Kay Properties Headlines Panel on Delaware Statutory Trusts and Why So Many Investors are Interested in Them

Kay Properties Headlines Panel on Delaware Statutory Trusts and Why So Many Investors are Interested in Them 

David Bodamer (00:01):

Good afternoon and welcome to the final session in our WMRE second quarter forum. This session is entitled Why Investors are Selling Their Investment Properties and Turning to DSTs for Their 1031 Exchanges. This session is sponsored by Kay Properties and Investments. I'm David Bodamer, Editorial Director for WMRE. In a moment, I'm going to be turning things over to our panel. But first, I'm just going to go through some housekeeping and how you can get the most out of this event. Firstly, to improve your viewing and listening experience, you can move your webcast windows around within the console by dragging on their title bars, or you can resize them by clicking on their lower right corners. In addition, at the bottom of your screen, you will find several different application widgets. By clicking on these buttons, you can open and close widgets on your screen, but this will not interrupt the webinar and will not remove you from the webinar.

David Bodamer (01:00):

Also, please note that a copy of the presentation is available for download if you go to the resource list widget. Also, our panelists will try to answer as many questions as they can following their presentation, but feel free to submit your questions to the queue at any time. All you have to do is type it into the Q&A window on your screen and hit the submit button. Also, note that this webinar has been accepted for one CE credit hour towards the AEP designation program. A live broadcast of this event has also been approved for one CFP board CE credit hour and Investments in Wealth Institute has accepted this program for one hour of CE credit towards the CIMA, CPWA, CIMC, and RMA certifications. Instructions for retrieving those credits are available in the resource list widget.

David Bodamer (01:51):

Lastly, please note that this webinar is being recorded and will be available for on-demand viewing. All you have to do is go back to the same URL you are using today or share that with anyone else and you will be able to view the recorded event. Now, I'm going to quickly introduce today's speakers. We have with us Chay Lapin, who is President of Kay Properties and Investments, Betty Friant, Senior Vice President, and Jason Salmon, Senior Vice President and Managing Director of Real Estate Analytics. You can find more about each of our speakers by clicking on their speaker bios at the bottom of your screen. With all that housekeeping out of the way, I'm going to hand off the floor to Chay.

Chay Lapin (02:35):

Thank you very much and thank you for everybody who is joining us today. As mentioned, this presentation is available for download and if you have any issues, you can reach out and we can get you a PDF. Some of these, for the sake of time, there's so much we could dig into. The 1031 exchange and real estate can be very complex. So, we're talking high level today and we may move over slides faster than others. Please do not hesitate in asking a question if we go over something too fast and/or reaching out to us directly if you want to go over any particular situation. We also are not offering any particular securities on this webinar or digging into any live deals. This is purely educational.

Chay Lapin (03:27):

Should you want to dig into that stuff, we could talk about that in a more appropriate setting. But again, today, what we are ultimately digging into is what's going on in the market, in the real estate market specifically and why investors are selling their investment properties and turning to vehicles like the DST, the Delaware Statutory Trust. We saw a big trend of this over really the last decade plus, but really a speed of this industry over the last three years of consideration for all types of investor profiles because of what we have gone through as a country through the pandemic. There's a large demographic that is retiring that is not interested in managing their assets anymore and then there's a demographic where their assets are struggling, again, from pandemic, from other things going on, or just in general, they've struggled with their asset for a very long time. So, in theory, they may not be getting the most out of their investment that they currently manage.

Chay Lapin (04:38):

We see this all the time, and there's no guarantees on returns in the DST product, but we see all the time people looking to this product for the passive nature that we'll dig into that the DSTs provide, and also the diversification that DSTs potentially provide to have some mitigation of risk, which I think is a huge transition that a lot of people are considering with today's environment in the economy. But to quickly go over for people that are not familiar with the 1031 exchange, a lot of people that are considering to sell their property will have a very high tax hit. Should they tax out or not do a 1031 exchange? Different states encourage you to reach out to CPAs because everyone's situation's different, but different states have different tax related that could hit the investor.

Chay Lapin (05:45):

That could be state level capital gains. It could be federal capital gains. A big one that a lot of people miss, even I've seen CPAs miss, is the depreciation recapture tax. If someone has owned their asset for 15, 20, 30+ years, there could potentially be a very high recapture tax and then there's some other ancillary taxes that could be taxed onto there. So, that's a big reason why someone would want to consider doing a 1031, outside of you need liquidity for your personal situation and that's why you're selling. But if you're just looking to go passive, diversify, or get out of your current asset, whether it was in DSTs or buying another property, that's the big advantage of the current tax code.

Chay Lapin (06:32):

So, you can see the 1031 exchange offers the same potential benefits as if you did a general 1031 exchange, as if you sold your property and went and bought something on your own. But the big reason, as I mentioned, of why people consider the DST is they're ultimately tired of managing their asset, they're tired of dealing with the headaches that come along, and now with the shift in interest rates, makes it very difficult to find properties that make sense, especially if you're using leverage, and we'll dig into that in a little bit as well of how leverage comes into play of a requirement for certain people's 1031 exchanges.

