First-time DST investors frequently have questions about selling their DST investment before the entire property sells. Most have an understanding of the traditional DST investing model (invest for the management-free income and appreciation, wait for the DST’s sponsor/manager/trustee to put the property on the market where ideally, it sells for a handsome profit, and then do another 1031 exchange). The trustee of the DST alone 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 happen, 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 DSTs consist of 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 advisor groups have proposed and created a secondary market for DSTs, but data on how successful they have been is limited. As a DST investor myself, and someone who is interested in and 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 (multiple sources NAR, Realtor.com, Redfin).  These types of properties have the largest pool of buyers (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, while DST investments do not.

Preservation of Principal

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

Hybrid-type DST investments are particularly vulnerable to underperformance including assisted living/memory care facilities, single-tenant retail, student housing, and even medical office buildings fall within this higher-risk category.

Let’s take an example of an Assisted Living Property DST where the sponsor and operator are facing income and expense challenges resulting in a drop or suspension of distributions, which is not an uncommon scenario for this asset type. 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 properties. 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 offer high utility and will always have value. We might be reaching a peak in multifamily valuations and we will discuss this in another article.

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 (https://ipropertymanagement.com/research/average-rent-by-year  and apartmentlist.comhttps://www.apartmentlist.com/research/rent-growth-since-1960 ). These were periods with an oversupply of housing and wage deflation as well, which stands 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 in a well-performing DST property 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, the investment structure, historical performance, market trends, and larger economic conditions. Most investors interested in buying secondary interests are in search of a bargain, or at least a discount, and they are in a position to command such because they understand that the limited buyer pool gives them leverage. 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. We’ll save a deeper dive into this for a future article.

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

• Contact the advisor who facilitated the original DST closing.
• The advisor will coordinate the DST Liquidity process with the sponsor to find a buyer. The advisor and sponsor generally do not charge a fee for this transfer.
• Current interest owners generally have the first right of refusal.
• If a buyer is found, the sponsor will initiate the DST Liquidity/Sale Transaction process and transfer paperwork for the buyer.
• The seller’s proceeds will be subject to applicable taxes.
• If the sponsor cannot find a buyer within the portfolio, they can notify DST investors in other DST investments they sponsor.
• If no buyers are found, you 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 DST interests you have held for a short time.

DST: 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. 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 your 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. These are used to lure under-informed investors.
• 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).

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

• Growth: Jobs, Wages, Population, Rents
• In-Fill: High Barriers to Entry
• Close-In: Close to CBD, economic centers, and natural amenities

About Income Property Advisors

IPA has been helping investors exchange into management-free income properties for more than 22 years. In that time, we’ve handled more than $1 billion in DST and related real estate transactions for our clients.

We partner with experts who have extensive experience with real estate investing, 1031 exchanges, risk mitigation, and tax and estate planning. We provide clients with a wide selection of well-priced property investments. As part of our due diligence process, we engage with industry professionals to independently analyze different risk factors for every property.

Whether purchasing a property as a sole owner or investing through a co-ownership structure, such as a Delaware Statutory Trust or a Tenant-in-Common, IPA 1031 Group will advise you and provide insight into cash flow, tax benefits, and capital appreciation and ultimately what is best for you!

If you have questions or would like to discuss further, contact us today by clicking here.