A client once asked me to look over a DST property shown to him by another rep. Everything looked great on the surface, good cash flow, excellent market, in-fill location, but when I saw the name of the sponsor, I told him, “run, don’t walk, away from this property.”  

What the client did not know was that this sponsor had a terrible history of mismanaging their properties. I showed him their track record, every property the sponsor syndicated, and what happened to those properties. It was not pretty.

“Would you trust a company like this to manage your property?” I asked.

“No, absolutely not,” he replied and then asked, “Which sponsors do you recommend? Which ones are good?”

These are questions that every DST investor must ask. Because you are buying real estate when you invest in a DST, most investors only focus on the property. However, who manages that property can be just as important to your success. Even a great property in a top location will not perform if it is managed poorly by a subpar sponsor.  

What is a DST Sponsor?

A sponsor is a real estate investment and management company that purchases properties under the DST structure and offers investments in the property through the trust. The sponsor’s role is to ensure the highest and best performance of each property they manage. The sponsor handles all asset management responsibilities, quarterly reports, annual tax and report packages, performance reviews and budgets, and distribution of monthly cash flow to investors. Most sponsors also provide an investor relations team, who handle all investor requests, inquiries, and communications.

So, how do you know which sponsors to invest with? We recommend that every DST investor review a sponsor’s track record with their rep before investing. This is where you can begin to separate high-quality sponsors from those who are likely to manage their properties poorly.

Sponsor Track Records

A sponsor’s track record provides information on all of the properties previously offered by that sponsor, including how the properties performed, how much cash flow the investors received, and what type of returns on equity they realized when the properties sold. That data gives useful insight into how well a sponsor manages their properties. While past performance is no guarantee of future results, a good sponsor with a proven track record of success is a much better choice than one with a long history of failures. 

Analyzing the sponsor’s track record requires more than just looking at total returns. You also need to consider other factors including:

• Length of Track Record: Generally speaking, longer track records are better. A track record that only goes back four years does not provide nearly as much insight as one that covers twenty years.
• Economic Cycles a Sponsor Has Experienced: You want to see that the track record predates the great recession. Many sponsors perform well during good economic times; it is that “rising tide” phenomenon when even the dart-throwers look brilliant. How a sponsor manages properties during a recession is much more telling of their investment and property-management prowess.
• Asset Type: What type of assets are listed in a sponsor’s track record? A sponsor with a long and successful track record of managing only medical office buildings may not be the best choice to manage an apartment complex. Whether the DST is multifamily, retail, hotel, self-storage, or NNN leased property, make sure the sponsor can demonstrate success with the particular asset you are looking to purchase. If you are investing in a multifamily DST, pay close attention to how well the sponsor managed their other multifamily properties, as opposed to their retail properties.

Many sponsors currently offering DSTs are relatively new to the industry and do not have a long track record. This does not mean that you should not invest in their offerings. However, it does require more research. For instance, you will want to know if the new sponsor has offered other types of real estate investments besides DSTs. One of the sponsors we work with has only been offering DSTs for the last five years, but they have a long and successful history with their REITs, LLCs, and other types of real estate investments. We have placed several clients in their DSTs over the last five years and all are performing very well, with most exceeding projections.  

Also, you should never take a sponsor’s track record at face value. It is important to verify what is in the track record. You can do this through title searches, investor reports, and operating statements filed with the IRS. Although it is rare, we did catch one sponsor that grossly inflated the returns on their property track record. It is important to identify these red flags before investing your money.

Background Checks  

Doing a background check on the principal officers of a DST sponsor is a must, especially if the sponsor is new to the DST industry. Some good questions to ask:

• How much real estate experience do the officers have? 
• What other companies did they work for, and how successful were those companies’ investments? 
• Are the principals familiar with the property asset types of their DSTs? 

Sponsors headed by principals with little real estate experience or a history of poor performance should be avoided. For example, we conducted a background check on one sponsor and found that the three top officers had previously run another sponsor with a terrible track record, which had closed shortly after the last recession. Although the new sponsor had a good track record, albeit short and in a rising market, we advised our clients not to invest with this sponsor given the principals’ prior history.

Size and Financial Strength

In 2019, there were 38 combined sponsors who raised more than $3.4 billion in equity across more than 171 DSTs. The sponsors varied in size from small operations of less than 20 employees to one of the largest financial institutions in the world with more than 10,000 employees and over $56 billion in real estate transactions. 