Chay Lapin (07:16):

If you are retired or you have a specific current income, you may not even qualify for a loan or you may have to take a lot of recourse because the banks are trying to position themselves in today's environment, and we'll talk about how, if you do have to utilize debt, how the DST insulates that. There's still risk layers, but maybe not the same level of risk that if you were getting the loan in your personal name. So, the big thing is passive investments and then the third reason, which I kind of blend with diversification, but you get to potentially invest into a larger, maybe more institutional quality property. So, that could be anything from a $20 million apartment building, it could be a pharmacy, a medical building, a grocery store. These are all typical properties that are, in a lot of cases in today's market, 10, 20, $100 million dollar properties.

Chay Lapin (08:19):

So, if we're only selling a build-, or a client selling a building, an investor for a million dollars, two million, three million, they might price themselves out of not being able to get into an equal or similar type quality that they were selling from or exchanging out of and then also being able to diversify into different asset classes, maybe having a piece of an Amazon distribution center, having a piece of a Class A multifamily, and then having a piece of maybe a value add multifamily that gives you potential upside or growth, this anchor buoy approach that we see a lot of times in different investment strategies. So, the DST is very neat in that perspective and that's why I think a lot of clients, advisors, and the world of real estate is really shifting to explore this fractional ownership piece. So, now, I'm going to pass this off to Betty. She's going to dig into some risk and disclosures and then we're going to get in the meat and potatoes.

Betty Friant (09:28):

Thank you very much, Chay. It's a pleasure to be here. I head up the Washington DC office for Kay Properties and I get to do the dirty work with the housekeeping here. So, I'll just go over a few of these because there are risks associated with investing in real estate and in VSPs. Just like properties you may own where you live, there's really no guarantee that your tenant will continue to pay rent or that the property will make money when it sells. Also, if you can't afford to lose money, you shouldn't invest in real estate, you shouldn't invest in DSTs, and diversification doesn't guarantee profits or protection against losses. The DSTs are only available to accredited investors. It's basically one of the ways to understand that is that they have a net worth of over a million dollars, not counting their primary residence. We'll go into that in a little more detail in just a minute.

Betty Friant (10:28):

Then the webinar today is really just for educational purposes only. You really need to read what we call the PPM, private placement memorandum, for the business plan, risks, disclosures on each property before you invest. As Chay said, we can't give tax or legal advice. So, you really should consult your CPA or attorney about the specifics of your own situation to make sure that DSTs might be suitable for you. So, with that being said, I am going to now break down the 1031 exchange and some of the rules that are associated with the 1031 exchange because the IRS has given us quite a gift when they a hundred years ago said that you can trade properties. So, if you sold a property that you held for business or investment, you can exchange into another property, a like-kind property, as long as you hold that property for use in business or investment.

Betty Friant (11:36):

So, it's really been a very effective way for investors to be able to keep wealth in the family, to not pay taxes on buying and selling, and to actually keep the economy humming because when you sell a property, you really do create a situation where there are a lot of people who are going to be working on that sale, whether it's real estate agents and appraisers and surveyors and building condition report people, and also the trades people who, when you sell a property, you really do often fix up the new one. So, a lot of new dollars are spent with the 1031 exchange. So, we're hoping that the government sees fit to keep it in our possession as a rule for a long time. There's some basic rules in the 1031 exchange and the first one is that you have to have a qualified intermediary.

Betty Friant (12:38):

That means before you go to settlement, you have to find a company or a person who is qualified to hold the funds from the sale. If you end up with those funds in your hand, then you're not doing a 1031 exchange because that would be having constructive receipt of the property, and if you get that money, it's not a 1031 exchange. Number two says that you could reinvest a hundred percent of the net sale's proceeds into replacement properties and that would be a full exchange. You could also do a partial exchange. So, you don't have to be wed to the idea that you sell a million dollar property and you have to buy something for a million dollars. You could pull out some dollars to use for something that might be fun for you and your family or it might just be another investment that you wanted to get into. But it can be a full exchange or a partial exchange. But in a full exchange, you'll see in number three, you have to basically replace your sales price.

Betty Friant (13:46):

So, the two rules that we look for are that you have to use up all the dollars that came out of your exchange. So, if your qualified intermediary ended up with $2 million, then you have to invest that whole two million and you have to replace your sales price. So, you can check with your CPA or qualified intermediary to see if you need to replace your sales price, less allowable expenses. But for today, let's just consider you're replacing the sales price. That means that you have to use up all your dollars that you have and you have to replace your sales price. So, it typically means that you have to either replace any debt that's on the property or you have to bring cash to the table to get to that sales price. Just as an example, on a million dollar sale, if you owed 300,000, that would give you 700,000 you invest and you have to get a loan for that 300,000, and I think Jason will explain a little bit how that works in just a minute.

