Having been present at the creation of the DST industry over 19 years ago, Peregrine Private Capital has seen it evolve form a niche product to a mainstay in the 1031 exchange industry.
This is in large part due to the aging of the population. It’s increasing popularity with accredited investors is in no small part driven by demographics. Managing your own dirt in your 20s – 30s and 40s is fine. For many it’s not so fine in your 60s – 70s and 80s. This is because real property is labor intensive. This is particularly true where rental housing and individual tenants are concerned.
At some point, nearly all landlords may reach the physical and emotional give up point. This being said, they may still be comfortable with real estate as a known asset class and loathe to leave it and pay years, sometimes decades, of accumulated capital gains tax.
This is where DST properties come in. If suitable, it allows individuals to segue out of active management and its incumbent burdens into a truly passive ownership role.
Differing structures of DST programs also provide investors with the opportunity to affect a clean exchange by exactly matching their debt/equity replacement requirements. Hence, no taxable boot.
We believe this demographically driven demand for DST properties is organic. In our opinion as a natural outgrowth of societal aging it should continue to grow. Therefore, income property investors are well advised to come up to speed ASAP.
In doing so, it’s critical to understand there are two components to DST: the objective and the subjective. The objective deals exclusively with the property itself and its underwriting; meaning what it is, where it is and what purpose it serves. More specifically, it’s age, construction quality, occupancy, cash flow potential, competitive environment, surrounding demographics, etc. Taken together, all these factors contribute to price paid for an asset and what future expectations may be in terms of potential cash flow and appreciation.
All this information and more is provided in the Private Placement Memorandum (PPM) which must accompany each offering. This document encapsulates all the due diligence a buyer would normally do himself/herself before purchasing a replacement property. Ideally, everything knowable about the property, good, bad or indifferent is available here. This is part of DSTs full disclosure requirement.
The second and in many respects, in my opinion, most important part of the equation is almost entirely subjective. This is comprised largely of who is bringing the property to market, what their track record is in terms of DST offerings (assuming they have one) and what they do when things get tough.
The latter is particularly important because we have been in a big bull market for real estate (along with just about every other asset type) since 2008 *. This is because all interest rates have done is go down. When interest rates go down asset prices go up. However, when this process reverses itself, asset prices will come down.
Unfortunately, many property sponsors active in the DST space are post 2008 creations. This means they may not have been tested in the fires of recession. We believe this may have consequences for investor equity and cash flow potential.
When DSTs started nearly 20 years ago, there were three companies present. The first two are still us and are dominant players in the industry with a combined market share approaching 80%.
By the peak of the housing market bubble in 2008 (created by the Fed leaving interest rates too low, too long) demand for DST product in 1031 exchange exceeded supply. As such, the number of property sponsors skyrocketed.
Sadly for investors, most of these new additions to the DST sponsor mix were opportunistic with little background in real estate. The properties they brought to market to satisfy investor demand for return were below investment grade. When crunch time came and the economy tanked, they stopped performing.
Investors lost both cash flow potential and equity while property sponsors simply disappeared. This is why it’s imperative to understand fully the subjective component of DST; the agency, reality and truth about the individuals bringing this product to you. They in large part will be responsible for its success or failure.
In our opinion, this is what differentiates Peregrine Private Capital in Portland Oregon from the competition. Our nearly 20 years’ experience in the industry affords us detailed knowledge of the background and track records of property providers. Furthermore, having lived through 2008, we can speak in a highly informed manner regarding the managerial skill of the current generation of property providers.
In our view, good management has the potential to fix a challenged property. Bad management runs the risk of ruining a good one.
*As of March 1, 2020