REITs vs. DSTs: Key Differences and Considerations for Investors

Aug 27

4 min read

When it comes to real estate investing, two of the most common structures to consider are Real Estate Investment Trusts (REITs) and Delaware Statutory Trusts (DSTs). Each offers unique benefits, but there are important distinctions between the two that potential investors should understand before deciding which is best for their needs.

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Understanding Direct vs. Indirect Property Investments

Before diving into the specifics of REITs and DSTs, it's essential to clarify the difference between direct and indirect property ownership. Direct property investments involve buying physical real estate, such as commercial, residential, or industrial properties. In this scenario, investors may own the property outright or collaborate with others via funds or trusts, making it an indirect investment. Both REITs and DSTs are examples of indirect property investments, where investors pool their resources to invest in real estate assets without direct ownership.

What is a Delaware Statutory Trust (DST)?

A Delaware Statutory Trust (DST) is a legal entity that allows investors to collectively own and manage real estate properties. DSTs are popular in 1031 Exchanges as they allow investors to defer capital gains taxes by reinvesting their proceeds into a DST. A real estate sponsor typically sets up the DST, and investors deposit their 1031 exchange funds into the trust. The trust then acquires properties, and investors receive income distributions, typically from rental income or the eventual sale of the properties.

Investors in DSTs must meet accredited investor criteria, meaning they must have either a net worth over $1 million (excluding their primary residence) or an income exceeding $200,000 annually ($300,000 for married couples).

What is a Real Estate Investment Trust (REIT)?

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate. By investing in REITs, individuals can own a share of a portfolio that may include properties like office buildings, apartments, and retail spaces. REITs provide the benefit of diversification as they typically hold multiple properties across different regions.

Investors in REITs are not required to meet the accredited investor criteria, making them more accessible to the general public. There are two main types of REITs: public and private. Public REITs are traded on major stock exchanges, offering liquidity as they can be bought and sold like stocks. On the other hand, private REITs are not publicly traded and typically have restrictions on liquidity, such as lockout periods.

Similarities Between REITs and DSTs

While REITs and DSTs are structured differently, they do share several similarities:

Passive Investment: Both are considered passive investment options, meaning that investors do not actively manage the properties or deal with tenants.
Illiquidity: Private REITs and DSTs are generally illiquid investments, meaning investors cannot easily sell their holdings. Public REITs, however, offer liquidity since they are traded on the stock market.
Risk Exposure: Both types of investments are subject to market volatility and economic downturns, potentially impacting property values and rental income.

Key Differences Between REITs and DSTs

While both REITs and DSTs provide indirect exposure to real estate, the investment minimums and fees differ significantly:

Investment Minimums: DSTs typically require a higher initial investment, with minimums ranging from $25,000 for cash purchases and $100,000 for 1031 exchanges. In contrast, REITs can often be accessed with as little as $1,000 to $5,000, making them a more accessible option for smaller investors.
Fees: DSTs involve various fees, including those for the sponsor, broker-dealers, and property acquisition. Investors should carefully consider these fees as they can affect the overall return on investment. REITs, particularly private ones, also come with up-front fees, which can range from 9% to 10% of the investment, reducing the net value of the investment.

Investment Objectives: REITs vs. DSTs

When investing in a DST, the primary objective is typically to secure a long-term, income-generating property. DSTs also allow for 1031 tax deferrals and can offer depreciation benefits, which may reduce taxable income for investors.

REITs, however, are often more focused on providing broad market exposure and liquidity. Investors in REITs may benefit from diversified portfolios that span across various property types, but they do not have the same tax advantages or control over the assets as investors in DSTs.

Risk Considerations for REITs and DSTs

Like any investment, both REITs and DSTs carry certain risks. Key risks include:

Market Volatility: Public REITs are more susceptible to market fluctuations and stock market volatility, which can affect share prices.
Property Vacancies: DSTs may also face risks from property vacancies or rising operating costs, potentially affecting returns.
Interest Rates: Both REITs and DSTs are vulnerable to interest rate changes, which can impact real estate values and financing costs.

Conclusion

REITs and DSTs provide unique opportunities for indirect real estate investment, each with its distinct set of benefits and risks. REITs offer accessibility and liquidity, particularly for smaller investors, while DSTs can be an ideal option for those seeking long-term income-producing properties and tax advantages. Investors should carefully consider their financial goals, risk tolerance, and the associated costs before making a decision.