DSTs - How are they funded?”

DSTs – How are they funded

Due to the nature and structure of Delaware Statutory Trusts (DSTs), it is important for investors to know how they are funded. Investors also need to know the restrictions and rules regarding the funding of DSTs and the timing on such funding. These are important aspects for investors to note when evaluating or looking into investing into a DST.

The following are some things to note about how DSTs are funded:

DSTs are commonly funded either before or after the acquisition of the property

Two common methods for funding DSTs are either pre-acquisition or post-acquisition of the property or properties. For the pre-acquisition method, the DST’s sponsor has to raise funds from investors prior to the acquisition of the property desired. This means that the sale of the property to the DST cannot close until the DST has met the required investment levels. This also means that investors will not know the exact property or properties that will be held and eventually managed by the sponsor. This is something that investors should look into when evaluating or looking into DSTs.

According to the DST’s trust agreement, a sponsor may have specific regions and/or types of properties (e.g. residential or commercial) that it must select from after the financing requirements are met. This can serve as some form of assurances for investors who might be interested in a specific DST. Nevertheless, there is more risk involved when DSTs are financed pre-acquisition of the property or properties since the investment will then be subject to the DST actually closing on and acquiring properties.

The other common method for financing DSTs is the post-acquisition funding. Under this funding method, the sponsor of the DST would have already secured financing for the purchase and acquisition of the property or properties. By having already acquired the property or properties, the sponsor is able to package and market the DST to potential investors. From an investor’s standpoint, this type of DST may seem more appealing because the investor will be able to evaluate the DST with a specific property already acquired.

Although investors will be able to evaluate DSTs better and more confidently if the DST is funded post-acquisition, this usually results in higher up front fees that must be paid when an investor decides to invest in the specific DST. In any event, investors need to be aware of how a given DST is funded in order to make the best investment decision.

DSTs cannot raise or receive additional funds after the offering period ends

One important aspect to be noted about how DSTs are funded is that there is a specific time period for the DST to raise funds called the offering period. This is important because once the offering period ends, the DST will not be able to raise or receive any additional funds. As a result, investors need to be aware of the amount and required levels of reserve funds that a given DST has after the offering period ends. This is really important because the reserve funds will be used if there are expenses incurred in the management of the property and cannot be covered by the revenues generated. If the DST runs out of funds to operate, the investors will likely realize losses and the sponsor will have to find the best possible way to dissolve the DST. This is also important because the expenses that are not covered by the DST will take away from the profits realized by the individual investors.

DST trustees have limitations on dealing with debts and leases

Another aspect of DSTs that investors need to be aware of is the fact that a DST’s trustee cannot renegotiate the terms of any loans taken out by the DST unless a tenant has defaulted on its lease or has filed for bankruptcy. Additionally, the same exception applies to when trustees may borrow new funds.

Additionally, depending on how the trustee has structured the leases with the tenants, trustees may have to renegotiate or restructure the leases if a tenant defaults or files for bankruptcy. Some DSTs may decide to circumvent this need to renegotiate or restructure tenant leases by using a master lease to handle the tenants.

Investors may directly invest in a DST or use a 1031 like-kind exchange

One common way for investors to invest in a DST is to directly invest money into a DST. Since DSTs are like real estate, investors are able to pool their money into a DST. The other common way is for investors to utilize a DST in order to complete a 1031 like-kind exchange and avoid paying taxes on capital gains. By utilizing 1031 like-kind exchanges, investors will be able to roll over the proceeds into the DST as investments.

As noted earlier, any investments made by investors, either directly or through the use of 1031 like-kind exchanges, will need to be made during the offering period. Once the offering period ends, however, no additional investments and funds may be received by the DST.

Any reserves or cash held by the DST may only be invested in short-term obligations

Reserves held by the DST or cash on hand in between disbursements to investors may be invested in short-term obligations. These investments are limited to short-term obligations in order to ensure that DSTs will be able to liquidate the debts and have capital available to make necessary disbursements and/or payments.

Whether or not a debt is short-term will typically be within the discretion of the trustee and/or sponsor. Additionally, the trust document governing the specific DST may also provide a definition for short-term obligations or may provide guidelines to help the trustee or sponsor decide whether the investment is short-term.
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