Don’t Fall For This Typical DST Sales Trick

Wally Smith:
We had a call, gosh, last week, and we were talking about typical interest rates, and again, we never talked product on the show, but the interest rates that are typical in the DST space. And he said, he saw this other project that was paying a ginormous interest rate and it turned out when we drill down on it was lands and sticks, getting ready to build something. And so that really prompted the whole question of a DST has to be what’s called stabilized. Okay. Can you talk about stabilization, value add, how much can you do before it comes becomes development?

Jeff Hertz:
DST, I believe the line in the seven deadly sins is you cannot substantially improve or build a property. So DSTs are never going to do grounded up development. They’re never going to buy a building that’s 50% occupied and hope to renovate it and lease it up to a much higher rate. So you’re always buying stabilized cash flowing properties, sometimes brand new. I’ve seen situations where the sponsor literally was buying the property from the developer, but the developer already leased it up to at least let’s say 85, 90%. They’ve gotten a certificate of occupancy. And again, I think from the investor’s standpoint, I’ve certainly talked to investors who have a little bit higher appetite for risk, but in a DST you really need to understand the cash flow and where it’s coming from.
And if the property was not properly leased up, then you would incur potentially a lot more risk in terms of wondering what those rents were going to do on a go forward basis. But in terms of value add, I usually say new carpeting, new countertops, great. Knocking down walls and building additional units is probably not going to fly. And I don’t think, again, the joy of the IRS is, things are fairly vague, but I think it is suffice to say that if your reserves and your overall budget for renovations is going to be higher than the purchase price of the property, then that’s probably not going to fly for a DST, plus the cash flow of the investors

Wally Smith:
Hundreds of units in a property and they to keep up with the competition and the live, work, play world that we’re in now, they say, hey, we need to put in some amenities and maybe it’s $100 million dollar project, maybe they put $3 million into a new club and a pickleball court and upgrade the pool or something like that. Expand the dog park.

Jeff Hertz:
And that’s a way that existing property owners can compete with new construction. New construction generally is more expensive, generally smaller unit sizes. I’m speaking obviously specifically about multifamily, but we’ve certainly seen situations where if we were to come in, put in new flooring, new countertops, new lighting, even some of these cool amenities like Wi-Fi or lighting, smart lighting, smart door locks, there’s a lot of things that you can do that will enhance the value of the property because at the end of the day, it’s all about driving NOI and maybe you’re lucky enough that your property just is next to the best place to go to restaurants or whatever, it’s blessed with that, but in general, you need to rely on things that are going to happen organically within the property to drive rents so that you’re going to drive value.
Because at the end of the day, the real estate market doesn’t always go straight up despite what most people might think. And if you can drive value within the property itself, then you could effectively within a vacuum, create value for the investors.

Wally Smith:
Well, good. I think summarizing that is that if it sounds too good to be true, maybe it is, see if it’s stabilized or see if you are buying into something that is much more speculative development, that hey, we’re not even going to be cash flowing for one, two, three years or something on a long project.

Jeff Hertz:
And to tip to your side of the table, to work with a quality advisor who helps the clients understand what they’re looking at because these documents can be hundreds of pages long. There can be boiler plate, there can be legal opinions and things like that. And to look at let’s say three different multifamily DSTs and say, well, why is this one paying five and this one’s paying four? There’s probably a reason for that. It might be a completely logical reason. In other cases it might be using a higher distribution rate as a marketing tool, not as a reflection of the realistic cash flow of the property.

Wally Smith:
Well, that also comes back to some of the knowledge our managing director of alternative investments, Rich Arnitz, he’s a good friend. He’s been in this industry so long that he’ll tell me, but I’ll ask him sometimes, well, why are these rates so much different? He’ll say, I got to tell you about the sponsor. This one they charge much higher fees. They promote some of their own properties, they’ve got their hands in the tilt several different ways. It’s good to know. It’s really good to know a lot of background about them and we’re very fortunate for the depth of our bench and our team.

Jeff Hertz:
Or it could be as simple as the asset class, right?

Wally Smith:
Sure.

Jeff Hertz:
There’s certainly going to be a discrepancy between an investment grade credit with a long-term lease where you know there’s very little chance something’s going to happen to the tenant, versus any number of asset classes that can be much more economically sensitive. We don’t have to go back very far in time to see where that’s been the case, whether it was COVID or previous recessions or different issues where certain asset classes got substantially altered due to the economy where others, let’s face it, if you owned an Amazon distribution facility in 2020, you had very little concerns because they kept the lights on pretty well.

Wally Smith:
Well, and getting back to what I talked about earlier, out of 40, 50, 60 sponsors who were out there, the ones who when the lockdowns came, or in 2008 when the Community Reinvestment Act finally blew up and took the whole real estate industry down, the stronger sponsors, many of them said, okay, we’re going to waive any of our fees. We’re in this with you. We’re going to invest more. And they came alongside. They had the depth, they had the strength, the financial, the balance sheet to be able to do that. So that’s really what we’re looking for for our more risk averse clients. It’s still real estate. It’s an investment. There’s always risk, but let’s mitigate those risks wherever we can.