Whether you are a financial advisor with a client who is interested in Delaware Statutory Trusts (DSTs) or a real estate investor looking to learn more about the benefits of DSTs, here are a few key factors/questions you should consider in order to decide if a DST is suitable for your investment needs.
First of all, every DST offering you’re evaluating should have a Private Placement Memorandum (PPM). It can seem a bit intimidating at first, but the PPM has important details you don’t want to overlook.
Step 1: Consider the Loan Specifications
What is the overall loan to value ratio (LTV)?
If it’s not readily available, as an investor you’ll want to calculate the LTV ratio to ensure that it is suitable for your debt replacement needs.
At a general level, investors will want to evaluate the LTV and the payment schedule to determine if the expected net operating income (NOI) and potential appreciation will support the loan payoff requirements and investor returns.
On the other hand, some investors prefer the benefits of all-cash DSTs and prefer no debt on the property.
How much of the loan payments are interest only?
Some investors prefer to significantly pay down a mortgage amount during the loan term so that the repayment of the loan is not dependent on a stable or appreciated property value.
- These investors seek to earn gains from the sale of the property by having less debt to cover with the sale proceeds.
- Other investors prefer to make minimal payments on the interest-only during the life of the DST.
- These investors have a priority of higher cash flow throughout the life of the DST rather than significant returns upon the sale of the property.
- They may also be concerned with the tax implications of reducing their overall debt obligations that would increase their earned income totals.
What is the debt-service coverage ratio (DSCR)?
While the lender likely has a reasonable belief that the property will produce enough to support the loan payments, an investor may like to verify that the DSCR is at a level to where if the property were to experience a reduced NOI, it would not be at risk of foreclosure, thereby risking the investor’s share.
Step 2: Turn your attention to the financial reserves
How much cash has been reserved? Because the seven deadly sins restrict DSTs from borrowing additional cash or accepting additional equity contributions, DSTs must keep a reserve of cash that can be used in the event the property requires repairs or faces unexpected expenses.
An investor will likely want to determine for themselves that a reasonable amount of cash has been reserved to protect the investment.
What expenses qualify for use of the reserves?
In general, reserves are in place for use on unforeseen expenses that the property may incur.
- In other cases, DST properties may have been purchased with the intent that capital would be used to add value to the property.
- In this case, additional reserves are necessary and will be used on the front end of the investment term.
- In the case of a value-add DST, you should determine if the planned property improvements have a reasonable likelihood of increasing the value of the property to justify the capital expense.
- You should also ask: What will happen to the reserves upon the sale of the assets?
- It is a good idea to confirm that all remaining reserves will be distributed to the beneficiaries once the DST disposes of its assets.
Step 3: Consider the asset and its production expectations
Is a single property DST enough to diversify your portfolio based on the property type and location? Would a multiple asset portfolio DST be more suitable?
You’ll want to decide if the asset suits your individual diversification needs.
Can the property produce a satisfactory income to overcome the load within the expected timeframe?
You may want to look at the lease structure and rental bump schedule to verify the property’s ability to produce sufficient income.
Will the property be desirable to buyers at the end of the investment term?
You should consider the NOI growth expectations to see how the property’s future capitalization rate will appeal to future buyers.
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