Your Interests and Those of the Property Sponsor Should be Aligned

The Importance of a Reputable Property Investment Sponsor

Saturday, March 16th, 2019

Article updated July 25, 2024.

One of the main objectives a real estate investor has is to mitigate risk in an investment.

Before investing in sponsored property, it’s important to select a credible property investment sponsor. A property investment sponsor can be an individual or a company. The sponsor is responsible for finding, acquiring, managing, and eventually disposing of real estate property on behalf of the partnership. Property investment sponsors also solicit investors for the partnership.

Sponsors of Delaware Statutory Trusts have the added responsibility of acting as the Signatory Trustee for the DST and maintaining control over the property and the tenant.

Some do this by diversifying their property investment portfolio by asset class and/or geography. Other real estate investors purchase passive investments such as triple net leased property, while others prefer collateralized debt obligations with mortgage-backed securities.

Sponsored property investments, such as Delaware Statutory Trusts (DSTs) or other real estate partnerships, offer investors passive, fractional ownership of investment grade commercial real estate. These structures can also qualify as like-kind 1031 exchange property, allowing investors to acquire shares as replacement property in a tax deferred exchange.

Before investing in sponsored property, it’s important to select a credible property investment sponsor, one whose interests are aligned with those of the investor.

Definition of a property investment sponsor

A property investment sponsor can be an individual or a company. The sponsor is responsible for finding, acquiring, managing, and eventually disposing of real estate property on behalf of the partnership. Property investment sponsors also solicit investors for the partnership.

Sponsors of Delaware Statutory Trusts have the added responsibility of acting as the Signatory Trustee for the DST and maintaining control over the property and the tenant.

Role and functions of a real estate property investment sponsor

A credible property investment sponsor should provide clear leadership in locating, purchasing, and operating profitable commercial real estate assets for investors. Property sponsors also have a fiduciary duty to investors to identify and share any foreseeable risk in an investment.

A real estate property sponsor fills several roles:

Locate investment-grade real estate that meets the criteria of the fund
Solicit investors to the sponsored fund with investment offering documents such as proforma statements and private placement memorandums
As part of achieving full subscription to – or invested in – the sponsor will get the property under contract and open escrow, performing all necessary due diligence and research
Once the due diligence is completed and approved by the sponsor, the property is purchased
Management and operations of the fund will be undertaken by the sponsor, or outsourced to a third party under the sponsor’s direct supervision, to ensure the investment objectives of the fund are achieved
When the property is sold the sponsor is responsible for winding down the investment and making capital distributions to the investors

Previous experience and performance of a credible property sponsor

The roles and functions of the sponsor have a direct effect on the success or failure of the investment. Investors should always conduct their own due diligence to determine the credibility of a property sponsor.

Sponsor experience and track record

Credible property sponsors can provide potential investors with a portfolio of past investments that include detailed operating and financial histories. When reviewing the experience and track record of a sponsor, investors should consider:

How many years of real estate investing experience does the sponsor have – including team members – and what is the track record for successful investments?
Has the sponsor been successful in attracting investors for past opportunities?
What is the combined capitalization of the sponsor’s projects to date?
Does the sponsor have relevant experience in underwriting, structuring deals, and negotiating with proven legal and financial strategies?

Approach to commercial real estate investing

Once the investor is satisfied with the experience and track record, the sponsor’s approach to investing in commercial real estate should be researched. Important questions to ask include:

Does the sponsor specialize in a specific asset class, geographic area, or investment real estate strategy?
Is the sponsor able to locate off market or ‘under the radar’ investment opportunities in addition to those that are publicly listed?
Has the sponsor demonstrated it can capably analyze potential investments and accurately determine risk factors?
For turn-around projects, is the sponsor able to develop and execute plans that achieve the property’s full growth potential?
Does the sponsor have the in-house infrastructure needed to handle all operating, leasing, and property management aspects of commercial real estate, or does the sponsor rely extensively on third-party support?
What are some specific examples of how the sponsor has applied their professional experience to improve the economic performance of the property and enhance investor ROI?

Sponsor fee structure

Sponsors normally collect management and other fees related to the property they are sponsoring. When reviewing the sponsor fee structure potential investors should ask:

What are the sponsor fees and how do they compare to the fee structures of other credible property investment sponsors?
Does the sponsor collect fees related to financing, property acquisition or disposition, and development fees?
If there is an asset/property management fee, is it based on actual capital contributions or on promised capital not yet received by the sponsor?
Are there ‘extra’ fees that the sponsor could potentially receive, and if so, what are they and is there a cap on the amount?

Ask for sponsor references

Before ‘hiring’ the sponsor by contributing capital to the project, investors should ask for sponsor references from companies, individuals, or past investors who have been involved with the sponsor:

Does the sponsor have established relationships with lenders and financial institutions?
Does the sponsor have a current vendor network including real estate brokers and leasing agents, loan servicers and receivers, accountants and attorneys, and bankruptcy or workout professionals?
What do these references have to say about their past and present experiences of working with the sponsor?

