Unleashing the Power of Passive Real Estate Investing
By Paul Chastain on June 26, 2023
The phenomenon is known as the "Amazon Effect", and chances are you've heard about it more than once. This e-commerce behemoth has revolutionized virtually every aspect of our lives, transforming consumer attitudes towards shopping and product accessibility and drastically altering the global supply chain. For institutional investors, the Amazon Effect has significantly boosted the appeal of industrial properties in the commercial real estate market, with properties housing Amazon operations being particularly sought after.
Amazon: A Rapidly Expanding Player in the Commercial Real Estate Scene
Amazon is witnessing one of the fastest expansions as a tenant. The company recently unveiled plans to establish 1,000 small delivery hubs near densely populated regions across the US to streamline product delivery to consumers. This rampant growth spurred by e-commerce giants like Amazon has led CBRE to forecast a surge in demand for an additional 1.5 billion square feet of industrial space within the next half-decade. This demand has positioned industrial distribution properties as some of the most coveted assets in the market.
Moreover, Amazon's relentless demand has prompted the company to consider alternative properties. Many market analysts anticipate that Amazon could repurpose defunct and unoccupied large-scale department stores into industrial distribution centers, further indicating the skyrocketing demand for such spaces.
Although investors have their sights set on the expansive e-commerce market, Amazon emerges as arguably the most coveted and creditworthy tenant for these properties. Property owners are eager to secure long-term triple net leases with Amazon, as they effectively mitigate operating costs for the owner. Similar to most industrial properties, Amazon operates facilities on triple net leases, under which they cover the majority of operating expenses, including common area maintenance charges, insurance, and property taxes.
This upward trend isn't exclusive to large institutional investors. Small and medium-sized investors also have the opportunity to strive to capitalize on the earnings potential of Amazon's industrial properties. They can do so through tax-deferred 1031 exchanges and passive real estate investment strategies, broadening their access to this burgeoning sector.
What Does Passive Real Estate Investing Entail?
Passive investing denotes a scenario where an investor takes a non-active role in the management of the property or business. It spans a range of asset types, from equity assets such as stocks or mutual funds, to real estate assets including Real Estate Investment Trusts (REITs) or Delaware Statutory Trusts (DSTs). Within real estate, passive investment can occur directly or indirectly.
Direct Passive Real Estate Investment
While real estate is often seen as a passive income asset, anyone who's managed an apartment complex firsthand knows it can be quite the contrary. However, owners who delegate the day-to-day management, upkeep, and leasing of the property to professional property management firms, or commercial owners with tenants on triple-net leases (where tenants bear most operational costs), can enjoy a far more passive investment experience.
With this strategy, an investor's role is reduced to simply collecting potential income each month, while their involvement in the property's operation remains minimal.
Indirect Passive Real Estate Investment
Indirect passive real estate investing involves a completely hands-off approach. An investor can participate in various real estate equity vehicles, acquiring fractional ownership in an asset or portfolio of assets. Beyond the initial capital investment, the investor plays no part in managing the property but shares in any profits or income generated.
Potential Advantages of Passive Real Estate Investment in Commercial Real Estate
Passive real estate investing in commercial real estate has seen significant growth, and there are now more opportunities than ever to invest your capital in high-quality, hands-off equity vehicles. Commercial real estate not only offers the possibility of a steady income stream and robust appreciation potential, but these assets also typically have a high entry barrier and require substantial expertise for successful business strategy execution.
However, passive investing can unlock the financial and wealth-building potentials of commercial real estate assets, making it an attractive option for many investors.
Three Key Options for Passive Real Estate Investment
Nowadays, there are numerous ways to invest in real estate through equity vehicles. Some methods, such as crowdfunding or opportunity zone funds, are relatively new, while others, like Delaware Statutory Trusts, REITs, and real estate funds, are established and tested vehicles with widespread popularity.
Delaware Statutory Trust (DST)
A Delaware Statutory Trust (DST) is a business trust that owns and manages real estate property. A real estate firm, known as the DST sponsor, initially acquires a property using its own capital, structures the property within a DST, and subsequently introduces it to the market through an official offering.
Investors purchase a fractional or concurrent ownership stake in a high-quality, professionally managed asset and potentially receive monthly income corresponding to their share of ownership. Over the past decade, DSTs have gained popularity due to their eligibility as replacement properties in 1031 exchanges.
Real Estate Investment Trusts (REITs)
A Real Estate Investment Trust, or REIT, is a company that purchases, owns, and operates real estate assets. There are public and private REITs, as well as traded and non-traded REITs. Private non-traded REITs typically engage with institutional capital sources, whereas public traded and non-traded REITs are registered with the SEC.
Shares of these are either traded on public exchange markets or directly purchased from the issuer. Historically, they've provided attractive dividends averaging around 5%, which is considerably higher than the average stock dividend of 2%.