Betty Friant (14:53):

The properties have to be identified in 45 days, number four, and this is just critical because what's going to happen is by the time 45 days arrives after your settlement, you will have to choose what properties you might want to buy. In our world of DSTs, most of our investors are typically closed within a week or so because the properties are already owned and they can invest in a piece of it. But in the real world of real estate of whole properties, you might want to get that property under contract and start your third party reports well before the 45 days are up, which makes it a real challenge because 45 days goes by so quickly. There's a couple different roles that we won't go into today, but you could call any of us to get more detail on this.

Betty Friant (15:48):

Those are things like the three property rule where you identify three properties of any price or the 200% rule where you identify any number of properties, as long as you don't go over 200% of your relinquished property, and then you have to close within the 180 days after your settlement. So, those are the rules that just have to be followed and this chart shows you a little bit more in detail on what happens. You close on your relinquished property, you have 45 days to choose what properties you might buy, and then you have to close on those properties within the 180 days. A lot of people think like-kind. I sell an apartment building. Do I have to buy an apartment building? That's just not the way it works and it's interesting because there are a lot of like-kind properties that you can trade for.

Betty Friant (16:50):

So, if you sold an office building, you could buy an apartment building. You could sell an apartment building and buy raw land. You can buy beach properties that are used for rental. You can buy a property that's just held for an investment. But in any case, it's called like-kind because it is real estate and the DST is actually a form of real estate that was allowed by the IRS as a like-kind property back in 2004, and that the 1031 really is a great rule that allows us to defer taxes. We call it swap until you drop. You get to defer taxes as long as the laws don't change until your heirs inherit the properties at a stepped up basis. So, the DST is an easy way to make that work, and I'll turn it over to Jason to give a little bit of detail about the Delaware Statutory Trust.

Jason Salmon (17:52):

Thanks, Betty, and it's good to be with everybody here. Hopefully, we're all learning a little bit. Again, just acknowledge and understand that the 1031 exchange, for those that haven't been immersed in this, this can be a little bit tricky. But this is for educational purposes and certainly if any of these concepts, like Chay said earlier, need clarification or expansion, please don't hesitate to reach out to us to understand in a little more depth or a lot more depth what this is all about. This is why we're here. This is what we wake up for every day and go to work. So, the DST itself, what is it? Like Betty said a minute or two ago, it's real estate. It's owned in the form of a Delaware Statutory Trust, a DST. We'll see that in a slide or two. But it's property that has, through the guidance from the IRS, through what's called Revenue Ruling 2004-86, is there for 1031 exchange in, and when it's sold, 1031 exchange out.

Jason Salmon (19:07):

So, continuing all that tax deferral that we were referencing earlier and talking through would continue on. Sometimes, people think, or we have conversations say, "Well, if I'm in a DST, then when it's sold, then there's a taxable event." So, again, as long as everything continues to move forward, the 1031 exchange in and of itself is there for the taking upon sale of a Delaware Statutory Trust, which is going to be held as an investment purpose, but for an investment purpose for, in most cases, a few years. It's an entity like any other. It's trust. It just happens to be a Delaware Statutory Trust. Group of people got together a few years back and in and of itself, again, the DST has been around, but utilized for this purpose, group of people got together, made an appeal, doing things like ultimately getting a private letter ruling, which evolved into that revenue ruling that we talked about a slide ago, and it's a Delaware Statutory Trust eligible for 1031 exchange.

Jason Salmon (20:23):

It's like an LLC, but unlike an LLC as group ownership, it qualifies as like-kind because other types of private equity real estate would not necessarily be eligible. Just want to be clear, if somebody sells something as an LLC or a partnership or a trust or a corporation, they can do a 1031 exchange, potentially. But as it relates to private equity real estate, like an LLC or a partnership or a private REIT, it's a little different way. So, people ask about distributions and appreciation. In a DST, the investors receive their pro rata portion of potential distributions and they also receive a hundred percent of their pro rata portion of any appreciation, net of any sales costs, when the property is ultimately sold. So, again, unlike other types of private equity real estate where there's a notion of either, it's called a waterfall, or basically on the back end, in Delaware Statutory Trust, the proceeds go to the investors.

Jason Salmon (21:40):

Again, from what I mentioned a few minutes ago and a few slides ago, when the DST's sold, investors can do another 1031 exchange into any type of like-kind replacement real estate. It is unlike other forms of private equity real estate like LLCs, private REITs, partnerships. Investors, again, typically can't do it in those situations because it's not set up that way. It can happen. They'd all have to be going together. But in the format of private equity real estate, it's not so much done like that. It's dissolved and on down the road everybody goes. Again, just for clarification purposes, if somebody has a partnership or an LLC, they would be able to do a 1031 exchange, just following the rules on that. Major motivator for this, of wanting to be a part of Delaware Statutory Trust is the fact that these are passive investments when somebody's selling investment real estate in a couple different reasons.