Investors should consider the size and financial strength of a sponsor when choosing a DST. Larger sponsors tend to have more sophisticated and experienced teams to better locate, analyze, and manage their properties. They also benefit from economies of scale that can reduce costs for the investors.  

Larger sponsors also tend to obtain better pricing and loan terms on real estate due to their higher volume of business. And while not required, a well-capitalized sponsor is able to better provide their own money to stabilize properties if needed. A couple of sponsors have actually done that because they were large enough to cover the costs.

Client Communications

Sponsor companies are responsible for keeping investors regularly updated on the status of their DST properties, and many have excellent client communications. They regularly keep investors apprised of all aspects of a property’s performance.

One primary aspect of this communication is providing investors with a Year-End Operating Statement well before April 15th so that investors can file their tax returns on time. However, there are some sponsors who do not keep investors as well informed, frequently provide Year-End Operating Statements late, forcing investors to file for an extension with the IRS. 

This level of poor client communication can be incredibly frustrating for investors. And if you are investing in DSTs to simplify your life, this is the last thing you need. 

Third-Party Review

The top DST sponsors sell their properties through third-party broker-dealers who all perform independent analysis and due diligence on both the property and the sponsor. This type of independent review is essential to ensure that the offering is sound. Independent third parties have no vested interest in promoting a particular sponsor’s property over another. Their only interest is in what is best for the client. They can, therefore, offer an unbiased and independent recommendation.

There are some sponsors who avoid third party reviews and instead sell their own “exclusive or proprietary” DST properties to investors directly. This creates a conflict of interest since the representative is the sponsor. They have an incentive to promote their own properties over their competitors even when properties offered by other sponsors might be superior. 

Thus, without third party review, investors are unable to confirm whether the information provided by a sponsor is accurate or reliable, or whether there are any issues or red flags they should be aware of before investing.

A recent example is the Noah’s Event Center DSTs promoted by a sponsor named Rockwell. Noah’s operated a chain of event centers in nearly 40 locations across the country. Rockwell sponsored the syndication of Noah’s event centers as DSTs and sold them directly to their clients as “exclusive” offerings. Representatives working for Rockwell promoted these DSTs as safe and assured their clients that they had done thorough due diligence on each offering. The cash flow was high, in some cases even 8%. (See our article, DST Properties & Cash Flow Trends: Is Higher Always Better?) 

What many investors did not realize was that Noah’s and Rockwell were owned by the same entity. Noah’s would build an event center and sell it to investors at an inflated price through their affiliate Rockwell. They were able to support the high cash flow by entering into a lease at often double the market rate. The price per square foot that investors were paying for, mostly empty space, was through the roof. A couple of these offerings were sent to us from investors asking for our opinion. Within seconds, we knew something was wrong. (See the Bloomberg article, Tax-Haven Wedding Venues Become Retiree Investors’ Nightmare from June 18, 2019.)

The high cash flow was unsustainable, and any independent review would have uncovered the underlying issues. Unfortunately, for investors in these properties, no independent review was offered since the only company selling the properties was the sponsor itself. Eventually, Noah’s declared bankruptcy in May 2019, well before the COVID-19 pandemic. The investors are now left with overpriced event centers with no tenants.    

Underwriting     

The cash flow and total returns projected for any DST are based on a sponsor’s underwriting. Some sponsors are very conservative in their underwriting, preferring to under promise and over perform. They want to exceed investor expectations and are dedicated to the performance of their properties.  

Other sponsors are more interested in selling as many offerings as possible, and they engage in creative and unrealistic underwriting. They want to make their properties look better than they are to increase investor interest and generate more sales.

So, when evaluating a sponsor, it is important to review their underwriting standards and to watch out for returns that are too good to be true.

Our Conclusions

DST sponsors have specific strengths, and weaknesses, which are important to evaluate prior to investing. Additionally, they differ in experience, strategy, and overall capability. These variables and the pertinent reports are taken into consideration when we perform our multileveled analysis of DST sponsor companies and their offerings. We recommend that every DST investor review this due diligence information with their rep before investing. We are happy to provide and review any of the reports listed above with you.

Contact us today to discuss further.