What are DST's and how are they different from other forms of syndications? Jason Salmon, Senior Vice President and Managing Director of Real Estate Analytics at Kay Properties and Investments LLC shares some insights with us.

Tell us a little bit about you.
Our company specializes in Delaware Statutory Trust real estate and 1031 exchanges for over a decade or so. We have relationships with a handful of very large asset managers of commercial real estate, of various asset classes, multi-family, industrial, medical office, health care related, triple net real estate and otherwise. These companies go out and buy fairly large real estate deals and then they come to us. We have a due diligence process and may or may not be able to offer those securitized real estate deals to our clients. And beyond that, it's a situational basis. If it's in the Delaware Statutory Trust or DST format, they happen to be 1031 exchange friendly for the lack of a better way of putting it.

Why don't we start with the basics, what is private equity real estate?
Private equity real estate is an all encompassing statement to describe how that real estate is owned. It means that the equity or the ownership of it is by private, and in our case, high net worth investors. So it's a way for high net worth investors to own pieces of very large real estate deals. There are different forms of that. There could be private equity firms who have that money and they're buying the real estate on behalf of their investors. In our case, it's the deal itself and the offering, and our clients have the opportunity to become investors in these very large real estate deals. It's a form of ownership of the real estate enabling, in our case, private, high net worth investors to own pieces of very large commercial real estate deals.

When you say high net worth, does that mean accredited investors or is it yet another level up?
That's exactly right. In some cases, it could be qualified investors. But in most cases, and specifically with the DST's, it's for accredited investors and accredited entities.

What is a DST and how is it different than syndications and REIT's?
Most upfront would be the 1031 eligibility, REIT's are not eligible for 1031 exchange straight away. There's always a way through different channels to eventually get there. But apples to apples, one cannot 1031 exchange directly into a REIT and the DST through what's called revenue ruling 2004-86 is on the books and there's a way for people to 1031 exchange in. Additionally, when that real estate is sold, they have the opportunity to do another 1031 exchange out moving forward. In and of itself, a DST is a syndication, but it's a hybrid because it's a really specialized sort of syndication whereby it is 1031 eligible. And in many cases, syndications of different sorts, whether it be partnerships or LLC's or any which way in that format would not be a 1031 vehicle for fractional, partial ownership. Those entities themselves could do a 1031. But if it's made up of private fractional ownership, it doesn't fly. So from a 1031 exchange standpoint, I think that's the linchpin of everything there. Notwithstanding from a direct cash investment standpoint, they all could work in similar ways, REITs could be public or private. They take on different complexions that way. If it's a syndication in and of itself could be put together, it could be friends and family. Whereas the DST, at least the DST space that we dwell in would have multiple layers of due diligence on various levels, specifically the real estate, the deal itself, and then the asset manager, or the sponsor firm running the deal just to be able to have that deal, see the light of day if it passes that due diligence. It's just a little bit different format. But again, going back to the beginning, I would contend that the 1031 eligible eligibility is the biggest differentiator.

That's really interesting. I did not know that the accredited investors themselves could not 1031 into another property in a standard syndication. That's very important to know because it has significant tax implications.
They could all go together, theoretically, if it was a partnership or an LLC, and I am not able to give tax or legal advice. One should always consult their own CPA and attorney to determine whether or not they have the ability to do that. But in and of themselves, the partnerships and LLCs would be able to do that. But as far as being comprised of multiple partial or fractional ownership, that's where it wouldn't pencil.

Why don't more people know about the DST's? I have not really heard a ton of people talking about them.
One is the space that it's in. It is, by industry reports, a multi-billion dollar annual industry, at least by last year's report. And certainly the preceding years. But it is only available for accredited investors. So that narrows the field a little bit. It also is something that has come to the fore as a result of that revenue ruling, which was in 2004. So there could be a lot of legacy understanding of it. And for me, 2004 is not that long ago, although we certainly have seen a cycle or two.

But it's just a matter of adoption. Who knows about it. And for us, we see quite a volume of business on an annual basis. So people are transacting. They are learning about it. But that's part of the conversations that I have with people on a near daily basis as to, why have I not heard about this before? Why aren't more people doing it? I wish I had the answer. It means I could help more people transactionally. Through education, I've helped CPA's learn about it for the past several years with continuing education credit. And they're continuing to evolve their own practices to understand how the DST's can be used as a tool, especially for 1031 exchange. And if you're an accredited investor and you're among a certain set, friends talk and it's always refreshing when the phone rings and somebody says, hey, my friend or my colleague mentioned the DST and I would like to learn a little more about it, I can't always say that that would convert into somebody that I could help. But I'm always pleased to be able to educate people about it. But you're right, at least from where I sit, I think would be wonderful if more people learned about it. Hopefully part of the reason that we're here today having this discussion is so that people can get a little bit of understanding of it or at least know that it exists and then do their own homework through their channels.

