Delaware statutory trusts (DSTs) are a new breed of leasing tool that may benefit net lease situations and others, according to experts. A DST is formed when a property or group of properties is overseen by a trustee. The arrangement provides many benefits for lessors and owners, not least of which are tax deferments and asset protection due to recent changes in tax law. Lenders also like them because it consolidates responsibility and power over the property into one presumably knowledgeable body, although some investors dislike them for the very same reasons. For more on this continue reading the following article from National Real Estate Investor.
Finding ways for multiple investors to join forces and buy net lease assets has been a challenge for the sector. The tenant-in-common structure used in the boom years has fallen out of favor. But now Delaware statutory trusts (DSTs) are becoming a popular option for investors.
In real estate, DSTs are formed as private governing agreements under which a property or several properties are held, managed, administered, invested and/or operated for profit by a trustee for the benefit of the trustor. Interest in DSTs has grown over the last decade, and especially following IRS rulings in 2004 that increased its advantages in connection with tax deferral, asset protection, and balance sheets
Panelists at NREI and RetailTraffic.com’s National Net Lease Investment Conference, held in Chicago on Nov. 1 and attended by more than 150 commercial real estate pros, offered a general overview of DSTs and provided a detailed discussion of how DSTs can dovetail effectively with net lease investments.
The panel discussion opened with Thomas B. Jahncke, senior vice president at PassCo Capital, posing the question: “Why are we talking about DSTs at a conference on net lease properties?” He then proceeded to begin to answer the question by outlining the advantages that they can provide.
“Lenders like them because you have one borrower that you are dealing with—the trust—and usually the sponsor is the trustee,” Jahncke said. “The investors have the advantage that there is no recourse, no involvement in management.”
However, Jahncke noted, there are negatives as well. Investors don’t have as much say on the operation of properties. “The sponsor decides when to sell and how to run the properties,” he said. “There are tradeoffs, but investors today appreciate the DST for the tradeoffs, more than in the past.”
Also key are the tax benefits that DSTs enjoy as a result of the 2004 IRS ruling. Because of this, explained Jahncke, “We are tapping into a certain kind of investor market—providing an investment vehicle that looks like a partnership for people who are doing 1031 exchanges.”
Investors can roll into these deals as 1031 exchange investments and be doing so by rolling out of their old real estate investments.
“Now, the price for that is significant restriction on what the DST can do,” emphasized Meier. “The DST cannot raise new capital, it cannot refinance any loan that it has, it cannot renegotiate leases. It has to hold only reasonable reserves. It cannot bring in new investors. There are these relatively strict restrictions.”
However, despite this, Jahncke explained that there is a nice match between DSTs and net lease in that “a DST fits fine with a net lease property,” explained Jahncke.
In fact, “it is exactly those restrictions that make DSTs perfect for net lease property, because net lease property typically is a sale-leaseback, or something which more of a set-it-and-forget-it type of property,” added Meier. “Unless you are dealing with a tenant that goes bankrupt—like a Borders—most of the time we are dealing with relatively safe credit companies, like Walgreen’s or CVS or a grocery store. For those types of properties, the DST is really ideal.”
“If you are buying a grocery-anchored shopping center or even a shopping center that is anchored by a Kohl’s with a 20 or 25 year lease, we are able to secure longer-term financing and build up the reserves through cash flow,” explained Rahul Sehgal, senior vice president of Inland Private Capital.
Another attraction of a DST is that forming one is relatively simple and inexpensive when compared to more complex filings of other entity types, although still has its quirks. It considered investing in a security rather than in real property, although taxed as real estate.
“This is a security for security law purposes. But tax is its own universe, so for tax law purposes, when a DST is designed properly, is treated as a direct ownership interest in the underlying real estate,” said Steven R. Meier is co-chair of the real estate securities practice at Jenner & Block. “So there is a dual purpose going on here—it is a security for securities law purpose, but a direct interest in real estate, for tax law purposes.”
Interest in DSTs also is like to get a boost from provisions in the Jumpstart Our Business Startups Act (JOBS Act) that are expected to loosen regulations that apply to DSTs.
“What you are going to see with the Jobs Act is that the potential for those portfolios will grow, because now you are able to bring more investors into the deal,” said Marc D. Goldstein, president of Covington Realty Partners.
This article was republished with permission from National Real Estate Investor.