By Dwight Kay, Founder & CEO
Kay Properties & Investments
Kay Properties & Investments
In recent years, non-traded and perpetual life REITs have emerged as attractive vehicles for real estate investors, especially within the 721 UPREIT DST structure. While these vehicles offer tax-deferred exchange benefits and diversified exposure to real estate, investors must scrutinize several key financial metrics to avoid hidden pitfalls.
Understanding Valuation and Markups
Investors should ask whether the REIT has marked up the DST they're investing in—and if so, by what percentage. Often, these REITs already own a property and then sell it to the DST at a significantly marked-up price, sometimes exceeding 20%, all while the REIT and financial advisors are ensuring to investors that there are no to minimal fees – a massive misrepresentation. However, a significant markup can indicate an overvalued asset and the presence of hidden fees.
Disclosure of Markups in Private Placement Memorandums (PPMs):
While the fine print of the Private Placement Memorandum (PPM) discloses these markups, the estimated use of proceeds page typically omits them. This omission makes these fees harder to track and understand, especially compared to traditional Delaware Statutory Trust (DST) offerings, which usually disclose all costs directly on the PPM's estimated use of proceeds page. This discrepancy can lead to misaligned expectations and increased risks over time for 721 UPREIT DST investors.
Assessing Debt Levels and Interest Rate Exposure
It's crucial to examine the REIT's debt profile. Investors need to know the total debt and how much of that debt is floating or adjustable. A heavy reliance on adjustable-rate debt can expose the REIT to interest rate volatility, increasing the risk of higher future costs and impacting overall financial stability. Many 721 UPREIT opportunities are tied to REITs that carry substantial borrowings, while other available opportunities remain debt-free with no loans. Investors must decide whether they are more comfortable with large amounts of debt (many variable-rate debt) or with a debt-free opportunity with no financial leverage risks.Dividend Coverage and the True Yield – A Critical Measure for 721 Exchange UPREIT Investors
A key indicator of a REIT's financial health is its dividend coverage, measured by Adjusted Funds from Operations (AFFO). Suppose the AFFO coverage is less than 100%. In that case, it means the REIT is not fully supporting its operational income dividend and instead relies on borrowings or fresh investor capital. This practice raises a red flag because it introduces systemic risk: relying on external funding to sustain a portion of the dividend rather than genuine operating performance jeopardizes the dividend's sustainability. Investors must avoid making critical decisions based solely on their relationship with a financial advisor or the REIT company's glossy brochures and impressive size and scale. Instead, they should base their decisions on the REIT's actual financial performance.Net Inflows and Capital Movements
Beyond debt and dividend metrics, investors should also review the REIT's net capital flows. For example, if a REIT raises $50 million in fresh capital but experiences redemptions and outflows totaling $200 million over the same period—resulting in a net outflow of $150 million—this discrepancy could indicate deeper financial challenges. Such a pattern might signal that the REIT is facing liquidity issues that could jeopardize future distributions.The Need for Rigorous Due Diligence
Due diligence is paramount in the 721 UPREIT DST space. Too often, financial advisors and so-called experts recommend plopping an entire client's 1031 exchange into a single 721 UPREIT DST without thoroughly examining these critical economic indicators. Investors must understand the nuances of the DST's underlying REIT, including markups, debt structure, dividend coverage, and net capital flows.
Why Kay Properties Stands Out for 721 UPREIT and DST Investors
At Kay Properties, our focus on these detailed metrics sets us apart. We help investors navigate the complexities of 721 UPREIT DSTs and non-traded and perpetual life REITs by providing transparent, data-driven insights into each offering. Moreover, our platform marketplace at www.kpi1031.com often offers lower fees than traditional financial advisors and DST brokers while providing many of the same 721 UPREIT and DST offerings and sponsor companies.
By paying close attention to these financial indicators, 721 UPREIT DST investors can better position themselves to make informed decisions. The financial advisor and the product REIT sponsor often will not share this type of insight with investors, which is why due diligence 101 on 721 exchange UPREITs and Delaware Statutory Trusts is so critically important for investors to understand.