DSTs and UPREITS: “Just the facts”

Borrowing from the great ‘50s TV show Dragnet and Sgt. Joe Friday played by Jack Webb, “Just the facts.”

The facts are the DST industry has grown tremendously in recent years.  It is on target to record over $10 billion in real estate transactions this year.  For better or worse (in my opinion worse) this has got Wall Street’s attention.

It is important to understand DSTs are not a Wall Street creation.  Bill Passo, founder of Passco Companies LLC of Irvine CA is credited with having created the template more than 21 years ago.  The Inland Real Estate Group, born and raised in Chicago followed hard in his wake to rationalize and homogenize the product for retail investment purposes.

Both these companies and all their principals were and are real estate professionals first and foremost.  To date, the latter has purchased over $53 billion in apartments, self-storage, medical, retail and net lease assets in their 50+ years in the real estate business.

It is this depth of real property experience and financial strength that makes DSTs so compelling to retail investors and continues to catalyze the industry’s growth.  Having started out west, DSTs have been on a steady march eastward, finally taking Wall Street and general securities professionals by storm.

As something that can no longer be denied, Wall Street seeks to co-opt as much of it as possible through the mechanism of the UPREIT and their retail brokerage distribution network:  Morgan Stanley, J.P. Morgan, etc.

Heretofore, these entitles have been abundantly clear about their inability or unwillingness to floor individual DST programs on their brokerage platforms.  Their excuses have been that they are too small, idiosyncratic and opaque.

We believe the real reason is DSTs lack of liquidity.  You see, Wall Street is a binary entity.  It makes nearly all its money buying and selling things.  Therefore, anything illiquid is anathema, dead money.

There are few things more illiquid than income producing real estate.  It is not cheap to buy or sell and must be held until these not insignificant transaction costs are recovered.

This is where Wall Street’s aggressive proselytizing of UPREITS as the one and only solution for real property investors comes in.

By having their huge network of captive brokers show investors only part of the story, the UPREIT, it increases the likelihood they will take the short offramp out of real property ownership into a product that can be traded like a straight vanilla mutual fund, albeit at a very significant cost from a capital gains tax standpoint.  In so doing, brokers capture more assets for their ‘book’.

Securities brokers primary rationalization for this has always been the increased diversification available via the UPREIT.  However, this is a simple canard.  

REITs tend to be property type specific.  Therefore, you achieve little or no functional diversification with the UPREIT option.  That’s great as long as the properties which comprise it remain topical from an investment standpoint.  It’s not so great if they don’t.

Furthermore, the fractional ownership nature of any DST program naturally lends itself to both functional and geographic diversification.

When exchanging into DSTs, you go from owning 100% of a single asset in one place to fractional ownership of many assets in different places.

As such, we posit real property investors can more easily create a balanced and diversified portfolio of income producing properties with individual DST programs than any UPREIT currently available.  

This comes with the added benefit of remaining in the 1031 exchange loop and continuing to defer capital gains tax.  This simply cannot be said for UPREITs, which cannot be exchanged out of.

When asked by our investors about UPREITs, we tell them it’s a great option if you plan on dying soon:  your heirs get a stepped up cost basis and they can cash out by converting operating units to shares of the trust.

However, if you want to optimize both cash flow and diversification opportunities, we believe a balanced mix of DST property programs is the way to go.

Don’t be fooled by Wall Street and their marketing gimmicks.  All it is really looking for is more investor cash to feed its insatiable appetite for buying and selling and the huge money trail, your money, this brings in its wake.  Get the facts, all the facts on DST and UPREITs.


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