Jason Salmon (22:57):

One, the typical tenants, toilets, and trash. You own a condo, you own a single family rental, you have a portfolio of them, you own multifamily, commercial even that have multiple tenants, there's a lot going on day to day, could call it property management responsibilities. But you're also an asset manager too. You're owning it, you're running it, you're looking to keep your finger on the pulse of it, decide when the appropriate time is to sell. With Delaware Statutory Trust, as an investor, you don't need to deal with that because somebody else is doing it. They have professional asset and property management in place and this does allow the investors to enjoy this part of their life, maybe the part of their life where they've decided to potentially defer taxes and they've done a 1031 exchange. They don't want to manage anymore, they're going to travel with their family, other business dealings.

Jason Salmon (23:58):

We see this every day through our clients, and also the ability to diversify, which was talked about a little earlier. Diversification doesn't protect against risk. But again, the opportunity because of the price points and minimums can make it very, very accessible for most investors, and for this reason. Typically, the minimum for 1031 exchange, or $100,000, dollars could spread around the equity, different property types, multifamily, i.e. apartments, office. We haven't really seen lately what would be the typical multi-tenant office. I think we all know how the world has been lately. But there's there's office using, major tenants, major companies, behind leases, certainly a lot of industrial and distribution, and we know what the world looks like now again for why that is important potentially, and medical and healthcare related, and net lease real estate, triple net, and the like. The DSTs could be set up as all cash debt free or they could be set up right out of the gate with leverage on them.

Jason Salmon (25:18):

This has importance when it comes to how Betty was mapping out the 1031 exchange in that you have to buy equal or greater real estate value and that means that if you had debt in your 1031 exchange, if you had a mortgage, the qualified intermediary and your accountant are going to want you to buy equal or greater value. How can you achieve that with DSTs? Well, the great thing about them is if you need it, it's there for you on such deals. If you don't need it or don't want it, there's DSTs that don't have any debt on it, which changes the dynamic as well and a few slides down the road on this presentation, you'll see some points about that. These Delaware Statutory Trusts, the real estate are purchased really around the country. It's not like they're throwing darts.

Jason Salmon (26:10):

You have very large firms that are looking to own real estate in specific places for specific reasons, but yet diversification does not guarantee profits, nor does it guarantee against losses. But with the DSTs, you certainly don't have to put all your eggs in one basket. People always ask what happens at the end of the year. It's not a K1, but it's like a K1. So, at the end of the year, the investor receives an operating statement for the DST, each one that shows their portion of the rental income and expenses, sometimes referred to as a substitute 1099 or a 1099 misc, M-I-S-C. I've seen grantor letter, grantor trust letters. For most people, the way they've invested structurally, that would then go onto Schedule E. Understand that certain other types of entities report on different schedules. But it will go to that place where all that depreciation and such would go in any other investment real estate deal, it works very, very similarly.

Jason Salmon (27:24):

The DST properties often have long term financing in place. So, that really helps when it comes to closing risk for the 1031 exchange and when it comes to the 45 days and 180 days because somebody has to go out and get a loan if they're going to buy their own property and not do DSTs. Then that really could be an impediment to closing and also the 1031 exchange being done, aside from negotiating with sellers if you're a buyer and you throw the realtors in there and their negotiations. A major one, if anybody on this presentation has experienced what it means to go through getting financing, there's a lot of hoops and hurdles and it can be tricky and it can take time. But with the Delaware Statutory Trusts, DSTs, they typically have long term financing in place if there's debt on it and that could potentially mitigate 1031 exchange closing risk.

Jason Salmon (28:39):

Also, I think one of the major things, if people do want and/or need debt in their 1031 exchange on DST or invest in DSTs is that the financing on DSTs are typically a hundred percent nonrecourse to investors and that means that non-recourse financing is where a lenders only remedy on a loan in the case of a default is the subject property thereby potentially providing protection for a borrower's other properties and assets. Nonrecourse debt on DSTs, and I think Chay's going to take it from here and bring it forward down the road a little bit.

Chay Lapin (29:25):

Yeah, exactly. So, the nonrecourse, I'm going to dig into here different DST structures regarding how the debt works. But yeah. Piggybacking off what Jason said, it's a hundred percent nonrecourse. Carve outs, which are very typical. If you're not familiar with financing, usually you'll sign carve outs and that could be like an environmental carve out. Or a lender wants protection. If you had a Walgreens property, decided to turn it into a gas station, they want that risk, that environmental risk to be outside of them. But then the sponsor, the trustee of that particular DST is signing on that carve out. So, you don't even have to sign on the, as an investor of a DST, those rare instances of carve outs. But what I see a lot of times for the retail investor out there that are out getting loans, there may not even be that many options to have a hundred percent nonrecourse.

