Last updated on February 18th, 2021 at 09:10 am
Overview of Delaware Statutory Trusts
Delaware Statutory Trusts are a unique investment vehicle for multiple investors to purchase smaller shares of a real estate investment. They are typically treated as passive investment mechanisms through the use of a property management liaison to handle all of the operational aspects of renting out the property. Recently, these trusts have become an increasingly popular real estate investment option because investors can defer their tax liability for capital gains and depreciation recapture when combined with a 1031 like-kind exchange. In this article, we’ll walk through Delaware Statutory Trust fees and commissions, how they work, and the pro’s and con’s.
How Do Delaware Statutory Trusts Work?
For Delaware Statutory Trusts, after the sponsor identifies the specific investment property for purchase, a lender typically makes a loan to a single sponsor of the trust. The sponsor then establishes a group of trustees to manage the overall investment structure. The individual investors in the trust are actually owners of their shares of the trust rather than the real estate itself.
Although the Delaware Statutory Trust functions similarly to and enjoys the legal protections of a limited liability company (LLC), each individual investor pays their portion of the taxes on their income and dividends based on their individual income tax rate. This minimizes overall operating and accounting expenses for the trust.
Delaware Statutory Trusts are highly sought-after by investors for their tax advantages and their relative ease of management as a truly passive investment option. Each Delaware Statutory Trust portfolio will have its own fee structure, but the following categories of fees are the most common expenses to expect when investing in a Delaware Statutory Trust.
Registered representatives and registered investment advisors possess the credentials required to purchase a property for a Delaware Statutory Trust. Since the sponsor of the trust will likely not have the required credentials to close the sale, commissions will have to be paid to the registered representative based on the purchase price.
In the acquisition of a property for a Delaware Statutory Trust, the broker-dealer is commonly reimbursed for the cost of marketing and advertising the property, including brochures, signage and other marketing materials, through a broker-dealer allowance.
Sponsors may choose to work with a wholesaling team that helps perform due diligence on the properties within a certain region. The wholesalers collaborate with the broker-dealers to ensure that all of the information in the offering is accurate and are compensated through commission on the sale.
Offering and Organization Expenses
The trust typically reimburses the sponsor for miscellaneous costs that are incurred as overhead in establishing and operating the Delaware Statutory Trust.
Depending on the terms of the deal, the sponsor is entitled to a fee from the trust for identifying and securing the real estate for purchase.
Delaware Statutory Trusts are technically classified as securities, which means that managing broker-dealers may issue the trusts. If so, they earn a fee for their performance of due diligence, documentation and securities compliance.
Ongoing Asset Management Fees
After acquiring a property, the sponsor of the trust is generally responsible for its ongoing management and will collect a fee for the services provided. Rather than having to go on-site yourself or hire a contractor for each individual issue that arises, the property management aspect of a Delaware Statutory Trust is relatively stress-free for investors.
How Delaware Statutory Trust Fees and Commissions Stack Up Against the Fees for Traditional Real Estate
One of the most common misconceptions about Delaware Statutory Trusts is that the acquisition, management, and disposition fees involved are higher than the expense of directly purchasing real estate through buyers’ and sellers’ brokers. While it is prudent to keep an eye on the total expenses involved, the individual categories of fees for Delaware Statutory Trusts are still less overall than the hidden and often uncapped fees indirect purchases of real estate.
The total amount of capital required at the acquisition of the investment property is called the load. When the load is higher, the underlying investment property must be sold at a higher price to recover the investment expenses. Indirect real estate sales, these fees are almost always lumped in as a percentage of the purchase price upon closing.
The Denominator Deception
To unpack the flawed assumption that Delaware Statutory Trusts require higher investment fees and expenses, consider the denominator problem. The denominator of all expenses involved in the direct purchase of an investment property is larger than that for Delaware Statutory Trusts because traditional real estate sales set out expenses as a percentage of the total value of the property, including debt and equity together.
On the other hand, the expenses for Delaware Statutory Trusts are expressed as a load-to-equity ratio without factoring in the debt involved in the purchase of the property. This skews the expression of acquisition fees for Delaware Statutory Trusts relatively higher than for direct purchases of real estate because the overall value of the property in the trust will be more than the equity. For highly-leveraged properties in Delaware Statutory Trusts, having relatively less equity going into the sale will distort the expression of the load-to-equity ratio even worse.
In addition, unlike in the direct purchase of real estate investments through buyers’ and sellers’ brokers, the closing costs for Delaware Statutory Trusts are already factored into the load.
The Pros and Cons of the Delaware Statutory Trust
Any prudent investor should evaluate the risks and minor disadvantages of Delaware Statutory Trusts before committing to this low-maintenance tax shelter of an investment vehicle. Although these considerations are part of any real estate investment deal, the following investors should be mindful of the following issues for Delaware Statutory Trusts.
- Delaware Statutory Trusts are typically longer-term investments to be held for at least five to 10 years.
- Per a 2004 IRS ruling, investors must leave the daily operations of the trust to the trustees.
- All of the capital required for Delaware Statutory Trusts must be raised before the offering closes.
The advantages of investing in Delaware Statutory Trusts are numerous and can be compounded with the guidance of an experienced tax and investment professional.
- These are truly passive investments thanks to the diligence of sponsors. Avoid the hassle and expense of managing property maintenance and repair services.
- Investment minimums can be as low as $25,000, which is less than most other real estate investments.
- Taking advantage of the 1031 like-kind exchange is easy because there are many properties that qualify for a rollover of investment gains.
- Gain access to high-value properties with high-profile tenants.
- Diversify your 1031 exchange properties by investing in multiple properties with lower investment thresholds.
- Avoid the exposure and time commitment of personally securing financing.
Final Thoughts on Delaware Statutory Trust Fees and Commissions
Simply put, Delaware Statutory Trusts have plenty to offer the savvy real estate investor in terms of avoiding tax liability while accumulating gains from a passive investment vehicle. Investors should not be deterred by misconceptions about fees involved, especially in comparison to other real estate investments. When treated as a 1031 exchange, real estate investors can easily and effectively defer significant tax liability through Delaware Statutory Trusts.