Are there any drawbacks of DST's vs. standard LLC syndications, for example? I'm just looking for a reason why people would not have a DST when they do syndications.
The 1031 eligibility is a great feature, but I can't negate the fact that on any private placement or any real estate investment there are always risks. There is no guarantees of returns. There's no guarantees of return of capital. There's always going to be risks. But that comes down to the fact that part of the job is to understand what these are all about. And try to mitigate that. One of the great features about Delaware Statutory Trust is that they are accessible, without getting too deep into it because minimums do vary. But it is a fairly accessible area by most owners of investment real estate. So it offers the opportunity to diversify in a 1031 exchange and also be passive. To get more on point with where you were going with your question, I think the biggest hurdle to get over for people is that most clients might not have heard about DST's before. And these are people that for decades in many cases, or it could be legacy real estate from one generation to the next, have done what they've always done and they've gotten what they've always gotten. And that's what they know. They've either done hands on, collected rents, chased tenants around, fixed faucets, whatever it is, or dealt with being an asset manager on a commercial level and negotiating leases and extensions and all that stuff. And when it comes to the Delaware Statutory Trust, I think the ability to be passive, the ability to diversify, the ability for it to be a 1031 exchange eligible vehicle, structurally, are all things that I think are attractive to investors.

With that being said, the other side of the coin is that it's passive, so for the people that are accustomed to being hands on, it just may not be for them because this is something where you do have to cede control to others. In the case of the firms that we work with, these are asset managers with, in many cases, hundreds of millions of dollars of commercial real estate assets under management and frankly, in more cases, billions of dollars of assets under management. That doesn't mean that just because that's what they have, that that's an automatic sign that nothing can go wrong because, again, there's always risk factors. But the ability to diversify is one of those features. But again, the lack of control and the leap of faith there is to understand what they're trying to accomplish through the ownership of that real estate. What their exit strategy is, why they bought what they did. The location where they bought it. What are the factors weighing in on that? And ultimately, it's not that different than any other investment. To be sure, you know, the name of the game in many cases would be to buy low and sell high, collect income along the way, in a tax advantaged way because you would get those passed through. And different entities work differently, but in many cases, Schedule E on your taxes. So you're getting the same tax treatment as one would on their hands on real estate. But for the fact that they do have to be comfortable with somebody else doing it on their behalf.

The risks are just with any kind of investment, be it a DST or a syndication or your own real estate investment, that you do and operate yourself. If I were an operator, what is the big difference between a DST and other forms of syndications that are set up typically?
If you're an asset manager there's a pretty high barrier to entry. It's needing to require third party due diligence just to have a seat at the table, is something that is an investment that they would have to consider. I don't really deal too much with that on a day to day, because that's not where I dwell. We as a firm are not the ones that are going out and buying the real estate. And by the way, I should mention that they don't take people's money and then go get the real estate. In most cases, they've already bought it with their money. So that's something important to note. In our firm the way we're set up is, because of our relationships with each of these firms, when they bring a real estate deal to us, we would screen these deals based on how we feel about them. But our loyalty ultimately is to the client themselves. We don't touch their money and we're not really pointing them into what goes into it. We're working collaboratively with them to determine which deal or deals makes sense for them. As far as an asset manager that wants to come into the space, in times past I might have fielded maybe two calls a week with firms that are interested in the space. And you have to have a back office set up, the ability to pay rent, make distributions, have a back office for closing.

You have to put together a private place memorandum, which is the ruling document for the deal itself. That deal has to go through multiple processes just to get on a platform, because just because somebody can go out and put together a Delaware Statutory Trust doesn't mean that that deal or a statutory trust is going to be offered by us. We would have to get what's called a selling agreement. And once that selling agreement is in place, it means that some levels of due diligence have already been done by the asset manager, having bought the real estate and putting together the securitized real estate deal before even coming to a firm like ours. So anybody can do that. But there's a lot of commitment to the space just to come into it, to feel confident with being able to go and do DST's going forward. A lot of times people are looking for a track record. They're looking for assets under management. They're looking for them to have a back office aspect in place. In some cases compliance people. Then we were talking about those third party reports. So there's a lot of disclosure when it comes to that, just from a regulatory standpoint by the governing bodies of the securities industry. Those are the things that an asset manager would have to be really comfortable with in order to come into this space that we're in every day.

Can you talk about how asset managers don't get any returns? They pass everything to the investors.
There is a cost of doing business generally. But in the Delaware Statutory Trust structure on the back end, unlike most syndications, there is no waterfall. Basically, they can't profit share at the back end, there is a disposition fee that is built in. Those have varying degrees. I wouldn't be able to cite it on this call. It would be deal specific, but it's there and it's akin to closing costs. Like anything else. But it wouldn't be like your typical two and twenty model or some kind of promote on the back end, because structurally in the DST they cannot profit share. So if a 100 million dollar deal was sold for one hundred and twenty million dollars after four or five years, if that was a net number, net of closing costs and all the associated closing fees, then the investors would indeed get their pro rata share of those proceeds. That's the bottom line for how DST's are structured.

That's pretty impressive from an investor's perspective.
It just happens to be the structure, the way it's set up. There's certain framework that these asset managers must follow. It's a compliance thing all around. And that's the name of the game. They would hope that they would have good volume of business, that they would have results that people would be happy and comfortable with. And when things are sold, then people would hopefully come back and do it all over again.

Is there anything else that our listeners should know?
It's a matter of education, knowing about the Delaware Statutory Trust, knowing that they're 1031 vehicles, knowing that we as a firm have a lot of direct cash investors as well. And it's a really specialized thing. We act as specialists in this space. And again, it's just because it's such a specific part of commercial real estate ownership. I think you've asked excellent questions about it. Hopefully people can get educated and get some exposure to this asset class, or form of real estate ownership, There are various asset classes within that, various property sectors.

Jason Salmon