Chay Lapin (30:29):

A lot of times, a hundred percent nonrecourse is more in the institutional world of gathering debt or for larger properties. Usually, if an investor was going to go buy a four flex or 12, they may have access to nonrecourse, or they may have a partial recourse, like 30% or 20% or have to collateralize something else. So, it's very neat and then also, like Jason said, that deck gets passed through. You're not signing as an investor. When you're coming into the DSTs, if there's prestructured financing on it, you understand what all that debt is because it's closed. That's a nice thing too is you get to see day one what that financing looks like and the different risks that are involved in that particular financing structure. Risks can be what kind of cash flow sweeps are there? What kind of default items are there, like debt coverage ratios? Or if you have to retenant the building, how much control is the lender going to have over that retenanting process?

Chay Lapin (31:29):

So, those are all things that an investor can look at from day one. But they decide they're comfortable with that and comfortable with whatever that debt structure is in that piece of property in the DST and they exchange. They don't have to go through the lengthy process of qualifying for the loan. You'll get the flow through benefit through that DST structure for 1031 purposes and tax purposes on your, what Jason said in a lot of cases, Schedule E. But you're not having to get it on your credit report and all of that stuff. So, that's kind of neat, especially for people that are at a point in their life where they may not, like I said earlier, qualify for a loan. They might be property rich and not a current income stream rich. A lot of investors have a lot of their net worth and hard assets like real estate and aren't producing a current salary.

Chay Lapin (32:20):

So, we're probably going to see a lot of that. As I said, earlier, loans coming due, people that traditionally would just refinance that debt and hold onto their real estate, they still may have a really good piece of real estate, but they might be forced to sell just for that pure fact of the new debt environment or the new requirements that lenders are going to start getting more stringent on, or they have to take very creative financing, which could be private lending or any other whole list of risks. So, a lot of times, our deals on our platform are 50 to 60% loan to value and if there is principle paydown, you do get that passed through to you. Now, I'm going to quickly go through this slide because we are getting close on timing and I know we're going to have questions, but there are on the flip side DSTs that are completely debt free. No first trust deed on them.

Chay Lapin (33:15):

So, a lot of investors, especially people who have owned an asset for a long time, they may be very lowly leveraged at this point in their investments cycle or life cycle, or they may have no debt at all because they've owned their asset for 25+ years and they paid it off. So, one thing that debt brings as a benefit is maybe you're fully depreciated on your asset. By taking on debt, you may find more property, which creates some additional depreciation. That could be a reason to blend it in and get some potential tax benefits, maybe get some interest deductions. Previous to today's world, you might have been able to get a higher cash flow with debt now with higher interest rates and still low cap rate environments. We have not seen the movements yet on real estate pretty much across the board being affected like you might see in the public markets or things like that. There hasn't been that swing. I think they'll be softening, but we haven't seen a swing.

Chay Lapin (34:15):

So, cap rates are still low. You're not getting that positive arbitrage that you used to get by using debt. The question that investors have to ask themselves is at a peak in the market, as we are arguably right now, with a lot of moving parts that we don't know which way certain things are going to go, we could all make guesses, but we don't know, do you want to take the risk of over-leveraging just for tax benefits, or is it time to put yourself in a defensive position, stay debt free where you can, or only take on the amount of debt that you need to in this exchange? So, if you're selling your property for $5 million and you only had a million dollars of debt, it might be very smart to only take on that million and stay de-levered, and if you want to take advantage of debt in the future when the market becomes more predictable than the next round when these DSTs sell, if you should go into DSTs, you could then take advantage during an upswing in the market, utilize debt.

Chay Lapin (35:18):

But once you take on debt, you are stuck there because per the 1031 exchange rules, you have to buy equal or greater of what you sold for. If you take on debt, you're now creating a bigger purchase price. So, when you sell in the future, you're going to pay off your debt, have less equity, but you still have to reach that point of your original sales price. So, by default, you either have to add in a bunch of fresh cash or you take on another loan. So, you have to look at yourself in your ... You may be at a certain age right now where you could take that risk of debt. So, you, okay. I want to leverage up, take advantage of all the depreciation, everything.

Chay Lapin (35:57):

But when we sell seven to 10 years down the line and go full cycle and there's a liquidity event, is that a point in your life where you should have debt? So, you may have to take a hit of not having all those tax benefits now because you're setting your future up in five, 10 years from now. But again, this all comes down to individual people's portfolios because maybe this little segment you're doing in DST, you're de-levered everywhere else in your portfolios and investment holdings that it's okay. So, that's why everyone's situation is different. But again, quickly, debt free, no refinancing risk, eliminates the equal or greater, like I said, no cross-collateralized debt. Some DSTs have 20 properties in them, but if there's one loan, you're kind of all tied together, and then there's no prepayment penalties.

Chay Lapin (36:51):

I think that's a huge one that people don't realize. You don't stay debt free just for risk mitigation. You also stay debt free dependent upon the business plan of the real estate, during that hold period, and having the opportunity to exit at an appropriate time, you may not be able to do in a debt situation because you might have a big defeasance or prepay or yield maintenance where you can't even sell for seven to 10 years. But what if it's a good opportunity to sell in six years from now, or what if we had a situation where we were managing the asset actually? We saw a big employer that was potentially exiting that particular market. So, as an asset management team, we saw the opportunity that we could sell for a profit for our investors at a good overall return, then take the risk of that employer leaving, and then having a domino effect for that kind of local economy.

