When comparing investment structures like Delaware Statutory Trusts (DSTs) and Tenancy-in-Common (TICs), it’s crucial to examine several key factors, including liquidity, certainty of close, tax reporting, financing structure, and associated costs and fees. Both DSTs and TICs allow multiple investors to own fractional interests in larger properties, yet they differ significantly in how they handle these aspects. Understanding these differences can help investors make informed decisions about which structure best suits their investment goals and risk tolerance. This article delves into these factors, providing a detailed comparison of DSTs and TICs.
Liquidity:
As with most real estate investment, both DSTs and TICs are not considered liquid assets, as there is no formal secondary market for either. However, ownership in both structures is transferable, meaning a DST or TIC owner can theoretically sell their shares to another investor in a secondary transaction.
For TICs, selling shares can be more challenging if the property was purchased with a mortgage, as the bank typically needs to underwrite each TIC owner. This additional requirement can complicate the transfer process. In contrast, DSTs do not have this requirement, making the transfer of ownership potentially easier.
Certainty of close:
For investors seeking a straightforward, turnkey solution, DSTs are typically more suitable. DSTs have several advantages: they can accommodate up to 99 investors, whereas TICs are limited to 35, and the minimum investment amounts for DSTs are often lower. Additionally, DSTs require less administrative effort upon closing. For TICs, each investor must be underwritten by the lender if the property was purchased with a loan. Moreover, TIC sponsors often establish a single-member LLC for each investor to provide legal protection and prevent personal liability for the loan. TIC investors frequently close on a property in coordination with the sponsor, which can take longer than a closing into a DST.
While the certainty of close is attractive to many investors, some are wary of the associated costs. These include expensive bridge loans and high marketing expenses needed to warehouse the DSTs for investors. Furthermore, bridge loans often come with lender agreements that may pose risks to investors if the sponsor fails to sell sufficient equity in the DST. Therefore, investors must assess how high of a premium they are willing to pay for that certainty of close.
Tax Reporting
Investors in TICs and DSTs both report income on the schedule E of their tax returns. If they have basis in their property, they can depreciate their asset for tax sheltering purposes. However, TIC investors do receive the property deed, whereas DST investors do not.
Financing Structure
Both TICs and DSTs can offer non-recourse debt to investors, allowing them to:
- Replace the debt from the property they sold and purchase property of equal or greater value to satisfy their 1031 exchange.
- Acquire more property to potentially amplify their upside potential.
- Buy additional property to increase the basis for their investment and gain potential tax benefits through depreciation.
A significant difference between TICs and DSTs lies in their refinancing capabilities. DSTs cannot refinance. This means that if interest rates drop, DST investors cannot benefit from refinancing without jeopardizing the structural integrity of the DST’s master lease, potentially causing it to “spring to an LLC.” On the other hand, TICs have no such refinancing restrictions. This flexibility is beneficial if interest rates fall, and it is critical if a property encounters financial difficulties. For instance, most commercial properties have balloon loans that mature after 7-10 years. DSTs may be compelled to sell the property when the loan matures, even if it results in a loss. Conversely, a TIC can refinance and extend the property’s lifespan, potentially increasing returns for investors.
Refinancing is often a crucial component of a real estate investment’s business plan. If interest rates fall in the next few years, refinancing can potentially produce an increase in income to investors. Currently, despite the current high-interest-rate environment, some sponsors have successfully assumed mortgages with extremely low-interest rates. However, these loans may only have 4-7 years remaining. This scenario might not be ideal for a DST, which cannot refinance, but it could be an excellent opportunity for a TIC that can refinance when the note is due, thus taking advantage of years of potential cash flow from the low-interest rate.
Cost and Fees
DST sponsors are prohibited from taking a cut of any potential appreciation, often referred to as a “waterfall,” unlike other syndication structures such as LLCs, Partnerships, or REITs. Consequently, DST sponsors earn the majority of their profit upfront, known as the “load.” Additionally, there is typically a disposition fee upon the sale of the property, which serves as another profit center for the DST sponsor.
From one perspective, the appeal lies in the fact that the sponsor does not take a percentage of the property’s appreciation. This means that if the property appreciates by 100%, the investor retains all the gains, minus the closing costs and disposition fee.
However, some investors view this fee structure as a potential misalignment of interests. The sponsor is compensated regardless of the property’s performance. In contrast, these investors may prefer a Tenancy-in-Common (TIC) arrangement, which involves fewer upfront fees and allows the sponsor to share in a percentage of the returns. Proponents of this fee structure believe it better aligns the interests of the investor and sponsor, ensuring both parties are motivated by the property’s success.
Structure
TICs allow investors a more flexible structure that can potentially be attractive to investors with an appetite for higher returns. Though DSTs offer a turn-key solution, they can often be restrictive. DST are not permitted to do the following:
- Contributions capital after the DST offering period
- Renegotiate loans
- New lease arrangements
- Invest cash reserves
- Major construction projects
- Reinvestment of sales proceeds of a property
Ultimately, the choice between Delaware Statutory Trusts (DSTs) and Tenancy-in-Common (TICs) structures depends on an investor’s specific needs and objectives. DSTs offer a more turnkey, passive investment with fewer administrative burdens and lower entry points, making them suitable for investors seeking simplicity and ease of management. However, they come with restrictions that may limit flexibility, particularly in refinancing and making significant property improvements. On the other hand, TICs provide greater control and potential for higher returns through active management and refinancing options, but they require more involvement and come with higher administrative and closing complexities. By carefully weighing the benefits and limitations of each structure in terms of liquidity, certainty of close, tax implications, financing flexibility, and fee structures, investors can better align their real estate investments with their financial goals and risk tolerance.
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