Delaware Statutory Trusts And The “Doom Loop”

  • – Venture Returns Weaken
  • – Small Businesses put Hiring Plans on Ice
  • – Default Fears Pressure T-Bills
  • – Trend of Employees Returning to Offices is Stalled
  • – Target Shoppers Rein in Buying, Denting Sales
  • – U.S. Economy Slows Dramatically to 1.1% in QI

This is just a sampling of headlines from Wednesday’s WSJ (5/17/2023).  We’re not technically in recession yet, but things sure seem headed that way.

What should be even more important to CRE investors and folks in 1031 exchange is the doom cycle beginning to play out in the office market.  With the continuing fire sale of San Francisco office buildings and wave of mortgage defaults in the New York Metropolitan area, the lending game has changed completely from a year ago.

Institutional investors get this as they watch buildings fall like dominoes.  However, it has yet to register at the retail level.

We are talking to more and more investors in 1031 exchange who are experiencing last minute loan failures.  Oft times, this is with lenders whom they have had a relationship for years.

Everything’s a go until the last minute when the rug is pulled out from under them.  Then they must go to a different lender and begin begging for money all over again.  All the while that 45-day identification clock is ticking down.  This simply adds another unnecessary layer of stress to an already stressful situation.

To avoid this disappointment and frustration, income property investors must understand, much like the housing market crash of 2008, lenders are pulling in their horns.  This is in anticipation of a more than $500 B drop in overall office valuations yet to come.

Due to the widespread adoption of hybrid work patterns and the 50% occupancy rates this brought in its wake, lenders could be saddled with huge losses in their CRE portfolios as landlords default.  Their inclination to continue lending in an environment like this will be slim and none.  Even those investors with the best possible credit could be negatively impacted by this in terms of loan availability.

One obvious way to avoid the fallout from this “urban doom loop” (professor Stijn Van Nieuwerburgh, at Columbia University’s Graduate School of Business) is DSTs.  This is because most DST properties come prepackaged with non-recourse debt.

Non-recourse debt (loan) does not allow the lender to pursue anything other than the collateral in the DST property itself.  As such, it is some of the most favorable debt available to borrowers.

Even better, the investor need not qualify for this loan personally.  As part of a ‘turnkey’ DST program, it is the obligation of the DST property sponsor itself.

These loan packages encumbering most DST properties also come in varying amounts.  Therefore, as an exchangor, you need only find that DST program or programs that most closely approximates your loan-to-value exchange requirement to avoid the penalty of taxable boot.

This is a simple solution to what is otherwise likely to be a long term commercial property lending problem.

All that is necessary is for retail investors ‘to get’ that things have changed and the loan they need may no longer be available.  Better to learn this now and take the necessary avoidance action, than when your 45-day replacement property identification clock is ticking down to a big capital gains tax event.


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