Chay Lapin (37:54):

So, that was a debt free deal. We could do that. If that had leverage, our prepayment penalty may have been so large that it could have ate into our profits. So, there's all different reasons. Again, I don't want to shoot down debt. There's a place for it and sometimes there's a need and then we go further by having the diversification of that debt if you have to. Quickly on how quick can investor close, if the DST is available, the nice thing is investors can close in three to five business days. So, you could really do planning ahead of time. I'm going to zoom through this. But like we mentioned earlier, we have all sorts of asset classes. There's a couple that we stay away from like senior care, hotels, and certain leverage type deals that may have higher risk financing attached to them, and they do exist in our world, but there's risk there.

Chay Lapin (39:00):

Lastly, who qualifies to buy a DST? We all talked about this. It's an accredited investor. That could be an individual with a net worth of a million or more, minus their primary residence. If it's an entity, like they're selling through a trust or a LLC or corporation, all of the underlying owners need to be accredited. Or if that particular entity has over $5 million of assets, then you can qualify as a accredited entity. So, that would be the case a lot of times for things like the irrevocable trust. Those, we have to do the entity accreditation. So, if you have questions on that, feel free to reach out and we can always direct you to the right professional to look at your situation. I'm going to pass this off to Betty here who's going to quickly go through, because we're coming up against the clock, Just some quick examples of past closed out DSTs. Some of these have even been sold and had a full cycle event. Then Jason's going to quickly go through the due diligence process and then we'll try to get to some of these questions that you guys been asking here.

Betty Friant (40:14):

Thank you very much. So, I am going to go fast and I'll say that DSTs can be almost any kind of property as long as it's real estate that is typically income producing. So, you might have properties like FedEx. It could be a debt free or a property with debt that would be a multifamily, or lately we're seeing a few of the single family built to rent properties that are in DSTs. Pharmacies are a popular option. We like sometimes that we get the investment grade credit that you might be looking for for that income.

Betty Friant (40:52):

Frito Lay over here near me in Dulles Airport is another type of an industrial property that could be a DST. Medical, we often see medical such as the dialysis or could be even something like a surgeon center or plasma, as a matter of fact, where it's a plasma collection company, and then data. Data centers themselves are very popular, hard to come by, but very popular. This one actually went what we call full cycle, meaning they bought it, it produced very well, and sold for a nice profit at the end of the term. Again, multifamily is always available. We have Amazons for that kind of credit. We even have government, sometimes government credit that you can be looking for. When we look at these properties, it's important to make sure that we like the property before we put it on our list. So, Jason's going to go through the due diligence process.

Jason Salmon (41:55):

Thanks, Betty. Again, this will be a point we're going to go a little quicker. This is almost an opposite effect because the due diligence process that Kay Properties invest time and effort to really dig in, as you're about to see, on these deals to determine if they would even be on the platform. So, our due diligence team is comprised of a lot of members who have worked for very large firms doing essentially the due diligence. So, what do we do? We mystery shop. So, we'll physically go to the properties that will become DSTs or are DSTs, inspect, utilize also databases, third party reports like appraisals, environmentals, and such, and contributing towards what we believe is okay to reject an asset class that we just don't feel comfortable with, or even the properties that come out. But certain high risk asset classes, like Chay mentioned, senior care, what's called memory care, assisted living, regional shopping malls, hotels, oil, and gas, these are a little bit specialized. We have the perspective of history and there are certain asset classes that just don't don't make it.

Jason Salmon (43:24):

But beyond, we saw the list of the types of real estate deals. So, we'll mystery shop, you have to be diligent, and we'll crunch all the numbers. We have sensitivity analysis and stress tests, thorough analysis. It's going to be different depending on the type of real estate. So, something like triple net real ... It's absolute triple net. There's not that many moving parts. But you really have to understand the essence of the lease itself. Do they have an out? Is there a strong corporate guarantee? What is going on at that level? So, first, to even see if that real estate deal would make it and even if it does, let the investor know exactly what they're getting into instead of just a nice story because it's about the underlying real estate and the tenant or tenants. If it's something like a multifamily, what's the essence of it? What's on the one, three, and five mile radius? Who are the competitors? What are the comparables on all these?

Jason Salmon (44:32):

These are the types of things that are especially important for us as a firm first to understand exactly what we're dealing with here, but more importantly, to allow our clients to understand exactly what they're getting into. So, you can conduct due diligence on bad deals all day long, but they're still bad. So, got to know it up front, stress on due diligence, very, very important, and if we've gone too quickly on any of these things, please reach out to us and we'll walk you through step by step. I think right now, Chay's going to talk a little bit further about the process and keep it moving.

