What a Delaware statutory trust is
A Delaware statutory trust is a legal entity formed under Delaware law that holds title to real estate. Investors buy beneficial interests in the trust, and a sponsor arranges the purchase, the financing and the ongoing management through a master lease or property manager. Each investor owns a fractional interest in the trust and receives a pro rata share of its income.
The structure became popular for one reason. In Revenue Ruling 2004-86, the IRS concluded that a beneficial interest in a properly structured DST can be treated as a direct interest in the underlying real estate for Section 1031 purposes. That lets an owner who sells an apartment building exchange into a passive, professionally managed property without buying and running another building themselves.
Why a DST can work in a 1031 and a syndication usually cannot
A 1031 exchange requires that you replace real estate with like-kind real estate. A typical multifamily syndication is an LLC or limited partnership that owns the property, and investors buy membership or partnership interests in that entity. Interests in a partnership are generally not like-kind real estate, so buying into a syndication with exchange proceeds would usually make the gain taxable.
A DST avoids that problem by keeping the trust passive enough to be treated as direct ownership. The trade-off is a set of restrictions, often called the seven deadly sins, that limit what the trustee can do after the offering closes:
- No new capital contributions from current or new investors once the offering closes.
- No renegotiating the existing loan or taking on new debt, except in narrow cases such as a tenant bankruptcy.
- No reinvesting sale proceeds in new property.
- Capital spending limited to normal repairs, minor non-structural improvements and changes required by law.
- Cash held between distributions limited to short-term debt obligations.
- All cash, other than necessary reserves, distributed on a current basis.
- No entering into new leases or renegotiating existing leases, which is why DSTs commonly use a master lease structure.
Side-by-side: DST vs. syndication
Both are typically private offerings sold to accredited investors under Regulation D, and both put a sponsor in control. Beyond that, they are built for different jobs.
- 1031 exchange: a DST interest can usually be replacement property; an LLC or LP syndication interest generally cannot.
- Business plan: DSTs suit stabilized properties with predictable income, because the trustee cannot raise new money or refinance. Syndications can execute value-add plans, renovations, refinances and capital calls.
- Debt: a DST locks in its loan at the start, often fixed-rate and non-recourse. A syndication can refinance to return capital or rescue a deal under stress.
- Returns: DSTs generally target steady income and modest appreciation. Value-add syndications typically target higher total returns with more execution risk.
- Fees: DSTs often carry substantial up-front load for selling commissions, offering costs and sponsor fees. Syndication fees vary widely and are usually spread across acquisition, asset management and a share of profits.
- Minimums and liquidity: both often require meaningful minimum investments and are illiquid until the property sells, which may take several years or longer.
- Exit: at the sale of a DST property, investors can often exchange again into another DST or property. Syndication investors usually receive cash and a taxable gain.
When a DST tends to fit
DSTs are most often used by owners who are selling a building, want to defer the gain, and are ready to stop managing property. They are also used as a backup identification in an exchange, because DST interests can usually be purchased quickly, which helps when a planned replacement property falls through near the 45-day or 180-day deadlines.
They can also help an exchanger match debt. Because DSTs are often already leveraged, investing in one can help replace the mortgage paid off at the sale and avoid mortgage boot. Some investors split proceeds among several DSTs to spread their exposure across properties, markets and sponsors.
When a syndication tends to fit
A syndication is usually the better tool when you are investing cash that is not tied to an exchange and you want the growth potential of a value-add business plan. Because the sponsor can renovate units, change management, refinance and adapt the plan, syndications can pursue outcomes a DST is not allowed to attempt. They also tend to offer clearer alignment between the sponsor and investors through preferred returns and profit splits.
Some owners combine the two over time: they exchange a building into a DST to defer the gain and step back from management, and invest new cash from other sources into syndications for growth.
Risks to weigh with either structure
Neither structure is a substitute for diligence. With a DST, the rigidity that protects the 1031 treatment can become a problem if the property struggles, because the trustee cannot raise capital or restructure the loan. Some DST agreements allow conversion to a limited liability company in an emergency, which can protect the property but may end the 1031 treatment for investors.
With a syndication, the flexibility depends on the sponsor’s judgment, and capital calls or dilution are possible when plans go off course. In both cases, read the private placement memorandum carefully, look at the fee load, the loan maturity, the sponsor’s track record and how they have handled problems, and review the plan with your CPA and attorney.
