Betty Friant CCIM is SVP and expert DST 1031 advisor for Kay Properties & Investments.
No question about it; these are turbulent times. Just read the headlines of pretty much any major news outlet, and you will be deluged by stories that would rattle even the calmest of nerves. Unsettling events are happening both globally and domestically. These events don’t just impact the psyche; they also can have significant financial consequences for all types of investors and entrepreneurs. For example, I know several business owners who were devastated by Covid-19 and forced to close their businesses. Because they owned the real estate where the business operated from, and because that real estate had appreciated over the years, they decided to sell their real estate assets. Similarly, many real estate entrepreneurs who invested in multi-family properties over decades have been negatively impacted by rent controls and eviction moratoriums and have similarly decided to relinquish their real estate holdings.
In both cases—business owners selling their buildings and real estate investors selling their rental properties—as a financial advisor, I encourage my clients to consider all-cash/debt-free Delaware Statutory Trust (DST) assets when entering a 1031 Exchange in order to reduce risk.
What is a debt-free Delaware Statutory Trust asset?
For those unfamilair with the term, entrepreneurs and real estate investors don’t have to live in Delaware to invest in DSTs; Delaware was simply the state where the law defining a DST and its structure was created. This special kind of real estate investment vehicle has been blessed by the IRS to qualify as “like-kind” investment property for the purposes of a 1031 exchange.
It’s striking to me that most investors entering into a DST 1031 Exchange investment are incredibly focused on the specific asset in question. Whether it’s a multifamily building in Houston or a logistics/distribution facility in Gulfport, investors are typically well-versed with the location, income potential and type of tenant. However, what they sometimes overlook is what type of financing is in place for the investment property.
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One of the ways investors can potentially reduce their exposure to risk—especially in turbulent times—is to avoid taking on any additional debt. While many 1031-eligible assets have debt associated with them, and not all debt is bad, many investors want to remain debt-free and take a conservative position on their 1031 investments. Many of my clients don’t want to increase their debt load, as many of them have already paid off their investment properties or business real estate assets and they just don’t want to go back into debt. This is the time in their lives when they want to reduce their exposure to potential risk and not increase it. Debt-free DSTs offer the perfect opportunity to invest in multiple asset classes and in different geographical regions without incurring debt.
Four reasons to consider this type of investment
In addition to personal reasons, there are a number of practical reasons for considering all-cash/debt-free DST investments, especially in today’s turbulent times. Here are some:
1. Business owners who sold their buildings have turned to all-cash/debt-free DSTs to give themselves greater resilience to hold throughout any potential market downturns, unpredictable world events or recessions, with zero risk of lender foreclosure.
If there’s one thing we’ve learned during the Covid-19 pandemic, black swan events can drastically alter economic patterns. Think about iconic brands that went bankrupt in 2020 (though some later emerged): Brooks Brothers, Guitar Center, JCPenney, Neiman Marcus and Pier 1. Entrepreneurs who decided to invest in single tenant-net lease buildings often faced a harsh reality after the businesses there went bankrupt or out of business and were unable to pay rent.
2. All-cash/debt-free DSTs can offer better cash flow potential.
With no monthly debt service to a lender, the all-cash/debt-free DST potentially can pay larger monthly distributions to investors.
3. All-cash/debt-free DSTs provide investors and entrepreneurs the ability to diversify a portion of their 1031 Exchange dollars into unlevered asset to lower potential risk
Many entrepreneurs who have invested heavily in the stock/bond markets turn to all-cash/debt-free DST properties as a strategy to diversify away from stocks and bonds.
4. All-cash/debt-free DSTs can help protect entrepreneurs and investors from the financial catastrophe of a complete loss of their principal due to a lender foreclosure.
While it is not common, investment property foreclosure can and does occur, causing investors to lose their entire investment. However, with all-cash/debt-free DST investment, investors never have to worry about a lender foreclosure because there is no monthly debt service attached to the investments.
Times are indeed turbulent, but considering all-cash/debt-free DST investments might be a good way to reduce investment risk and avoid lender foreclosure.
Securities offered through FNEX Capital, member FINRA, SIPC.
Potential returns/appreciation not guaranteed & loss of principal is possible. Speak with your CPA/attorney for tax/legal advice.