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How a DST Can be Used to Hedge Against Inflation

In times of economic uncertainty, a Delaware Statutory Trust can offer investors the kind of solid growth, diversification, and steady income to combat the effects of inflation.

Americans are concerned about inflation. In a survey conducted in September 2023 that asked voters what issue they felt was most important, the most common response (24% of respondents) was inflation and prices.

Coming off a period where inflation reached levels not seen in 40 years, it’s easy to see why voters are concerned. According to the International Monetary Fund, “most workers’ wages have failed to keep up with inflation, eroding the purchasing power of households and causing significant hardship.”

Though inflation is down from its peak of 9.1% in June 2022, it was still at 3.1% as of November 2023, above the 2% threshold seen as a long-term goal by the Federal Reserve. We don’t yet know how voter concerns over inflation will affect next year’s election cycle or policy decisions made in 2024 and beyond, but investors may be curious as to how to proceed in uncertain economic times.

Most investors understand that cash loses value in inflationary periods, and rightly want to guard against losing wealth. Investors looking to hedge against the possibility of continued inflation may want to consider the benefits of a Delaware Statutory Trust.

How a DST works

A Delaware Statutory Trust (DST) is a real estate product where a group of investors uses its combined purchasing power to acquire a property or group of properties managed by a professional property manager. By purchasing an interest in a DST, an investor is entitled to distributions from rental income along with the appreciated value of the portfolio over time without having to actively manage properties, making DSTs popular among those looking for passive income.

Because each investor is only responsible for a fractional share of the investment capital, a DST gives investors access to a wider array of properties (and potentially more valuable properties) than they may otherwise have access to.

Delaware Statutory Trusts can qualify as like-kind properties for purposes of executing a 1031 exchange, and are a popular choice for identification as a backup option in case of a failed exchange.

JTC is one of the industry’s leading experts on 1031 exchanges into and out of Delaware Statutory Trusts and the advantages they can provide. Some of these benefits are especially notable in times of inflation.

Why a DST can be a smart defense against inflation

One reason why investors may want to look to a DST during times of inflation is that commercial real estate (CRE) has historically done well during inflationary periods. According to McKinsey & Company, “during the seven inflationary periods from 1980 to 2022, CRE returns, at 11.7 percent annualized, have generally outperformed inflation, their own historical average, and other asset classes, including the S&P 500.”

Commercial real estate properties are the exact types of properties that can be made available to investors through a DST. Large commercial properties could be too expensive for an individual investor to purchase on their own, but might be achievable through a DST structure.

Some commercial real estate sectors performed better than others during different periods of inflation. If you were only able to invest in one type of commercial real estate, you’d be running the risk of picking the wrong one. But what if you could invest in multiple types of commercial real estate at once?

Because DSTs offer access to a portfolio of properties, potentially in different areas and tied to different industries, they can provide investors with instant diversification. One DST might focus on office buildings in several metropolitan areas while another focuses on a single industrial facility in a rural area.

The low minimum investment amount for a DST may mean that the sale proceeds from a relinquished 1031 property would be enough to invest in both of these DSTs rather than choosing between the two, spreading your investment among property types, sizes, and locations through a single 1031 exchange.

As McKinsey notes, not all sectors see rises in rents that match inflation. Sectors like multifamily and student housing reset rents more often due to shorter-term leases, and certain types of long-term retail leases may require tenants to cover increases in operating expenses or tie rents to retail incomes, directly connecting a rise in the price of consumer goods to rental income. If rental income rises, so will the consistent income investors receive through distributions from the DST, which can help investors through tough financial times.

How do you perform a 1031 exchange into a Delaware Statutory Trust?

It’s possible to use a Delaware Statutory Trust as a replacement property in a Section 1031 like-kind exchange. It’s also possible to perform an exchange out of the trust at the end of its lifecycle into another DST or another like-kind property. To receive the full tax deferral benefits of Section 1031 and avoid a taxable boot, you need to follow all IRS rules, which include the required use of a Qualified Intermediary (QI).

Unfortunately, not all QIs have experience with Delaware Statutory Trusts or understand the complexities of exchanges involving DSTs. JTC’s 1031 exchange team has specific expertise in these kinds of exchanges, and can help exchangers navigating unique exchange scenarios. If you’re considering a 1031 exchange into a DST, get in touch with JTC to benefit from our years of experience working with Delaware Statutory Trusts.

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