3 reasons why owners of highly appreciated investment real estate are hesitant to do a 1031 (and how the DST solves these issues)
1. The short 45-day identification period.
A 1031 investor only has 45-days to identify the property or properties they plan to buy. If they are unable to find a suitable replacement property they will get stuck having to pay capital gains. For some investors this could mean as much as 30-50% of their profits. This short identification window can be a deterrent for many long-term real estate investors, who worked hard to grow their equity and are wary about taking this risk.
DSTs are pre-packaged prior to being made available to investors. This means the financing, due diligence, and inspections have already been completed. The DST has no escrow period and no deposit required of the buyer. As a result, there is no closing risk, something inherent in most traditional real estate transactions. And, there are usually dozens of DSTs available to choose from at any one given time.
Additionally, unlike sole-ownership real estate, both the property and the sponsor of a DST can be vetted. The due diligence process centers around not only looking at the fundamentals of the real estate but also, the track record of the sponsor making the offering.
2. The “terrible T’s” (toilets, tenants and trash).
Many long-term investment property owners have grown tired of the management associated with a traditional real estate purchase. They desire more investment passivity and know that effective property management takes considerable time and effort. Even managing an on-site property manager can challenging.
DSTs require no daily management freeing up an investor from this burden. The DST investor simply receives a monthly distribution and a monthly or quarterly performance report.
While some long-term owners are hesitant to relinquish control of management, for many others, this freedom is welcomed.
3. They want more diversification.
Being diversified is a great way to mitigate risk. Unfortunately, the short IRS timeframe for identification (45-days) and re-investment (180-days), makes diversification difficult to accomplish. Additionally, when a sole-ownership investor divides their equity into traditional real estate investments, it often leads to lower returns. This is because there is generally a much larger buyer pool for lower priced assets, which drives up prices and drives down returns. As a consequence, the goal many sole-ownership investors is to find something that is cash flow positive then hope for some future appreciation.
Since DSTs are pre-packaged before they are brought to market, and many DSTs contain portfolios of multiple properties, it is very easy for DST investors to diversify. It is common for a 1031 investor with $1,000,000 in 1031 proceeds to exchange into three to as many as ten (or more) DSTs that vary by location, asset class, sponsor and business plan. This diversification does not cost the DST investor anything extra, and can be a fantastic way to reduce investment risk.