There are various ways to invest and take advantage of possible benefits in the real estate market. Two popular investment vehicles that provide opportunities for investors in property investing are the Real Estate Investment Trust (REIT) and the Delaware Statutory Trust (DST). These investment platforms provide a passive means of owning interest in real estate property.
A comparison of Real Estate Investment Trusts (REITs) vs Delaware Statutory Trusts (DSTs) involves analyzing certain factors that are specific to each investment vehicle as a result of their operational structures. It is important to understand how REITs and DSTs operate and the benefits or risks associated with each investment option. While both of these investment vehicles possess some similarities, there are operational differences with how they managed. Understanding how they work is important in deciding what works best for your specific investment goals.
It is quite understandable why many investors are curious about these two types of real estate investment given that they both happen to be ‘Trusts’ for the purpose of property investment. This review of how DSTs and REITs operate would provide details on the way they work, thus helping you in your REITs vs DSTs investment decision.
Delaware Statutory Trusts operate as entities formed for property investment purposes. DSTs identify as separate legal entities; this means the beneficial owners of interest in the trust have limited liability status as regards the operations and assets of the trust.
DSTs provide an alternative route for investors looking to diversify their investment portfolio through the real estate market. The DST investment vehicle allows accredited investors to tap into possible advantageous opportunities associated with property investment.
Delaware Statutory Trusts are usually set up by sponsors and managed by trustees or managers who oversee the acquisition and management of real estate property under the trust. Investors become beneficial owners in the trust by purchasing investment interest. The ownership interests in the DST provide investors with distributed income from the trust, usually in proportion to their investment.
Investors are made aware of any binding terms and conditions outlined in the trust agreement also known as the governing instrument. The investment agreement for DSTs outlines the responsibilities of sponsors, managers and investors. It also provides information of ownership interest income, gain or loss allocation.
As an investor, you have access to fractional units of high valued institutional quality properties in different niches such as retail, commercial and residential real estate portfolios. Investments in these properties through the DST vehicle can qualify as a 1031 exchange provided all requirements are met. This provides potential capital gains tax deferral benefits for investors.
Pros of DSTs
Investors have access to highly valued properties for a fraction of the cost
Qualify as 1031 like-kind exchanges and may offer tax deferral benefits
Provide a means for passive income for investors who want to stay away from the day to day property management required for most real estate investments
Cons of DSTs
Similar to other forms of investments, DSTs offer no guarantee for returns
DSTs are illiquid and are more suitable for long term investors
Can be affected by economic and legal risks
DST investments attract management fees
Real Estate Investment Trusts have existed for over fifty years and continue to provide investors with a means to invest in the real estate market. Investing in REITs involves purchasing interest in a company that primarily owns real estate properties for the purpose of generating income. Real estate investment trusts allow multiple investors to buy into the company in return for investment income through dividends.
REITs that are registered with the Securities Exchange Commission (SEC) and publicly traded through the stock exchange market are known as publicly traded REITs. An active public market for REITs makes them relatively liquid and enables investors to buy or sell fractional interests in real estate property as opposed to direct investments with highly illiquid characteristics. There is also the option to invest in non-exchange traded REITs. This type of REITs is considered illiquid.
REIT companies invest in diverse real estate properties, retail buildings, commercial properties or residential apartments. Some REITs specialize in specific property niches while others have portfolios with various property types. Types of REIT include equity REITs, Mortgage REITs or hybrid REITs (A combination of equity and mortgage REITs).
The main purpose of REITs is to generate net rental income through investment properties that become distributed as dividends to share owners in the company. A REIT may own and operate property or finance property as in the case of a mortgage REIT. REIT companies are expected to distribute at least 90 percent of taxable income as dividends to its investors.
Additionally, for a company to qualify as a REIT, it must meet certain requirements which include being managed by a board of directors or trustees, having a minimum of 100 shareholders after the first year of operation, having transferable shares, investing at least 75 percent total assets in real estate assets and cash, being taxable as a corporation and deriving at least 75 percent of its gross income from real estate related sources amongst others.
Pros of REITs
A means for portfolio diversification for investors
Provide passive earnings for investors
Public traded REITs can be sold on the stock market
Cons of REITs
Value of shares in a REIT company can fluctuate due to market volatility
There could be some illiquidity risks associated with REITs especially for non-traded REITs
No guarantee for returns
May require investment fees
REITs and DSTs provide investors a passive form of investing in real estate. Investors have access to potential benefits of property investment without getting directly involved in active hassles of management, maintenance and dealing with tenants. This may however mean that investors get charged management fees.
Also, both investment vehicles do not provide investors with direct ownership of specific properties, creditors are not able to claim remedies on properties invested in through REITs or DSTs. They both offer income payouts that are taxed in the hands of the investors.
REITs and DSTs have some differences inherent in the mode of operation. These real estate investment vehicles have different investment structures. DSTs are usually only accessible to accredited investors who are able to invest a minimum of $25,000. REITs on the other hand can be explored with lower value investments in the low thousands.
Additionally, to invest in DSTs, you need to be an accredited investor. The Security Exchange Commissions (SEC) classifies individuals as accredited investors based on income, net worth and professional experience or knowledge.
For example, individual Investors with income greater than $200,000 for two most recent years and expected to at least remain in this income band for the current year are considered eligible to invest in DSTs. Also, certain organizations that own assets with total value greater than $5,000,000 may qualify to invest in DSTs. REITs do not have these net worth restrictions making them more accessible to general investors.
Public REITs can be traded on the stock exchange market, but this means that the value of investment is subject to market volatility. DSTs on the other hand are not listed, just like non-traded REITs, they do not have an active market and are therefore illiquid. This makes it difficult to sell off an investment to another party.
A major notable difference is the ability of a DST investment to qualify as a 1031 exchange. Investors looking to dispose of existing property may be eligible for capital gains deferral if they make a 1031 exchange with investment in DSTs. Investing in REITs does not provide real estate investors with this benefit.
In making the decision on which real estate investment platform to utilize for portfolio diversification, the REITs vs DSTs comparison comes down to certain factors such as accessibility, risk appetite and investment objectives.
The most compelling advantage of DSTs is that direct ownership interests qualify as 1031 like-kind exchanges and investors with substantial amounts of capital gains can defer taxes on these gains.
While DSTs provide a means for accredited investors to purchase interests in institutional quality properties, it is important to note that this type of investment is highly illiquid and cannot be sold on an exchange market.
Both REITS and DSTs are good options for real estate investment, the most suitable option is dependent on what objectives an investor is trying to achieve while also putting into perspective the exclusiveness of DST investments to only accredited investors.
Investors may need to consult with financial advisors to assess their financial situation and consider any tax implications associated with both investment vehicles in other to make the best investment decision.
Need to discover more about DST investments? You can contact the team for opportunities to take advantage of possible tax deferrals through DSTs or Direct Participation Programs through real estate investment trusts. The professional team at Stax partners with you to explore wealth management strategies that are suitable for you as a real estate investor.