Over the past few years, the co-owned 1031 exchange industry has changed drastically. Some of the more important changes are listed below.
Today, nearly every co-owned 1031 exchange offering is structured as a DST (Delaware Statutory Trust). DSTís have replaced TICís as the structure of choice because most lenders are unwilling to underwrite multiple borrowers (a requirement under the TIC structure). Lenders have embraced the DST structure because it allows them to underwrite a single borrower in a bankruptcy-remote entity. Despite its lender benefits, the DST structure does have some limitations that you need to be aware of. Specifically, the Trustee of a DST (the DST sponsor) is prohibited from certain actions, including:
- Refinancing the mortgage
- Entering into a new lease
- Accepting capital contributions after the initial syndication
- Reinvesting sale proceeds into another property
Because of these prohibitions, some properties are more conducive to the DST structure than others. Most DST offerings involve either multi-family (apartment) properties or single-tenant NNN leased properties. In the case of apartments, the DST Trustee master leases the entire property, which allows them to avoid the prohibition against entering into new leases. The prohibition against refinancing the mortgage means that the DST will most likely sell the property before the mortgage expires. Other things you need to know about a DST include:
- The DST investors do not get to vote on major decisions (like sell the property)
- There is no need to establish or maintain a bankruptcy remote single-member LLC
- Each DST investor does not have to qualify for a mortgage
The Selling Agreement
The Selling Agreement directly impacts an Advisor's ability to recommend a specific property. Here's why. A DST offering is considered a security (not real estate), and is regulated by FINRA (the Financial Industry Regulatory Authority). Before your Advisor can recommend a particular DST offering, his or her securities broker/dealer must review the offering, and sign a selling agreement with the sponsor. Today, many broker/dealers are hesitant to sign selling agreements because of regulatory requirements and liability concerns. This is critical because it could limit your Advisorís ability to recommend properties.
DST offering fees are generally lower than they used to be under the former TIC structure. This is partially due to the fact that a DST doesnít have to establish and maintain an LLC for each investor, and the lender is not required to underwrite each co-owner. It is also because of a recent trend among DST sponsors to become more competitive. Historically, syndication costs have run about 13% of equity (87% of equity ends up going into the real estate). Many recent offerings have reduced fees resulting in 89% Ė 91% of the equity to go into the real estate. There are three main fees you should be aware of, including syndication feed, operating fees, and disposition fees.
TIC's were limited to 35 or fewer investors. As a result, it wasnít uncommon for investment minimums to be several hundred thousand dollars. The DST structure doesnít have this constraint, so investment minimums are usually $25,000 to $100,000. This makes it easier for exchange investors to diversify their investments (within the constraints of the 1031 exchange ID rules).
The role of the Advisor vs. the DST Sponsor
Investors need to understand the different perspectives of the Advisor and the DST sponsor. The DST sponsorís objective is to raise capital for its current offerings. This is far different from the Advisor (Registered Representative), whose job is to help the investor find the best possible replacement property regardless of who the sponsor is. Talking to a DST sponsor is kind of like walking into a Ford dealership and asking the salesman which is better, a Ford or a Chevy?
Unlike the DST Sponsor, the Advisorís job is to look out for the best interests of the investor. To do this, the Advisor needs to understand the investorís objectives, as well as the pros and cons of each offering, the 1031 exchange rules, what can go wrong, and how to prevent it. It is the Advisorís job to be an educator, an advocate, and a good listener. A knowledgeable and experienced Advisor is the investorís most valuable resource.