In our recent blog on UPREITs, we mentioned that some Delaware Statutory Trusts (DSTs) may utilize an exit strategy that involves a 721 exchange into an UPREIT. Since this type of exit strategy is just one way DSTs dissolve their assets and provide a return to beneficiaries, we thought we’d briefly discuss some of the considerations that go into determining an exit strategy.
DSTs typically come full-cycle in a 5-7 year period. At the end of the cycle, the DST must dispose of its real estate asset(s) before it can distribute all final income to the beneficiaries. How the DST disposes of its assets may vary from one trust to another.
Today, a majority of DSTs are created to benefit 1031 exchange investors. That means that not only do DST sponsors ensure the DST is established in such a way that it will qualify to serve as the replacement property for 1031 exchangers when they acquire beneficial interest in the trust, but they also ensure to dissolve it in such a way that exchangers can complete a 1031 exchange upon their exit from the trust. To do this the real estate asset(s) must be sold.
Almost all potential exit strategies involve selling the real estate assets. Therefore, the DST fund managers have a responsibility to not only acquire properties that will produce income during the life of the fund, but to acquire properties that will also maintain resale value so the exit strategy can be accomplished in the stated timeframe. To do this, managers must know the types of potential buyers their properties will attract and then how to manage the property in a way to attract those buyers.
Because DST portfolios consist of high-value, investment-grade commercial properties, potential buyers of these properties typically include high net-worth investors such as Real Estate Investment Trusts (REITs), institutions, pension plans, other real estate investment funds, and ultra-high net worth individuals.
These types of buyers have specific requirements for the properties they consider acquiring. The good news is that most DSTs have equal or even greater requirements for the properties they will acquire. DSTs aim to acquire high-valued, investment-grade properties with long-term, triple net lease agreements that include annual rate increases with single credit-rated tenants. These types of investments tend to be more secure because of the stability of the tenant. They have greater profitability because of the long-term, accretive nature of the lease terms. By executing a DST that operates by these standards, DST fund managers will operate properties that will increase in value over time, maintain their appeal to potential buyers, and be sold according to the exit strategy.
As an alternative to selling the real estate assets, as we mentioned in our UPREIT blog, some DSTs may utilize an exit strategy that disposes of its property by contributing it to an UPREIT in exchange for units of interest in the UPREIT. DST beneficiaries, in return, exchange interest in one property for interests in a large portfolio of properties on a tax-deferred basis.
Whether a DST plans to sell or contribute its property at the completion of its cycle, it is important for you to know the expected exit strategy, so that you are sure to be left in a position to make whatever future investments you have planned.
