Diversification Among Delaware Statutory Trust Property Types

Investment property owners generally own one property type, in one geographic area. The reasoning behind this approach is understandable – owners develop a proficiency acquiring and managing a particular property type, such as residential rentals or multi-family properties, and want the properties to be within a commutable distance of their home. The problem with this approach is that it creates “concentration risk”.

At some point in time, most owners’ objectives shift toward preservation of capital and stable predictable income potential. When this objective shift occurs, transitioning concentrated assets into a broadly diversified replacement property portfolio is worth considering. While diversification does not guarantee returns, it can provide downside protection as different property types and geographic markets trend differently throughout market cycles. A savvy stock investor would not choose to own only one sector or industry in their investment portfolio – the same stands true for investment real estate.

Delaware Statutory Trusts (DSTs) enable owners of investment real estate to 1031 exchange into “fractional ownership” of high-quality institutional real estate. One of the key benefits associated with DSTs is the relatively low minimum investment requirement, generally $100,000 of equity for each offering. The low minimums allow exchangers unparalleled access to diversification. Effectively, an exchanger can design a portfolio of replacement properties among different property types and markets – a “mini-REIT” (Real Estate Investment Trust) if you will.

When we work with an exchanger to design a portfolio of DST replacement properties, there are many factors we take into consideration. Each investor has a unique set of considerations and objectives and their DST portfolio should be reflective of such. Each Delaware Statutory Trust owns a single property type within the trust. Typically, we see the following property types owned within DSTs:

• Multi-Family Apartment Buildings (either “Class A” or Class B”)
• Single-Tenant Net Lease Retail Properties
• Net Lease Industrial and Fulfillment Centers
• Self-Storage Properties
• Medical Office Properties
• Net Lease Commercial Office Buildings
• Hospitality Properties
• Student Housing Properties

The various property types all have respective strengths and weaknesses. When we analyze DST replacement properties, we first break them into those that have long-term leases (referred to as “Net Lease”) such as single-tenant retail, medical office, industrial and commercial office and then those that have annual leases such as multi-family apartments, self-storage and student housing. Net Lease properties historically have provided more predictability as the leases are guaranteed by corporate tenants and often extend well beyond the DSTs’ anticipated hold period. The annual lease properties tend to have more opportunity to add value to the subject properties and can regularly adjust rents for market changes and inflation. Net Lease properties have the potential, but are not guaranteed, to be the stabilizing keel of a sailboat and the outboard motor that could propel you forward during low winds. The annual lease properties have the potential, but are also not guaranteed, to be the sails that “catch the winds” of a growing market that is generating increased demand.

However, it is important to understand that every real estate investment presents uncertainty. Net lease properties tend to be susceptible to interest rate risk as they behave much more like bonds given the fact that they are largely valued on the competitiveness of their stream of remaining income compared to other income focused investments. Likewise, annual lease properties such as apartment buildings, may be much quicker to react to economic slow-downs due to the properties’ shorter lease duration.

Significant diversification is a unique feature of Delaware Statutory Trusts, but there is no “one-size fits all” portfolio for all investors considering an exchange. If you are interested in learning more about whether DSTs are a suitable replacement property option based on your individual objectives, feel free to contact us today at 206-686-2211 for a complimentary one-hour consultation.