As individuals approach retirement, the ability to ensure their financial security becomes a vital concern. At this point, real estate investors often switch their focus from active management to passive investment opportunities geared toward preserving capital and generating steady income. Among the various investment options available, Delaware Statutory Trusts (DSTs) and Triple Net Lease (NNN) properties are the most prominent choices for retirees seeking to diversify their portfolios and secure potential passive income streams.
Both DSTs and NNN properties offer unique advantages and disadvantages, and understanding their characteristics and associated risks is crucial for retirees to make informed investment decisions.
This article defines both NNN investments and DSTs and explores the pros and cons of both types of investments. Hopefully, it will shed light on which may be more suitable for an investor’s portfolio.
Understanding the Difference: What is a NNN Investment? What is a DST?
Both NNN investments and DSTs offer the potential for investors to access passive, stable income. In addition, both are 1031-qualified assets – investors can identify NNN investments or DSTs for their tax-deferred exchanges. However, they differ drastically in their investment structure.
What is an absolute NNN Investment?
An absolute NNN lease stems from the responsibility of the tenant versus the landlord, according to the lease. Every “net” in a triple net lease generally refers to the expenses for which the tenant is responsible, including property taxes, insurance, and maintenance.
These expenses are paid for by the tenant in addition to the base rent. In other words, in an absolute NNN lease, the tenant is responsible for the base rent plus all expenses associated with the property. As a result, the landlord simply collects any income from the real estate.
Most NNN investments leveraged for retirement planning are single-tenant assets. These properties are freestanding with one tenant – the strength of the tenant can vary by investment.
What is a DST?
A DST, unlike a NNN investment, involves investing in a trust. Rather than investors having direct ownership of the real estate, they purchase ownership interest in one or multiple assets. The trust, which is managed by an investment sponsor, can include a range of assets from a 300-unit apartment multifamily property to a 1.5 million square feet industrial asset or a portfolio of NNN properties.
DST investors who own fractional ownership are known as “beneficiaries” of the trust – they are considered passive investors.
The Pros and Cons of Investing in NNN Investments versus DSTs
By far, NNN properties and DSTs are among the most popular investment options for retirement planning. Their passive nature is intended to enable retirees to relax and enjoy the fruits of their labor. However, there are significant differences between the two, and, as such, there is no one-size-fits-all investment strategy utilizing these. Below, we dive into the major characteristics of each and assess how a NNN deal, and DST directly relate.
Diversification. DSTs offer investors greater diversification compared to direct NNN investments, especially when trading lower-priced assets. Let’s review an example. If an investor is selling a multifamily property for $1 million, they can purchase one, maybe two, direct NNN assets as replacement properties.
A DST, on the other hand, permits diversification. Properties held within a DST can range from multifamily properties to manufactured housing, mineral and oil rights, retail and NNN assets, industrial properties, etc. Furthermore, minimum investments for DSTs are generally only $100,000, so, in this case, an investor could mitigate risk through diversifying across multiple properties, asset classes, geographical regions, and sponsors.
Liquidity. One of the biggest pushbacks of DST investments is the absence of liquidity. When an investor invests in a DST, it is up to the sponsor to determine when to sell the asset. The typical hold period of a DST is five to seven years. In the case of a direct investment in a NNN property, the landlord determines when to sell the asset.
However, it’s important to note that some DSTs transition through a 721 Umbrella Partnership Real Estate Investment Trust (UPREIT). Essentially, they either provide the option or require an investor to roll the DST investment into a REIT of which the investor now owns shares. Shares are not taxed until the investor sells them. This can be a great option for those who are looking for greater diversification and additional liquidity optionality.
Ownership structure, control, and management requirements. While the real estate in a DST can include a NNN investment, the ownership structure differs from a direct deal. When investors trade into direct NNN investments, they are the decision-makers. If a tenant vacates the property or a lease is set to expire, it is up to the landlord to negotiate the lease.
With a DST, the sponsor is responsible for the property or properties. An investor in a DST is truly passive, while an investor in a direct NNN deal is only passive so long as there are no issues with the lease.
Estate planning. Investors considering selling their real estate and trading into a passive investment are generally also reviewing their estates. DSTs can be the best option for those who are in the process of estate planning. Let’s say an investor has three children. In the case of a direct NNN property, when the investor passes away, the children are granted a stepped-up basis; however, they are then faced with making real estate decisions together.
By contrast, investments in DSTs can be divided directly among the beneficiaries. Each beneficiary receives an allocated equity position in the DST – which also qualifies for a stepped-up basis. In this event, every beneficiary can decide on how to proceed with their portion of the real estate – cash out or complete another 1031 exchange.
Which, if either, is right for you?
Those who are considering selling their real estate to access a passive investment can reach out to the team at Perch Wealth to learn more. Our team of professionals understands the pros and cons of both investment strategies and can provide an unbiased opinion on which, if either, is better suited for your investment portfolio.
Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.
There’s no guarantee any strategy will be successful or achieve investment objectives;
All real estate investments have the potential to lose value during the life of the investments;
The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;
All financed real estate investments have potential for foreclosure;
These 1031 exchanges are offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.
If a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;
Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits