By the Cove Capital Investments Team

Article Summary: 

While there are never any guarantees for appreciation, income or principal safety in real estate investing, Cove Capital Investments believes that the best DST investments offer investors the ability to offset certain risks including those associated with leverage and certain asset classes. This article describes in detail how these factors should be considered by any 1031 exchange investor prior to investing in DST real estate properties. 

Key Takeaways:
• What are the best DST investments? 
• Why are debt-free DST investments considered potentially safer than those with leverage?
• What are some examples of debt free DST properties?

While commercial real estate has traditionally been an investment class available to only very large investment firms and elite individual investors, the Delaware Statutory Trust structure allows investors to access what many believe to be the best DST commercial real estate investments in fractional shares, giving smaller investors the opportunity to access real estate investments that would otherwise be out of reach for most individuals.

Still, the question that is often asked by Cove Capital investments clients is what are the best DST investments? While this question could be answered many ways by different real estate and DST sponsor companies as well as this answer may vary depending on each individuals goals and objectives, Cove Capital believes that for many 1031 exchange investors the best DST investments are those that are debt-free.

The Cove Capital Answer to What Are the Best DST Investments? 

This emphasis on debt-free real estate is what sets Cove Capital apart and is a major point of differentiation from other real estate Delaware Statutory Trust sponsor firms who acquire DST real estate assets using leverage or loans.

By acquiring real estate assets with zero leverage and no loans, Cove Capital is really removing a large amount of risk from the equation for 1031 exchange and direct cash investors. We believe that debt-free real estate investments make the best DST investments for many 1031 exchange investors for several reasons. However, before we explain some specific reasons why debt free DST offerings can help investors reduce risk, let’s look at what exactly are some examples of debt free DST offerings.

Why Cove Capital Believes Debt-Free Real Estate Assets Make the Best DSTs For Many 1031 Exchange Investors

Here are some specific reasons why Cove Capital believes that debt-free DST investments can potentially benefit investors through reduced risk and therefore can be considered some of the best DST investments for many 1031 exchange investors.

 1.         Debt-Free DST Real Estate Reduces Overall Risk to Investors

The first and foremost of these reasons is that debt-free real estate and DST investments reduce the overall risk profile for investors. While there is never any guarantees of profits or asset appreciation when it comes to real estate investments, by investing in debt-free DST assets, investors are removing all of the challenges associated with a lender and financing equations and specifically with a lender foreclosure.  Cove Capital principals have seen other DST sponsors lose buildings to foreclosure which cost those DST investors their entire invested capital.  Being debt free in a DST removes the risk of a lender foreclosure and the resulting loss to investor equity.

2.         Debt-Free Real Estate Provides Investors Greater Flexibility

Another reason Cove Capital believes that debt-free real estate makes the best DST investment for many 1031 exchange investors is because by removing the leverage component of real estate, investors have greater flexibility to hold through any potential market downturns, credit crunches, recessions, or even depressions.

The Cove Capital team is comprised of a group of highly seasoned real estate professionals with hundreds of years combined experience, and one area that each member of this team has in common is their experience seeing - through the course of their careers- that the most successful investors are those that have the flexibility to hold through potential down markets. Debt-free real estate adds an additional layer of flexibility for investors.

3.         Debt-Free Real Estate and DST Investments Help Investors Avoid Cross Collateralization Risk Found in Many DST Portfolios

One of the things lenders will often insist on from DST sponsor companies is the need to use multiple assets as collateral to secure a single loan. Called cross collateralization, this action allows the lender to lay claim to all the collateralized DST properties in the case of default. With debt-free real estate investments more and more investors are entering the world of commercial real estate investing but without the risks of debt and financing. Debt-free DST investments avoid the risk of cross collateralization.

4.         Debt-Free Real Estate Eliminates the Risk of Lender Cash Flow Sweeps

One of the unrecognized risks of leveraged real estate and Delaware Statutory Trust offerings for 1031 exchange investors is a cash flow sweep from the lender. Cash flow sweeps or sometimes called "cash traps" can be triggered by a number of situations at the DST property level. This could include a tenant having their credit rating downgraded, drop in occupancy levels, or overall performance issues at the property. All of these scenarios could potentially allow the lender to sweep all excess DST investor cash flow. This means “bye bye” to monthly distributions to DST investors.  Many investors are not aware that these cash flow sweep risks are included somewhere in the loan documents and the DST sponsors selling these offerings rarely mention it to investors in their conversations with them. Debt-free DST 1031 exchange real estate investments have no lender and therefore no risk of cash flow sweeps to the DST investors.

5.         Debt-Free DST Real Estate Offerings Can Potentially Provide Higher Cash Flow

One of the things that Cove Capital is seeing in today's higher interest rate environment is that some of debt-free real estate offerings have a higher projected cash flow than leveraged DST investments because there is no monthly debt service that needs to be paid to a lender.  Oftentimes investors are searching for DST investments that have a higher potential cash flow to them than what many of the DST sponsors are offering.  Considering a debt free DST investment from Cove Capital may potentially help to satisfy this investor objective.

6.         Debt-Free Real Estate Offerings Have No Balloon Mortgage Maturity Date

Most leveraged DST properties have a balloon mortgage maturity attached with the loan that will often come due in five, seven or ten years. The balloon mortgage is a hard maturity date. That means if you don't sell the property by that date or pay back the loan, then the lender will seek to take back the property through a foreclosure or other mechanism. Debt-free DST properties don't have balloon mortgage maturity payment risks associated them.