The potential for diversification with DSTs knows no bounds, as it is solely dependent on the investor’s financial goals and creativity. By combining multiple DSTs from various exchanges, investors can create a well-diversified personal portfolio of institutional-grade properties that span across different sponsors, locations, and asset types. Whether an individual is seeking cash flow without the risk of concentration to fund their retirement or looking to build a personal real estate portfolio of institutional properties throughout their career to supplement their professional income, a well-diversified DST portfolio can be the perfect solution. Below, we outline the available asset classes for alternative real estate investment.
One of the most popular types of investment properties for small investors is multifamily apartment properties. This is because everyone needs a place to live, and many individuals have lived in an apartment at some point in their lives, making them familiar with residential-income properties. Real estate investors often start by converting their current residence into a rental property instead of selling it when purchasing a new home. This allows them to gain experience in owning residential-income properties. Over time, these investors may acquire multiple small residential-income properties and eventually consolidate them into a multi-unit apartment building. These properties have historically shown strong appreciation and minimal downside.
However, apartment properties require intensive management. Owners of residential units often receive calls in the middle of the night regarding electrical or plumbing issues or tenants locked out of their units. Additionally, residential-income properties are typically rented to individuals with limited financial resources, many of whom live paycheck to paycheck. Evicting a tenant can be a time-consuming and expensive process, especially in jurisdictions with strong tenant-rights laws. Furthermore, more desirable tenants with stronger financial backgrounds may leave the property as soon as they are able to purchase their own residence. The apartment rental market was heavily impacted by renters purchasing homes during the recent period of historically low interest rates. Despite these potential downsides, apartment properties can provide steady cash flow and have shown strong appreciation over time.
Retail NNN-Leased Properties
In contrast to apartment properties, NNN-leased properties are typically leased on a long-term basis to highly creditworthy tenants who are fully responsible for management and operating expenses. In a true NNN-leased property, the tenant is responsible for utilities, maintenance, management, insurance, property taxes, and even structural aspects. This type of lease allows the property owner to have a passive investment with steady and predictable cash flow. Lenders often evaluate the lease more than the underlying real estate when determining debt limits and interest rates for investment-grade tenants. This can result in greater loan proceeds and lower interest rates compared to properties leased to non-investment-grade tenants. However, NNN-leased properties have their downsides as well. The lease terms are typically flat for the entire term, meaning there are no rent increases or inflation protection. Additionally, the pricing for NNN-leased properties tends to be influenced by interest rates, similar to bonds.
Office buildings have been a popular asset class for DST investors over the past decade. This includes downtown high-rise skyscrapers, medical office buildings, and single-tenant headquarters for large corporations. Lease terms for office properties are typically shorter than retail properties, ranging from 5 to 7 years. This allows for potential rent escalations but also increases the risk of vacancy. During the Great Recession, the office sector experienced a significant decrease in rents and occupancy levels. When investing in office properties, conservative due diligence is necessary, including looking for mission-critical assets for multinational and publicly traded companies, as well as ensuring there are significant reserves for tenant improvements and debt service.
Senior Care and Healthcare Properties
With the baby boomer generation reaching retirement age, senior care properties have become increasingly popular among DST investors. Some sponsors even specialize in this asset class. While historic returns do not guarantee future performance, many investors who have invested in senior care DSTs and TICs over the past decade have seen double-digit cash flows and total annualized returns in the double digits. Senior care facilities offer a range of services, from Alzheimer’s care to assisted living. It’s important to note that DST investors are acquiring the real property, not the business itself. Due diligence should focus on operators with a long and successful operating history, as well as facilities that rely less on government subsidies.
Industrial complexes and warehouses, including self-storage and parking lots, may not be as glamorous as other asset classes, but they can be lucrative investments if the fundamentals are right.
Hotels are often considered glamorous investments, and past DST offerings have included national operators such as Marriott and Hilton. Lease terms for hotels are not measured in years but in days, allowing for almost instantaneous rent increases based on revenue per available room (RevPAR). Cash flows from hotels are typically higher than other asset classes to compensate for the immediate and substantial vacancy risk. However, during the Great Recession, the hospitality industry was hit hard, with high unemployment rates and a decline in business travel. Some hospitality assets faced foreclosure, but those that survived were the first to recover, resulting in record returns for hotel TICs that have been sold in recent years. When investing in hotels, due diligence should focus on demand generators in the area, such as major corporations, airports, and universities.
In conclusion, DSTs offer a wide range of asset classes for alternative real estate investment. Each asset class has its own advantages and potential downsides, and thorough due diligence is crucial when selecting investments. By diversifying across different asset classes, locations, and sponsors, investors can create a well-rounded DST portfolio that aligns with their financial objectives.