ZYTrade Editor: Real estate is one asset class that can provide you not only with wider diversification opportunities but also income. Here are a few things to consider before you jump into this sector.
Investment real estate is the largest asset class in the U.S. behind the equity and bond markets. Millions of investors allocate some portion of their investment portfolio to income properties, including commercial and multifamily real estate, to diversify their assets and as part of a potential wealth-building strategy.
Before you invest in real estate — or add to your portfolio if you already own investment property — you should know about two increasingly popular passive investment vehicles, and one of the most attractive real estate tax benefits.
Two Ways to Passively Invest in Real Estate
No. 1: Delaware Statutory Trusts
A Delaware Statutory Trust (DST) is an entity used to hold title to investments such as income-producing real estate. Most types of real estate can be owned in a DST, including industrial, multifamily, office and retail properties. Often, the properties are institutional quality similar to those owned by an insurance company or pension fund, such as a 500-unit Class A multifamily apartment community or a 50,000-square-foot industrial distribution facility subject to a 10- to 20-year lease with a Fortune 500 logistics and shipping company.
There can be up to 499 individual investors in a DST, typically. Each investor holds an undivided fractional interest in the property or properties (if the DST holds multiple assets), making the investor an owner. That said, decision-making authority typically rests with a trustee who is the asset manager designated by the sponsor of the DST offering. The asset manager takes care of the property day to day and handles all investor reporting and monthly distributions.
A DST is considered a security and is governed by securities laws. The typical minimum investment in a DST is $100,000. Owners of a DST receive an operating statement at the end of the year showing their pro-rata portion of property income and expenses, which investors input onto Schedule E of their tax return, in the same way that you would any other commercial or rental properties that you may own directly.
No. 2: Tenants-in-Common
A tenants-in-common (TIC) structure is another way to co-invest in real estate. With a TIC, the number of allowable investors is limited to 35. As a result of the lower investor limit, the minimum investment requirement to purchase a property through a TIC may be substantially higher than a DST. We often see minimums for TIC investments between $250,000 and $1 million.
Although TIC investments and DSTs have their nuances and differences, they often will hold title to the same types of property. While the DST is generally considered the more passive investment vehicle, there are some circumstances in which a TIC is desirable, including if the investors wish to utilize a cash-out refinance after owning the TIC investment for a few years in order to get some of their equity back, which can be invested in other assets.
Real Estate Tax Benefit that Helps Build Wealth
Whether you’re invested in DSTs or TICs, you are eligible to take advantage of one of the most attractive real estate tax benefits on the books in the U.S.: the 1031, or “like kind,” exchange.
1031 exchanges are so-called because they are governed by Section 1031 of the Internal Revenue Code. About one-third of all commercial and multifamily property sales involve a like-kind exchange, which is available to investors of all income levels. (You don’t have to be a high-net-worth investor to take advantage of this tax benefit.)
Originally posted on Kiplinger
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