Real Estate Funds
Real estate funds present another option, acting as an alternative to investing directly in a single REIT. These funds, such as real estate interval funds, invest in a variety of REITs, offering investors enhanced diversification. Some real estate funds are traded on public exchange markets, while others can be directly purchased through the fund.
Contrary to DSTs and REITs, real estate funds do not distribute dividends or monthly income. Rather, they seek to generate value through appreciation, realized at the exit or sale of the investment.
Investing in Amazon via a 1031 Exchange DST Property
Thanks to these passive investment strategies, individual investors can tap into high-quality, institutional-grade assets - bringing us back full circle to the Amazon Effect. While these strategies aren't exclusively tied to Amazon, they provide an avenue for investors to attempt to capitalize on the thriving industrial market.
One such strategy worth considering is employing a 1031 Exchange with a Delaware Statutory Trust to own Amazon Net Lease properties as a 1031 replacement property. This approach combines the tax deferral advantages of a 1031 Exchange, the passive management benefits of a DST, and the consistent income potential offered by Amazon's industrial properties.
Understanding the Mechanics of a Delaware Statutory Trust
Since 2004, DST investments have been recognized as suitable replacement properties in a 1031 exchange. Even though this exchange allows owners to transition their business model from direct to fractional ownership, the fundamental principles of a 1031 exchange remain the same. Upon selling an asset, the seller has 45 days to identify a replacement property, in this case, one or more DSTs.
The identified replacement property must comply with one of the three permissible identification methods: the 3-property rule, 200% rule, or 95% rule. The transaction must be completed within 180 days from the original property sale date. Similar to a conventional exchange, investors can defer capital gains taxes through this process.
Numerous reliable DST investments are available from trusted sponsors with a proven track record. DST sponsors undertake the task of structuring the trust, which encompasses property inspection, due diligence, securing debt if required, and organizing the DST offering in accordance with SEC regulations. All these costs are included in the official offering.
When considering properties occupied by Amazon, investors should look out for industrial DST offerings. Due to SEC regulations, DST sponsors are prohibited from publicly advertising certain offerings. To locate an offering that aligns with your objectives, it's advisable to conduct thorough research on reputable sponsors and consult with a licensed 1031 Exchange professional.
Pros & Cons of Delaware Statutory Trusts
Investing in a DST via a tax-deferred 1031 exchange offers the potential for significant benefits. Shifting away from direct ownership alleviates the responsibilities associated with daily property management. Plus, DSTs generally have low minimum investment requirements – typically $100,000 – which allows investors to spread their investment across multiple DST properties and diversify their portfolio.
As DST investments are usually comprised of institutional-grade assets, such as an Amazon net leased property, they potentially provide higher monthly income and appreciation compared to direct ownership – although this largely depends on the specific asset.
However, as with any investment, there are also drawbacks. Two of the risks associated with DSTs relate to liquidity constraints and the timing of exits. DST properties are usually held for a period ranging from 3 to 10 years, and early exits are generally not feasible.
While the hands-off management nature of a DST is one of its attractive features, it also implies that investors do not have a say in management decisions. Therefore, it's critical to select a robust sponsor with a demonstrated successful history when investing in DST real estate.
Leveraged DST properties also present a risk. High leverage – say 80% – can notably decrease monthly cash flow as the majority of profits will be allocated towards servicing the asset's debt. Most DSTs apply leverage between 50% - 58% to avoid undue risk. Consequently, when considering a DST property, thorough due diligence is essential prior to investing.
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Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.
1031 Risk Disclosure:
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
Securities offered through Emerson Equity LLC, member FINRA / SIPC. This is not an offer to buy or sell securities. Securities investing carries an inherent risk of loss of some or all of the principal invested. We are not tax professionals. You should always discuss your investments with a tax professional prior to investing. Securities are sold only in those states where Emerson Equity LLC is registered. Perch Wealth LLC and Emerson Equity LLC are not affiliated. COMPANY and Emerson Equity LLC do not provide legal or tax advice. Securities offered through Emerson Equity LLC Member FINRA / SIPC and MSRB registered. Emerson Equity LLC is unaffiliated with any entity herein.
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Perch Financial LLC and Emerson Equity LLC do not provide legal or tax advice. Securities offered through Emerson Equity LLC Member FINRA/SIPC and MSRB registered. Emerson Equity LLC is unaffiliated with any entity herein. 1031 Risk Disclosure:
There is no guarantee that any strategy will be successful or achieve investment objectives;
Potential for property value loss – All real estate investments have the potential to lose value during the life of the investments;
Change of tax status – 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;
Potential for foreclosure – All financed real estate investments have potential for foreclosure; ·Illiquidity – Because 1031 exchanges are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments;
Reduction or Elimination of Monthly Cash Flow Distributions – Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;
Impact of fees/expenses – Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits
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