Chay Lapin (45:14):

Yeah. I was actually thinking that I'll quickly go through, really because we're coming up against ... You guys actually have some decent questions here that I think are worth attending to. We may jump to those here shortly. But I think the important thing that hopefully you guys will get from this approach is our hyper-specialization. I think that's really important. We have from the inception of our firm and then previous to that, our founder be in the industry before he launched Kay Properties, being in this DST industry before the last Great Recession before 2008 and seeing how different deals reacted through financial crisis, seeing how they acted through coronavirus, seeing how they're responding in today's environment, and surprisingly very good overall, and there's still risks and anything can change at different times and there's a few questions about that. But being involved in over 30 billion of this product type has really exposed us and we have people throughout the entire country.

Chay Lapin (46:30):

We have, like Betty said, DC, Jason's in New York, we have West Coast presence, we have people on the ground in the middle United States, in Texas. So, we're really getting and then talking to all the different investors and advisors out there and brokers. We get exposure to the entire country and what's going on out there. So, it's very interesting to be in our perspective and I think, to just kind of wrap this up, another important part out there that investors are considering, as Jason kind of mentioned, and I'm going to have Betty just kind of go off track here and talk about, because Betty's experience of 30+ years in the real estate industry, and specifically a lot of it in the net lease or a lot of you guys might have heard, triple net leases.

Chay Lapin (47:23):

A lot of people are looking to sell their properties to be in a passive investment. So, the two passive investments out there a lot of times are the DST vehicle or a triple net property. That's kind of what we're seeing being offered to investors. We're not brokers of triple net properties. We are real estate brokers. So, we don't act in that capacity. But we're very familiar with that structure through Betty's background and then also, my background. I've been involved in hundreds of millions of dollars of actual acquisitions and underwriting of net leases as a principal. So, a triple net property, it is more passive than a multifamily deal. Absolutely. But it's not as passive as someone may think it is because as Jason said, you got to keep your finger or thumb on the pulse.

Chay Lapin (48:22):

Just because it's a passive investment triple net doesn't mean that Walgreens isn't taking care of their responsibilities. It doesn't mean that Walgreen's, not to call out Walgreens, but CVS or FedEx or whoever it is, doesn't mean that they're truly paying the property taxes or that they're truly staying on top of their obligations. You got to ask to manage that situation. We've heard many times of situations like that. I've been involved in the portfolio we manage where our team's constantly staying on top of reimbursements. A lot of triple net leases or net lease structured also aren't passive in the sense of the tenant really doing all their obligations.

Chay Lapin (49:02):

We have tenants or lease structures with Fortune 500 companies where it's on a reimbursement. So, if something still breaks or property taxes [inaudible 00:49:10] paid, the landlord is taking care of all that and then submitting for reimbursement through FedEx and hopefully they pay you or you're going to be hiring an attorney and going after them. That's one of the things that the DST trustee and in-house council stays on top of to the best of their ability probably better than maybe an individual has the capabilities of doing without bringing in additional costs. So, I don't know, Betty, if you want to kind of just quickly dig into that and then we can kind of review some of these questions.

Betty Friant (49:48):

Yeah, that sounds good. I know there was a question that Mark asked about the Walgreens portfolio, say where you do see stores that are closed, and that does happen. It is a little reassuring to know that the Walgreens or any other corporation or tenant, no matter who they are, has an obligation to pay the rent, even if they close the store. So, if it's a dark store and you happen to be the landlord of that property, unless the tenant went bankrupt, you are likely to still be getting your rent. But it does take someone who knows real estate to help you through maneuvering what's going to happen there and that's why Kay Properties does such a good job because we are real estate people and we are doing real estate all the time. So, it does make a lot of sense to look at it that way. Do you want to answer any of the other questions since we have a few minutes left, Chay?

Chay Lapin (50:45):

Yeah, and one thing to piggyback off that, you still receive the rent if you were debt free on that Walgreens, but almost 99% of the time, if you had a loan on that Walgreens and you owned it yourself, had all your eggs in that basket, most likely the lender's going to sweep your cash flow until you can reposition that asset, and that's why the DSTs of diversifying, God forbid, you're in something that goes dark, which is rare, I've seen it happen, but so far it's been rare, but you don't have all your eggs in that basket. So, when that does happen, you don't lose a hundred percent of your current income and then have to spend hundreds of thousands of dollars addressing that situation. David, did you want us to just run through these questions?

David Bodamer (51:33):

Yeah, probably. Yeah. There's a lot of questions here and rather than me kind of picking, if there's just any that you want to prioritize. Also, I will note for our audience, thank you so much for sending in so many questions. Our panelists will get a full report of all of these. So, any that we can't get to in the next seven or eight minutes, they'll be able to follow ... the whole full report to follow up offline. But I'll let you guys just kind of jump in on any of these that you think are the most important to jump in on.

