Betty Friant CCIM is SVP and Expert DST 1031 Adviser for Kay Real Estate & Investments†
No doubt about it; these are turbulent times. Just read the headlines of just about any major news outlet and you’ll be inundated with stories that would rattle even the calmest nerves. Disturbing events are taking place, both globally and domestically. These events don’t just affect the psyche; they can also have significant financial implications for all types of investors and entrepreneurs. For example, I know several entrepreneurs who were devastated by Covid-19 and forced to close their businesses. Because they owned the real estate where the company operated, and because that real estate had increased in value over the years, they decided to sell their real estate. Likewise, many real estate entrepreneurs who have invested in multi-family properties for decades have been negatively impacted by rent controls and eviction moratoriums and have similarly decided to part ways with their real estate holdings.
In both cases – business owners selling their properties and real estate investors selling their rental properties – as a financial advisor, I encourage my clients to consider completely cash/debt free Delaware Statutory Trust (DST) assets when entering a 1031 Exchange to mitigate risk .
What is a Debt-Free Delaware Statutory Trust Asset?
For those unfamiliar with the term, entrepreneurs and real estate investors don’t have to live in Delaware to invest during daylight saving time; Delaware was simply the state where the law defining daylight saving time and its structure was created. This special kind of investment property vehicle has been blessed by the IRS to qualify as “like-kind” investment property for the purposes of a 1031 exchange†
It strikes me that most investors making a DST 1031 Exchange investment are incredibly focused on the particular asset in question. Whether it’s a multi-family home in Houston or a logistics/distribution facility in Gulfport, investors are typically well-versed in the location, income potential, and type of tenant. However, what they sometimes overlook is what type of financing is available for the investment property.
One of the ways investors can reduce their exposure to risk, especially in turbulent times, is by avoiding taking on additional debt. While many of the 1031-eligible assets are in debt and not all of the debt is bad, many investors want to remain debt-free and take a conservative stance on their 1031 investments. Many of my clients don’t want to increase their debt burden because many of them have already paid off their investment properties or commercial real estate and they just don’t want to get back into debt. This is the time in their lives when they want to reduce, not increase, their exposure to potential risks. Debt-free DSTs provide the perfect opportunity to invest in multiple asset classes and across geographic regions without taking on debt.
Four reasons to consider this type of investment
In addition to personal reasons, there are a number of practical reasons to consider completely cash/debt free DST investments, especially in today’s turbulent times. Here are a few:
1. Business owners who have sold their properties have turned to completely cash/debt free DSTs to help themselves more resilient to potential market downturns, unpredictable global events or recessions, without the risk of foreclosure from lenders.
If there’s one thing we’ve learned during the Covid-19 pandemic, black swan events can dramatically change economic patterns. Think iconic brands that went out of business in 2020 (although some emerged later): Brooks Brothers, Guitar Center, JCPenney, Neiman Marcus, and Pier 1. Entrepreneurs who decided to invest in single-tenant rental properties often found themselves battling after inception with a harsh reality there went bankrupt or went bankrupt and couldn’t pay the 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 may be able to pay larger monthly distributions to investors.
3. All-cash/debt-free DSTs offer investors and entrepreneurs the opportunity to diversify a portion of their 1031 Exchange dollars into unleveraged assets to lower potential risk
Many entrepreneurs who have invested heavily in the stock/bond markets are opting for completely cash/debt-free DST properties as a strategy to diversify away from stocks and bonds.
4. All-cash/debt-free DSTs can help protect business owners and investors from the financial catastrophe of a complete loss of their principal due to a lender’s foreclosure.
While it is not common, foreclosures on investment properties can and will cause investors to lose their entire investment. However, with completely cash/debt free DST investments, investors never have to worry about foreclosure from a lender as there is no monthly debt service associated with the investments.
Times are turbulent indeed, but considering completely cash/debt free DST investments can be a good way to reduce investment risk and avoid foreclosure from lenders.
Securities offered through FNEX Capital, member FINRA, SIPC.
Potential returns/valuation not guaranteed and loss of principal is possible. Talk to your CPA/lawyer for tax/legal advice.