On Advice

A better TIC?

DSTs still carry high costs and are illiquid but independent broker-dealers not rusing in to sell them

Apr 13, 2014 @ 12:01 am

By Bruce Kelly

Some independent broker-dealers over the past few years have increased their sales of complex real estate private placements known as Delaware statutory trusts for wealthy investors.

These deals allow investors who are selling commercial real estate to reinvest those profits and defer the capital gains taxes from the sale of their property.

Such a real estate investment vehicle may sound familiar.

(Don't miss: Berthel Fisher has new lease on life)

DSTs share similarities with tenant-in-common exchanges, which gained popularity after a favorable Internal Revenue Service ruling in 2002 that allowed investors to defer capital gains on commercial real estate transactions involving the exchange of properties. Instead of owning one commercial building, the TIC investors would buy the private placement and own a fractional slice of the property.

Many TICs backfired and took down broker-dealers in the process.

Indeed, 43 of the 92 broker-dealers that sold TICs sponsored by the defunct DBSI Inc. — a staggering 47% — are no longer in business, according to a recent InvestmentNews analysis.

Indeed, some independent broker-dealers went TIC-happy during the few years before the credit crisis and real estate crash.

At the height of the TIC market in 2006, 71 sponsors raised $3.65 billion in equity from TICs and DSTs, according to Promontory Consulting.

The overwhelming majority of those deals — about 94% — were TICs.

ALL BUT EXTINCT

TICs now are all but extinct because of the fallout from the credit crisis. Banks are extremely reluctant to finance the deals, and want to limit the number of investors to 10, down from 35 under the tax code.

TIC and DST equity raised in 2010 was just $169.8 million, a mere sliver of the market height.

And TICs made up just 24% of the deals that year, according to Promontory Consulting.

The market for DSTs, which are sold by representatives of independent broker-dealers, is showing signs of strengthening. Equity raised for DSTs and TICs has increased every year since its low, with $427.1 million in equity raised last year.

Promontory does report equity raised separately by DSTs and TICs.

Again, DSTs, which were 89% of the deals last year, have all but replaced TICs.

Likewise, the number of sponsors for the real estate private placements has narrowed dramatically, falling last year to an even dozen, according to Promontory Consulting.

Although both DSTs and TICs are structured to invest in commercial real estate and allow an investor to defer capital gains, there are potentially fewer headaches with DSTs, according to market observers.

For example, in a DST, the trustee decides and determines what happens in a commercial property. At the moment, most deals invest in apartment buildings or triple-net-lease properties with a long-term lease.

That stands in stark contrast to the way a TIC works. With up to 35 investors who were partial owners, TICs proved a nightmare for some.

Often with conflicting interests, those TIC owners had to be in unanimous agreement before making a decision such as raising the rent or selling the property. In the free fall of the real estate market after the credit crisis, for TIC owners to find such consensus was often difficult, which has made banks reluctant to lend to TICs.

“The Delaware statutory-trust investment has emerged as a preferred fractional-ownership structure and allows sponsors to im-plement several investor-friendly innovations,” said Keith Lampi, chief operating officer of Inland Private Capital Corp., the DST leader that raised $233.2 million in equity last year, or more than half the entire market.

'STRUCTURAL IMPROVEMENTS'

DSTs' lower upfront fees, lower minimums, portfolio offerings and added options when it comes to the use of leverage are some of the recent improvements in the product, he said.

These structural improvements encourage investor diversification and position DST products for enhanced performance,” Mr. Lampi said.

“DSTs allow for easier and better financing,” said Taylor Garrett, managing director of Orchard Securities, a related company to Promontory Consulting. “Individuals don't have to get approved individually by the bank, as the trust is the borrower.”

These trusts may make sense in estate planning for older clients who own commercial real estate and want to defer taxes.

But the rap on DSTs is similar to that on TICs. They are private placements and carry high fees and commissions.

They are illiquid, and financial advisers and investors crave liquidity in the post-credit-crisis landscape. Like TICs, DSTs can concentrate a client's portfolio into one large real estate holding.

The data show that broker-dealers and reps aren't plowing into DSTs as they once did with TICs.

Indeed, the total equity raised in DSTs and TICs last year was just 12% of the equity that the industry raised in 2006 at the height of the real estate private-placement market.

Such restraint is a welcome sign for the independent-broker-dealer industry, which was burned terribly by TICs as the credit crisis unraveled.

0
Comments

What do you think?

View comments

Recommended for you

Sponsored financial news

Upcoming Event

Apr 26

Webcast

Cracking the Code: Making Sense of Alternative Investments

InvestmentNews Research estimates that $150 billion in alternative assets could be added to client portfolios among independent advisers over the next three years. Roughly 85% of all clients are now expressing interest in learning more... Learn more

Accepted for 1 CE Credit by the CFP Board. Pending by Investments & Wealth Institute for 1 credit towards the CIMA® and CPWA® certifications.

Featured video

INTV

Here's how we came up with our list of undiscovered talent in mutual funds

Senior columnist John Waggoner talks with assistant managing editor Susan Kelly about how hard work, curiosity and passion landed some fund managers on our list.

Latest news & opinion

SEC advice rule hearing updates

Commission says a lot of work ahead, public will have 90 days to comment.

SEC advice proposal unveiling: Here's what to expect

Chairman Jay Clayton will initiate momentous action Wednesday, as the commission meets to debate a rule on broker and adviser standards.

How active are the largest actively managed funds?

Active-share measures for the 15 largest actively traded mutual funds.

Morgan Stanley's success looks long in the tooth to analyst

Sanford C. Bernstein & Co. analyst Christian Bolu, concerned over stalled adviser growth and what it means for lending and deposit growth, believes the stock will "under perform."

Retirement coverage gap, 401(k) rollovers are big emerging threats for plan advisers

Proliferation of state retirement programs approaching the 'tipping point' where it will lead the federal government to step in.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print