfer of the relinquished property. Identification generally requires a signed written document delivered to a permitted recipient. Receipt must occur by the earlier of 180 days after that transfer or the due date of the applicable tax return, including extensions. [3]
The identification rules offer several paths. Under the three-property rule, you may identify up to three properties without regard to their fair market value. Under the 200% rule, you may identify more than three if the total identified value does not exceed 200% of the value of the property you gave up. The regulation specifies when those values are measured. [3]
If an identification exceeds both limits, the 95% exception may matter. It generally requires receiving at least 95% of the aggregate fair market value of all identified replacement property, subject to the regulation's measurement rules. That is a demanding rescue provision, not a casual way to list every possible option. [3]
For a simple illustration, assume you sold one property worth $1 million. Four separately counted replacement interests valued at $350,000, $400,000, $450,000, and $500,000 total $1.7 million. That is within a $2 million 200% limit. Adding a $400,000 backup raises the total to $2.1 million. The backup changes the result even if you hope never to buy it.
Do not automatically count every DST subscription as one property. Revenue Ruling 2004-86 treats qualifying interests under its specific facts as interests in the underlying real estate. A portfolio DST can raise questions about how the real estate is described, counted, and valued for identification. Have your qualified intermediary and tax counsel settle those questions before you sign the identification. [4]
Use the value of the real estate interest being identified, not merely the cash you plan to contribute. Debt can make those amounts quite different. Have the final list checked as a whole, including backups and any property already received during the identification period.
The SEC warns that private placements may be difficult to resell and may require investors to hold them for a long time. Private investments can also involve limited disclosure and a risk of losing the investment. Several DST holdings do not create a reliable source of emergency cash. [5]
That matters when applying familiar portfolio advice. With publicly traded investments, rebalancing may involve selling one holding and buying another. A DST interest may have transfer limits, require consent, lack a ready buyer, or attract a deeply discounted bid.
Nor should you assume you can send more money into an existing DST whenever you wish. Revenue Ruling 2004-86 describes limits on the trustee's powers, including accepting additional contributions. Review the actual structure rather than treating it like an open-ended investment account. [4]
A review still has value even when you cannot trade. Track changes in rent collection, occupancy, reserves, debt, distributions, and planned sale timing. Compare sponsor reports with the assumptions you relied on at purchase. Ask about differences instead of simply filing the statements.
You can also update your household plans. A delayed sale may change when you can make a major purchase. A lower distribution may require changes elsewhere in your budget. Discuss those choices with your advisers before a cash shortage forces a rushed decision.
Every added investment brings documents and decisions. You need to understand its fees, risks, reporting, tax information, and exit terms. More holdings can be useful, but more paper is not proof of better diversification.
Create a single record for each position. Keep the final PPM and amendments, signed subscription documents, closing information, tax basis records, and sponsor contact details. Record where distributions are sent and who should receive notices if your contact information changes.
Ask your CPA what tax reporting the actual holdings require. Multiple properties or states can add work. Do not assume one DST always means one state return or one specific tax form. Your tax status, ownership, and the properties matter.
Make the records useful to a spouse, trustee, or other authorized person who may need to help. A folder full of offering names without ownership and contact details can be hard to use. Limit access to sensitive records while making sure the right person can find them when needed.
For each candidate, I would write down these items in one place:
Then compare the proposed mix with the rest of your finances. Run a few clear tests: the largest position stops paying; several properties face higher expenses; a planned sale is delayed; one investment sells at a loss. These are hypothetical exercises, not predictions.
Finally, explain the choice in plain English. “We chose four because these four serve different purposes at sensible sizes” is more useful than “four is the standard number.” If you cannot explain what the last investment adds, the portfolio may need more thought rather than another position.
No. There is no universal count that makes a portfolio suitable. Your exchange size, existing assets, cash needs, available offerings, and underlying risks matter. A suggested range can start a discussion, but it cannot replace a review of the actual investments.
It can provide exposure to multiple properties or tenants if it actually owns them. Review the size and risk of each exposure. You may still depend on one sponsor, one sector, shared debt terms, or common markets. A portfolio label alone does not establish broad diversification.
Not automatically. Equal amounts make position sizes easy to track, but the offerings may have different risks and purposes. Test how each allocation affects income, potential losses, debt, and exchange requirements. Smaller allocations do not make unsuitable investments suitable.
No. It is one identification rule, not a lifetime ownership limit. Other identification paths may permit more replacement properties. The treatment of interests in a portfolio DST needs careful review. Have your intermediary and tax counsel confirm the property count and values for your exchange. [3] [4]
No. They may spread certain risks, but losses remain possible. Different properties can suffer at the same time. Debt, expenses, weak tenants, market changes, and poor sale results can affect more than one holding. Private-placement risks remain even when the portfolio has several positions. [5]
Do not plan on that. Transfers may be restricted and buyers may be unavailable. Read the offering documents and discuss liquidity before investing. You should monitor the portfolio, but monitoring does not create a right to sell or receive your capital back on demand.
Bring your estimated exchange proceeds, debt paid off, sale date or expected closing date, income needs, and a broad picture of your other assets. Include known upcoming expenses. Your adviser can then assess actual options with your qualified intermediary and tax adviser.
Educational information, not an offer or a personal tax, legal, or investment recommendation. Examples are hypothetical and omit stated adjustments. Tax treatment depends on your facts and current law. Review your transaction with your CPA, attorney, and qualified intermediary. Real estate investments can lose value and may be illiquid.
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