Delaware Statutory Trusts (DSTs) have become a popular vehicle for 1031 exchange buyers in recent years. They offer passive ownership, diversification, and the ability to defer capital gains taxes while investing in institutional-grade real estate. For many investors, DSTs appeared to be a safe harbor, especially for those looking to avoid the headaches of direct property management.
Market dynamics have shifted. Interest rates are climbing, cap rates are adjusting, tenant risk has increased, and uncertainty clouds the broader economy. In this environment, investors should take a fresh look at DSTs to ensure they still serve their long-term financial objectives.
1. Rising Interest Rates are Squeezing Returns
Interest rates have experienced a rapid and substantial increase during the past two years. Many DSTs that were structured in a low-rate environment are now under pressure. Debt costs are higher, refinancing options are more limited, and projected distributions may not match original expectations.
Investors who depend on DSTs for stable cash flow may find themselves exposed to greater uncertainty. Lower returns could undermine the very reason investors chose DSTs in the first place.
2. Limited Flexibility and Control
By design, DST investors have no operational control. The sponsor makes all decisions regarding leasing, financing, and eventual property sales. While this can be attractive for truly passive investors, it can also feel restrictive, especially in a volatile market where flexibility is key.
If the market shifts or a major tenant defaults, investors are at the mercy of the sponsor’s decisions. Unlike direct ownership, they cannot sell early, refinance, or reposition the asset to improve performance.
3. Compressed Cap Rates and Overpaying for Assets
DST propertiesare often acquired at low cap rates because sponsors compete for high-quality assets that attract exchange money. In today’s market, cap rates are rising in many sectors due to higher interest rates. That means investors in newly formed DSTs may be overpaying for properties at yesterday’s valuations—leaving little room for growth and creating downside risk if property values correct further.
4. Liquidity Challenges
DSTs are illiquid by nature. Once you invest, you’re typically locked in until the sponsor sells the property—often 7 to 10 years later. In uncertain markets, this lack of liquidity becomes even more concerning. If personal circumstances change, or if better opportunities arise, DST investors cannot easily exit or reposition their capital.
5. Tenant and Sector Risks are Heightened
DST offerings often emphasize sector-specific assets, commonly retail, healthcare, or industrial properties. While these can be strong assets, concentration risk is real. If a tenant defaults or an industry experiences disruption, DST investors may face reduced income or extended vacancies without the ability to diversify further on their own.
6. Alternative Strategies May Offer Better Value
Today’s shifting market is creating opportunities outside of DSTs. Direct NNN properties, joint ventures, or even fractionalized private placements can provide better pricing, more control, and stronger cash flow potential. Exchange buyers willing to step outside of the DST model may find deals that align more closely with the realities of today’s economy.
Conclusion: Time to Reassess DSTs
DSTs served an important role for many investors over the last decade, offering tax deferral and passive income during a period of low interest rates and rising real estate values. But in today’s environment, exchange buyers need to think critically.
Locking capital into illiquid structures, with limited control and uncertain future cash flows, may no longer make sense for every investor. Instead, buyers should evaluate a broader range of 1031 exchange options and consider how to balance passive ownership with flexibility, risk management, and long-term growth potential.
The bottom line:
DSTs aren’t inherently bad, but today’s market conditions require a fresh look. For many exchange buyers, it may be the right time to reconsider.