First-time DST investors frequently have questions about selling their individual DST investment before the entire DST sells. Most have an understanding of the DST investing timeline (exchange into a management-free DST for income and appreciation, wait for the DST sponsor to put the property on the market where ideally, it sells for a handsome profit, and do another 1031 exchange). The DST sponsor/trustee is responsible for deciding when to sell the asset, and investors have no control over when an asset is sold. For reasons explained in this article, we recommend holding DST Investments until the entire property is sold, rather than selling early.

We understand that financial emergencies occur, and investors may find themselves needing money from less liquid investments, but the reality is that DSTs are far less liquid than individually-owned real estate investments.

DSTs & Illiquidity

The pool of potential investors/buyers of individual DST interests is often limited to the co-investors of that particular property and/or investors who work with specific advisory groups who specialize in this “secondary” market. Additionally, DST interests can only be purchased by accredited investors, which can limit the pool of investors further. Because DST offerings have many fractional owners, they do not have legal restrictions on the number of accredited investors who can participate, but there are usually self-imposed, pre-defined caps ranging from 99 to 499 investors.

There is no public market for DST interests and no MLS or online platform where they can be bought and sold quickly and easily. Without outside investors and broader public access, akin to what is available for traditional real estate investments, DST investors have an extremely limited pool of potential buyers if there is a need to sell early.

In an effort to remedy this, several investment advisory groups have created a secondary market for DSTs, but data on how successful they have been is extremely limited. As a DST investor, and someone who is interested in and personally purchased secondary interests, I have been unable to find a reliable source of information and statistics.

If an investor is interested in doing a 1031 exchange into a DST for the purpose of holding for a short period of time (i.e., one to two years), they should seek a different investment option. A fractional interest in a well-performing DST investment property might hold its value, but in my experience, an investor selling their interest in a DST gives up most, if not all, of the potential profit they might receive if they had waited for the entire property to sell. 

Depending on the investor’s particular experience and area of expertise, they would be better off choosing direct ownership of real estate, rather than attempting to use DSTs for short-term holds. Residential real estate investment properties (SFRs, condos, townhomes, etc.) have the highest level of liquidity for individually owned real estate. Even with the recent slowdown in the housing market, the average days on the market for residential properties is 43 days (Sources: NAR, Realtor.com, Redfin).  These types of properties have the largest pool of buyers with a variety of needs (investors, primary residence, vacation homes, second homes, etc.) and are easy to access via online platforms. Larger commercial properties appeal to specific groups of investors, and sometimes they even have their own MLS or online platform, such as Co-Star or LoopNet. DST investments do not. 

Preservation of Principal

An underperforming DST investment, particularly one with leverage, may have little to no value. At the forefront of our property, sponsor, and investment analysis is the phrase: “preservation of principal.” Avoiding potentially underperforming DSTs is crucial, especially if an investor may need to sell their interest earlier than expected.

Hybrid DST investments are particularly vulnerable to underperformance and are considered more high risk, including assisted living or memory care facilities, single-tenant retail, student housing, and medical office buildings.

Let’s take an example of an assisted living DST where the sponsor and operator are facing income and expense challenges resulting in a drop or suspension of distributions. If an investor needs to sell their interest in one of these properties, their value may drop to pennies on the dollar.

Comparatively, let’s now consider multifamily DSTs. Even an underperforming multifamily asset should maintain value closer to the original investment amount when compared to many commercial and hybrid property types. There is high utility value in multifamily properties (i.e., people will always need somewhere to live), and this is considered by both large and small multifamily DST investors. Now that many people are working from home, the utility value for apartments has increased even more. Although DST multifamily properties experience ebbs and flows through cyclical periods of demand, pricing, and occupancy, they will always have value. 

Multifamily and residential rental rates have only briefly declined nationally since the 1960s despite the eleven recessions the economy has experienced in this time frame. Local markets and even entire states have suffered periods of rent declines, but nationally, rents have not dropped more than a couple hundred basis points for a year or two (Average Rents). These were periods with an oversupply of housing and wage deflation as well, which stand in contrast to our current economic dynamic.

DST Secondary Market

Given the small pool of potential buyers, the most common buyer for a secondary interest is a fellow co-investor who is already familiar with the property, sponsor, and performance.

As the owner/seller, you determine the price for your DST interest. The price will be based on the property’s performance, recent transaction pricing, investment structure, historical performance, market trends, and larger economic conditions. Most investors who are interested in buying secondary interests are in search of a bargain, or at least a discount, and they are in a position to request it because they understand the leverage that comes from a limited buyer pool. However, it is entirely your decision to accept or reject an offer from a potential buyer.

The IRS recognizes and allows fractional or partial interests to be discounted because of “Lack of Control” and “Lack of Marketability.” Many trusts and estates benefit from discounted values of fractional interest when transferring (and gifting) property between individuals and trusts. 

If you intend to sell your DST, these are the steps to follow:

• Contact the advisor who facilitated the original DST closing.
• The advisor will coordinate the liquidity process with the sponsor. The sponsor does not charge a fee for the initiation of this process, but may charge a fee once the actual transfer takes place. 
• Generally, current interest owners have the first right of refusal.
• If a buyer is confirmed, the sponsor will proceed with the transaction and transfer paperwork.
• The seller’s proceeds will be subject to applicable taxes.
• If the sponsor cannot find a buyer within the DST, they will often notify investors in other DST investments they sponsor.
• If no buyers are found, the investor will need to look elsewhere, but there is no guarantee you will find a buyer.

As mentioned above, attempts have been made to create a secondary market for DSTs. However, the liquidity is still extremely limited, and anecdotally, data regarding the results is unreliable. There is some suspicion that these secondary markets were merely created as a way to solicit new business, not to actually facilitate DST sales.

If you acquired DST interests as part of a 1031 exchange or plan to conduct another 1031 exchange upon selling your current DST interests, the IRS may look into how long you owned the current DST. Typically, the “safe harbor” holding period for a property involved in a 1031 exchange is at least two years. It is wise to consult a tax professional before selling any DST interests.

What to Look For & What to Avoid 

We recommend against investing in a DST investment property if you foresee selling your fractional DST interest before the entire property sells. However, we understand that sometimes investors need money from less liquid investments, and selling cannot be avoided.

Whether you find yourself in the position of having to sell early or you hold the investment until the property sells, our advice for analyzing and selecting DST investments remains the same:

• Invest in the best properties with the best sponsors – no exceptions.
• Avoid hybrid asset types with higher cash flows. 
• Avoid sponsors who have a higher risk of management.

If you are determined to invest in a DST despite suspecting you may have to sell early, be sure to look for a DST with a high number of investors (i.e., a greater pool of potential buyers).

Conclusions 

At Income Property Advisors, we will help you determine which properties are likely to perform the best. In addition to property and management analysis, we prioritize the following location attributes when considering a real estate investment:

• Growth: jobs, wages, population, and rents
• In-Fill: high barriers to entry
• Close-In: close to CBD, economic centers, and natural amenities

We have been helping investors exchange into management-free income properties for more than twenty-two years and have handled more than $1 billion in DST and related real estate transactions.

We partner with experts who have extensive experience with real estate investing, 1031 exchanges, risk mitigation, and tax and estate planning. As part of our due diligence process, we engage with industry professionals to independently analyze various risk factors.

If you have questions or would like to discuss further, you can contact Income Property Advisors by clicking here.