DST DUE DILIGENCE
Due Diligence and 3rd Party Review
When purchasing real estate, investors typically research issues relevant to that property. The same applies to Delaware Statutory Trusts (DSTs). Investors should look at all aspects of the transaction including but not limited to the property—its location, condition, and use; the tenant—their viability, corporate structure, and time in business; the lease—cash flow, inflation protection, and length with renewal options; and the potential for capital gain on the property once the DST is sold. All of this requires proper due diligence.
Definitions:
Sponsor: a company/entity offering the DST to the public.
Broker Dealer: a firm who has advisors working under their entity umbrella.
Advisors: sometimes referred to as registered representatives; they sell directly to the public
FINRA: the regulatory agency for the financial industry who passes rules and makes recommendations for consistency and protection of the public.
3rd Party Legal: an independent entity specializing in real estate and/or securities law who performs due diligence on the Sponsor and the DST. They are in an adversarial role to the Sponsor.
Why Due Diligence
Due diligence is required to provide potential investors with disclosures of benefits, costs, and risks as well as other information to help a prospective investor make an informed decision before investing. Due diligence is research done by an individual working for an entity who then gives an opinion on the DST itself. There is no guarantee that the due diligence was performed accurately or that because of the due diligence the DST will succeed. However, it does give a potential investor a starting point for their own research.
Types of Due Diligence
Sponsor: Before a Sponsor can launch a DST to the public, Broker Dealers want a report on the financial viability and experience of the Sponsor and its principals. This typically involves looking at internal processes, tax returns, resumes, and relationships. Not only does a Broker Dealer perform this due diligence on their own, but they may also require a 3rd Party Legal entity to do the same and provide a report.
DST Offering: Once a Sponsor launches a DST but before it is sold to the public, the Broker Dealer will perform their own due diligence on the offering but may also want a report from a 3rd Party Legal entity on the investment prior to releasing it to their advisors to sell. Entities reviewing the DST will read the Private Placement Memorandum (PPM) issued by the Sponsor and its supporting documents. The 3rd Patry Legal entity will often do a much deeper dive into the DST (see below).
What Due Diligence offers
From the Sponsor: The Sponsor provides written details on the economics of the DST including income, expenses, net profit, and potential for appreciation. In addition, the Sponsor substantiates that the DST qualifies as a 1031 replacement property, provides risk disclosures, tenant information, property condition, etc. As part of the real estate purchase process the Sponsor gets an appraisal, an environmental review, and property condition report and makes this available for due diligence.
From the Broker Dealer: The Broker Dealer review usually begins with multiple interviews with the Sponsor where verbal details of how the property was acquired, the efforts made to obtain financing, and the sales narrative, including benefits and risks, is discussed. This is followed by a review of the DST documents (PPM and supporting documentation). Once this is completed to the satisfaction of the Broker Dealer, the DST is allowed to be sold by their advisors to the public.
From the 3rd Party Legal: This entity provides a comprehensive report on both the Sponsor and the DST to the Broker Dealers who request it. This entity looks at all information provided by the Sponsor, gathers relevant information independent of the Sponsor, and analyzes the information before giving an opinion on the DST. This opinion does not guarantee the success or failure of the DST. The opinion can be satisfactory, confirming that the information provided by the Sponsor is supported by fact, seems reasonable, and is in line with industry norms; or unsatisfactory, indicating that the information and projections by the Sponsor may not be accurate, do not fall in line with industry norms, or do not seem reasonable and should not be relied on.
From the Lender: If a loan is placed on the property, the lender always requires due diligence as it underwrites the loan. This usually includes Sponsor experience, security, net cash flow, projections, and the viability of the property to meet debt service. Having a financial lending partner in a DST lends more credibility to the DST as an investment because it is another layer of due diligence.
From the Financial Advisor: The Advisor has the responsibility first and foremost to understand your specific situation. Secondly, they should be familiar with the Sponsor offering the DST including previous transactions, management team, and business philosophy. Thirdly they should know the specific DST investment they are recommending.
From the Investor: You have the responsibility to perform your own due diligence by finding a licensed Financial Advisor who you feel understands your situation and can offer you products to help you achieve your goals. The Advisor should be in good standing with FINRA and their own Broker Dealer firm. They should be knowledgeable about DSTS generally, be familiar with the Sponsor offering the DST, and have done their own research on the DST itself.
Final Comments on the Due Diligence Process for DSTs
The due diligence cost paid by a Sponsor can be extremely high depending on the number of entities involved. A Sponsor must be committed to the DST to pay this expense. A DST investor receives the benefit of this comprehensive and expensive research done on the property and the offering. This helps the investor make an educated decision to invest or not invest in the DST.