Breaking Even: How to Choose a DST for Your 1031 Exchange
As the leading online marketplace of 1031 exchange qualified Delaware Statutory Trusts (DSTs) 1, one of the primary questions we get from investors involves preservation of capital and how a DST “breaks even.” DSTs are a vehicle for exchangers to pool their capital with other investors to purchase large institutional grade real estate. Here is an excellent excerpt from our Q&A section. Question:How do I break even with this DST? I’m looking to invest $100,000 into real estate. I want to increase the value of my principal, but I understand there is no guarantee that any investment will increase my principal. I want to grow my investment, but if I can’t do that, I certainly do not want to lose money.
Answer: To truly break even or “get back to par,” two things must happen.
One, you must receive back the total amount of capital you used to purchase the asset.
Two, you must receive back an amount equal to all principal payments made to pay down the debt on your investment. When we evaluate the DSTs that come across our platform, we do a sensitivity analysis to determine the conditions needed to both return your initial investment and also to get you back to par. For example, let’s say you invest your $100,000 in a DST with a 60% loan-to-value ratio, acquiring $150,000 in debt for a total $250,000 worth of beneficial interest in a $10 million offering. Over 5 years, 20% of your debt is paid down, lowering your debt total by $30,000. Some investors would be satisfied if the property sold for $8.8 million, enough to pay the remaining $4.8 million loan and still return the original equity investment. While this may be acceptable in a down market, the property is still being sold for below what was originally paid. This represents a $30,000 loss of the equity built by debt payments made on the investor’s behalf. To fully break even, the property would need to appreciate in value enough to
1) Overcome any fees associated with the DST,
2) Repay the original equity investment, and
3) Recoup the principal payments made on behalf of the investor.
In order for any piece of commercial real estate to increase in value, one of two things must happen. Either the NOI on the property needs to increase, or the market needs to increase in the form of cap rate compression. Since it is difficult to predict market conditions at the time of sale, at 1031 Crowdfunding we focus our property analysis on making sure that there is enough NOI growth potential to keep the investor at or above par. Additionally, in a DST there can be no capital calls or additional money invested into the property beyond typical maintenance and capital expenditure needs. Because of this, the original principal paid into the DST must be able to appreciate in value based on the property performance and not based on additional capital investments. Any real estate investor should look for property that can appreciate in value without being a “money sink,” investing in real estate through a DST is no different. A major benefit of DSTs is the presents of a professional management team known as a sponsor. A sponsor’s proven track record brings significant experience to the process of selecting investment properties capable of producing competitive cash flow and appreciation at the time of sale.While having an experienced Sponsor behind a DST adds credibility, it does not replace the need for individual investors to do their own due diligence. To supplement this due diligence, we at 1031 Crowdfunding carefully analyze and evaluate each DST independently and can help match you with a DST that suits your investment needs.
Edward Fernandez is Founder/CEO of 1031 Crowdfunding, LLC based in Orange County, CA.