Chay Lapin (52:05):

Okay. Yeah. Quickly, and I'll keep these short so I can maybe hopefully hit most of your questions here. So, someone asked about three to five year hold periods. Is there something that makes this or triggers that or makes it preferable to resell after a short timeframe? Really, a lot of these do have, especially in today's market at a peak of the market, they are probably going to be longer term old periods to kind of weather the storm and then create value. So, you're probably looking at a seven to 10 year hold. There are maybe some value add projects that have a shorter hold period. There's typically a business plan that investors can review and understand the hold period. But that could be shorter or longer, dependent upon what happens in the economy. Someone also asks about does a DST work with an LLC? Do all members of the LLC need to go into the same DST or can the LLC members split up and take advantage of the DST?

Chay Lapin (53:01):

It's really a CPA question for the high level, unless they've done some fancy footwork prior to their exchange. The LLC, if it's a partnership that's selling whatever building and coming to exchange into a DST or even a normal property, the rules don't change just because it's a DST. Usually, they have to move together. If you have 10 partners in the deal in that LLC, you can't all just individually pick a deal. Now, maybe you all exchange and then there's a legal way to split it up down the line and it's easy on our end, as long as you're legally doing it, not causing a tax consequence for yourself personally, we can change ownership on a membership interest or the fraction ownership. It's just documentation that you're not messing up your future 1031 exchange, should you dissolve that LLC down the line.

Chay Lapin (53:58):

If you're looking to do that, it's a process. Again, a CPA professional question or legal to dissolve that LLC before you get yourself into a 1031 exchange situation or a certain amount of time afterwards. What if ... Or Betty answered that. Walgreens. What are your desired yields? Someone's asking basically about yields. They're probably comparing it, I don't know exactly where they're going with it, but probably comparing it to the open market. There's a current cash flow on all BSTs and there's a wide range in today's market. It just depends on risk layer, just like anything, that yield, that current actual dollars coming to you, and it's paid on a monthly basis. It could be anywhere from three to 6%. There's stuff all over the place. There in the coming months, there may be actual more opportunistic. But that's just current.

Chay Lapin (54:53):

Because it's a DST, it's not set up as a preferred return where you're targeting day one, someone's telling you it's a 9% or 12% preferred return. The goal is to get there through an IRR in a business plan. So, the current cash flow that you see on DSTs, that's current cash flow projections. That's not IRR projections. So, hopefully through this inflationary period and current economy, you're offsetting everything by the total return. You're looking big picture. Seven to 10 years. You may get hit in the first three years, but hopefully you make it up down the line from a total return perspective. Is existing debt measured by the dollar amount or the debt to equity? If I think I know what you're asking, it's debt to equity, basically the down payment, which is the equity from the offering and then the loan.

Chay Lapin (55:52):

Are losses created through depreciation? For example, passed through the investor? Yes. If depreciation is available, if a client has fully depreciated their situation, then they are not going to have any more depreciation and that's why maybe they would use debt. But that is passed through in that tax package that you get at the end of the year, there will be a land and building valuation. In some deals, we have a cost segregation report. So, that may further enhance someone's situation. Is a trustee needed? No. There's a trustee already on there managing the deal, if that's what you're asking. Can you put your property in a DST or is this just an investment tool for diversification? I don't know exactly where you're coming from, but yes, in theory, the DST is a wrapper. It's just like an LLC, I guess. If I own my own building, I could go put in the DST wrapper.

Chay Lapin (56:47):

We specifically use that wrapper because the IRS has qualified that for fractional ownership. So, in a normal LLC, as I wrap this up and I'm not going to go get to all the rest of the questions, but a normal LLC, like I just mentioned in that other question, has to move together. But in a DST, the investors come in today, all 50 of them are all 20 of them, and then seven, years that DST sells, they can all go their own direction and do a 1031 exchange. They don't have to move together. So, we use that wrapper for the pure exchangeability on the front and back end. I think we're out of time here, but on my end, we really appreciate everybody jumping on this call with us and learning about it. We're always available. As mentioned, you can download this PowerPoint and we can go from there.

David Bodamer (57:56):

Cool. Thank you so much. Thank you for getting through as many of those questions as efficiently as you could. Appreciate that for sure, and I'm sure the audience does. Then for the ones that you didn't, like I noted, we give you a full report of that so you can follow up. With that, we are done. This is the conclusion of our fourth and final session of our WMRE second quarter forums. I'd like to thank this afternoon's panel for an outstanding presentation. Would also like to thank Kay Properties and Investments for sponsoring this afternoon's session. We'd also like you to check out our future forums. We're planning to do these quarterly, so we should have updates hopefully in the next few weeks about scheduling, calling for speakers, calling for sessions for our September forums. Just make sure you're on our email list to find out about that stuff.

David Bodamer (58:59):

Once you leave the event, a short survey is going to pop up in your browser window. We do appreciate if you could share your feedback on this session as to just help us to provide you with the best content going forward. So, lastly, I just want to thank the audience for taking time out of your day to listen to this and to ask so many good questions of our panel and on behalf of Wealth Management Real Estate, thank you for attending and have a productive rest of the day and rest of the week.

Jason Salmon (59:30):

Thanks everybody.