Delaware Statutory Trust (DST) 1031 exchange properties represent a special category of risk even in a market where the demand for investment opportunities is putting extreme pressure on DST sponsors to get more product into the pipeline. Last week was a case in point: we received a sell-side underwriting analysis and due diligence review assignment on a property. The buy-side broker-dealer had already done the primary underwriting and the deal was headed for the market with a syndicate of broker-dealers aiming to sell it as quickly as possible because the yield was roughly 50% higher than what is typically offered to 1031 exchange investors. Yet a cursory examination of the use of funds page showed less than 0.1% of the offering proceeds would be made available as working capital. This equated to having less than enough cash on hand to pay its current bills if operations experienced a stall-out of some kind. Gee, that’s kind of risky, don’t you think? Yet no one had asked why.
Underwriting is like picking a scab, I think. As long as you don’t mess with it things are okay. This was the case as well. Due diligence in a hot market doesn’t mean that we all just agree the yield is so great whatever the risks are they are going to be manageable because that’s a great yield! Whether it is working capital, exposure to future market disruptions, conflicts-of-interest that could spell problems for everyone but the sponsor, or asset condition, the facts need to be disclosed so people can make informed decisions and if things don’t work out later on down the road, there’s no hurt feelings because everyone knew what they were getting themselves into with that particular opportunity.
DSTs and other 1031 exchange vehicles require the investor to hold the investment for 10 long years and that means extensive exposure to market disruptions that lead to investment losses. While the impact of market disruptions may be avoidable in some cases, the reality is that, in the absence of proactive monitoring of the market and investment, problems will likely come starting about two years out past the date of close of escrow.
It might be hot, but being a loser is not. Investing requires we all do our homework.