There have been several DST Sponsors promoting all-cash DSTs in recent months.
Although they try to convince investors that all-cash DSTs are safer than DSTs with financing, I believe they may have ulterior motives.
In order to evaluate if all-cash DSTs make sense, one must understand how financing for typical DSTs work.
Financing is one of the major features for DSTs that make it attractive to 1031 investors. Debt for DSTs is NON-RECOURSE debt, meaning the Sponsor takes on the liability if anything goes wrong. Investors would never have to pay off any debt from a foreclosure.
Although the investors don’t have liability with non-recourse debt, the investors do enjoy any appreciation and tax advantages on their debt portion of the DST.
Thus, if one invests $1,000,000 of equity in a DST with 50% financing, they receive $2,000,000 of the property in all, and would receive all-earned appreciation on the $2,000,000 of their property (equity & debt).
They would also enjoy any extra tax advantages (depreciation) which go with the combined $2,000,000 share of their property.
Thus, financing can be a major positive attraction for DST investors. Giving up such advantages with DST non-recourse financing should not be done lightly.
Of course, if property values go down, the loss would be double on a 50% financed DST – but how likely is that scenario in today’s environment?
For triple net (NNN) ESTs, the most common type of DST, this could be a serious problem because most DSTs have no more than a 1-2% rent increase which is inadequate in a rising rate environment.
For apartment and storage facility DSTs, however, this is not a concern because their leases are always short in length and therefore easy to adjust.
So why are some sponsors promoting all-cash DSTs?
In the case of NNN ESTs, Sponsors are sometimes unable to get acceptable financing for their projects. The interest rates of their loans are simply too high to allow them to generate a profit – particularly if the project has little to no rent escalations built in.
The Sponsor therefore decides to forego the loan process and instead rely on investors’ cash to finance the project.
On the other hand, DST financing from government-sponsored entities like Fannie Mae, financing on Apartment DSTs can be 100+ basis points lower than on commercial loans. Fannie Mae only provides loans for multi-family properties, thus such favorable financing is not available for NNN DSTs.
But you should know the all-cash DST promotion is more for the Sponsor’s benefit than the investors’.
As a consultant working with DSTs and other tax-advantaged methods, I can steer my clients to the best DSTs available in the marketplace today.
I help clients find the few Sponsors that have long and successful track records. Give me a call for a consultation today at (617) 965-7900.