If you are searching for alternative channels for real estate investing, Direct Participation Programs (DPPs) may be an effective approach to investment diversification. DPPs for property investors are often in institutional quality investments and provide a means to explore possible benefits of a market that is not directly correlated to traditional investment assets.
Direct Participation Programs for real estate investors are usually operated in a structured manner and may entail complex requirements. There are inherent possible benefits as well as risks associated with DPPs. Interested in Direct Participation Programs and how they may be beneficial for your portfolio? Here’s what you need to know.
What is a Direct Participation Program (DPP)?
A Direct Participation Program, sometimes referred to as a direct participation plan, is an entity that operates with a pooled structure, offering investors access to possible business cash flow and tax benefits. The pooled nature of direct participation programs affords investors access to institutional quality properties when they purchase fractional units in a typical program.
The different types of DPPs could include: investment or asset focus, investment entities or registered vs. unregistered DPPs such as in private placements.
How Direct Participation Programs work
Direct Participation Programs are alternative investments that are not directly impacted by the market volatility of traditional investments in the stock market or bond market. They therefore offer an option for investment diversification.
DPP entities are generally operations in oil and gas assets, equipment leasing projects, energy, commodities, business development companies (BDCs) and real estate. The most common types of DPPs are real estate businesses which offer investors the opportunity to own real estate ownership interest in a passive form.
Real estate DPPs are more commonly operated as non-traded Real Estate Investment Trusts (non-traded REITs). The real estate direct participation programs could include investment in affordable housing, development properties, operating properties, land development or mortgage programs.
DPPs generally operate as pass entities in the form of limited partnership, a subchapter S corporation, Limited Liability Corporation (LCC) or a general partnership. Real estate DPPs widely operate in the limited partnership form or Limited liability corporations. What this means for investors is that they have limited liability as regards the operations of the DPP. This limits their losses and liabilities to only their ownership interest in the direct participation program.
As limited partners, investors are not involved in the general management and operations of the DPP. The management of a direct participation program is handled by the general partner or sponsor who oversees the operations and business investments of the program. In some forms of operations, limited liability partners are able to vote in favour of the general partners or vote them out of management.
DPPs usually have no tax liability on a corporate level. A direct participation program’s operational structure enables it to transfer income, losses or capital gains to participation partners and investors on a pre-tax basis.
A binding document such as an investment agreement directs the responsibilities of all parties involved in the direct participation program. The investment agreement generally outlines items such as contribution obligations, allocation of income, loss or capital gain, cash distribution, rights and obligations of sponsors, general partners and limited partners. Some DPP agreements may allow for transfer of ownership interest.
DPPs are relatively illiquid, they do not have a direct market and thus cannot be traded publicly. The pricing of units in a DPP are usually not as transparent as publicly traded financial instruments such as equities. Operational requirements may differ across DPP entities but usually, this type of investment is only accessible to investors who meet certain income and net worth status. Also, due to its illiquid structure, as an investor with interest in a DPP, you would expect to receive possible income in a relatively long term period, from about five to ten years.
Possible Benefits of a DPP
Here are the potential benefits you can tap into as a real estate investor with a Direct Participation Program.
Portfolio Diversification: Direct participation programs can be utilized for portfolio diversification strategies. Investors looking to buy into alternative investments asides their holdings in stocks, bonds, Exchange Traded Funds (ETFs) or mutual funds can diversify with DPP investments.Property DPPs allow for diversification in the real estate market.
Potential Income: Asides diversifying your investment portfolio, investments in a DPP is also driven by the potential income and profits that can be earned through the real estate market and possible property capital gains. Investment properties have the potential for appreciation especially in development properties or land development.
Passive cash flow: The business structure of direct participation programs allows the investors who are limited liability partners to earn passive income. They are usually not involved with the management of the business. The general partner (s) are in charge of running the business operations.
Possible Tax Advantage: An investment in a DPP may provide opportunities for tax deductions and credits especially in the case of losses passed through to the limited liability investor. This tax deduction can be claimed on the taxable income for the year in which you file your taxes. There could also be possibilities of partial deferred cash flow for investments in DPPs.
Institutional Quality Investment: If you have always wanted to participate in real estate investment for high end, institutional quality properties but haven’t been able to do so due to the substantial high costs, DPPs provide a solution for you. With fractional investment value as low as $25,000, you can own interest in institutional quality investments through a direct participation program. The pooled investment form of operations provides access to high valued properties that would have been out of reach.
Limited Liability: Investors in DPPs have limited liability legal status. The losses incurred is capped at their investment principal amount.
Risks associated with Investments through DPP
Direct Participation Programs come with certain cons and risks. Given its mode of operations these are the possible setbacks of real estate investments through DPPs.
Illiquidity: The illiquid nature of direct participation programs is perhaps the most common downside to some investors. Investments in DPPs need to be held for the long term. If you are looking for investments that can be readily sold off within a short period or one to three years, in a public or private market, a DPP may not be the best option.
Accessibility: Due to its complex structure and operations, DPPs are usually only made accessible to accredited investors. Asin alternative investments like a Delaware Statutory Trust (DST), accredited investors are classified based on their annual income, net worth, asset value and/or professional investment knowledge.
Economic Risks: Although real estate DPPs are not directly impacted by the traditional stock or mutual funds market, it can experience losses due to changes in economic factors that negatively affect the real estate market.
Performance risk: As it is with any other investment type, there is no guarantee of consistent income or gains from an investment in direct participation programs. Real estate properties may experience vacancy issues or even devaluations in extreme cases.
Complexity: As an investor, if you decide to include DPPs as part of your investment portfolio, you would need the expertise of financial advisors to simplify the complex nature and implications such alternative investments
Transparency: Due to its structure of operations, non-traded DPPs are not listed on the public stock market and hence there is no much public information about price and performance except what is provided by the general managers of the DPP. This risk of non-disclosure can be managed by carrying out thorough research on a DPP’s historical performance, management practices, mode of operation and quality of real estate properties.
Bottom line on DPPs
Investment in real estate through a direct participation program may provide you with investment diversification benefits and the ability to invest is a different class of asset that is not correlated to the traditional financial markets.
However, you need to ensure that this type of investment suits your overall investment strategies and that the associated risks are considered before delving into DPPs. Partnerships in DPPs run for the long term and thus investors can not readily pull out any gained income in the short run. Also, considering the illiquidity of direct participation programs, you should determine if the possibility of not readily finding a means to sell off your interest in a DPP is an acceptable risk for your portfolio management.
Financial advisors and tax experts are best suitable to provide you with advice on how to incorporate DPP investments into your portfolio as they can provide clarity on tax implications as well as the possible related benefits and risks.
Looking to diversify your investment portfolio and want to consider investment units in a Direct Participation Program that provides you access to institutional quality properties while effectively managing your investments? Please contact the Stax Capital team for more information.
We are a team of highly professional experts and are always available to guide you through the process of investing through a real estate direct participation program.