Summary

While investors contribute capital, the success of the property investment rests in many ways with the sponsor. When selecting a credible property investment sponsor, investors should choose sponsors whose projects are aligned with their interests and goals.

A credible property investment sponsor serves as a fiduciary to the investor, providing reliable stewardship of the capital invested and creating long-term relationships for future sponsored commercial real estate investment opportunities.

About the Author

Karen E. Kennedy's expertise spans various areas, including 1031 Exchanges, Delaware Statutory Trust (DST) structured investments, fractional interest ownership, tenancy-in-Common (TIC) owned properties, property acquisitions, portfolio management, and investor relations.

More about Karen E. Kennedy »

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Frequently Asked Questions

What are the advantages of a DST-Structured investment in commercial property?
There are numerous advantages to investing in a DST structured property offering.
- The purchase of DST interests is simpler, faster and does not require as many documents as buying sole ownership of a property.
- Capital Gains are deferred, if investment is for a 1031 Exchange
- No daily property management obligations that come with sole ownership
- Ability to create a diversified real estate investment portfolio
- Cash flow distributions
- Annual depreciation/tax deductions
- Appreciation upon sale of the property
- Upon the sale of a DST property, the investor may engage in a 1031 exchange, even if the DST interest was purchased without 1031 exchange proceeds.
- A DST is a pass-through tax entity, which is not subject to federal income tax, nor to the Delaware franchise or income tax.
- Because the DST is the mortgage borrower, the lender does not require individual DST investor guarantees, nor does the lender require investors to submit personal financial information to qualify for the mortgage loan.
- Investors with interest in a DST property are protected from property liabilities held by the DST. As a result, the maximum pre-tax loss (excluding income tax considerations) is equal to the amount invested in the DST.
Are there a minimum and maximum investment amounts to participate in a DST property offering?
- Yes; $50,000 to $100,000 are typical minimum investment amounts but this may vary from sponsor to sponsor.
- The maximum amount is contingent on the overall size of the DST offering and the discretion of the DST Sponsor.
Are DST-Structured properties commonly used for a 1031 Exchange?

Interests in Delaware Statutory Trusts are the primary investment method for fractional 1031 exchange investments at this time.
Are there any restrictions on a DST-Structured Investment?
- The IRS places several prohibitions on the power of DST trustees if the Delaware Statutory Trust is to be used with a 1031 tax deferred exchange. There are seven restrictions, sometimes referred to as the ‘Seven deadly sins of a DST’:
  - Once a DST offering is closed there can be no further contributions by current owners, new owners, or beneficiaries.
  - Existing loan terms cannot be renegotiated, nor can new funds be borrowed, by the DST trustee.
  - Sales proceeds from the investment real estate cannot be reinvested by the DST trustee.
  - Capital expenditures can only be made by the DST trustee for normal repair and maintenance, minor non-structural capital improvements, or those required by law (such as items related to zoning codes).
  - Liquid cash held by the DST between distribution dates can only be invested in short-term debt obligations.
  - All cash in excess of necessary reserves must be distributed to investors.
  - New leases or re-negotiations of current leases may not be entered into by the DST trustee.
How does an investment in a DST-Structured property differ from an investment in a TIC-Structured property?
- Like TICs, DSTs have multiple investors that purchase fractional interests and the investors share in the total financial performance of the underlying investment property. However, the primary differences between the two investment structures are:
  - A DST is not limited to a maximum of 35 investors required by Revenue Procedure 2002-22.
  - DST investors (Beneficiaries) are purchasing a beneficial interest in a trust and do not receive deeded property.
  - Beneficiaries in a DST are not necessarily required to form single-member Limited Liability Companies (LLCs).
  - Beneficiaries do not have voting rights or operational control of the property.
  - In a DST structure, there can be no cash calls or additional money invested into the property beyond typical maintenance and certain capital expenditure needs, unlike in TICs.
What is a 1031 Exchange?

A 1031 exchange is a swap of one real estate investment property for another in a specific way that allows for capital gains taxes to be deferred.
How a 1031 Exchange is Accomplished?
There are seven recommended steps common to most Section 1031 tax deferred exchange:

BEFORE YOU CLOSE ON THE SALE OF THE RELINQUISHED PROPERTY:

Step 1: Consider retaining the services of a certified public accountant or an attorney with tax deferred exchange experience to assist in planning for an exchange.

Step 2: Engage a Qualified Intermediary, or “QI,” (also called an Accommodator), being sure to name the QI as the principal in the sale of the relinquished property and in the purchase of the replacement property.

Step 3: Sell the relinquished property, making sure to include a cooperation clause requiring the buyer to cooperate with the seller’s 1031 exchange, and instruct the escrow officer or closing agent to order exchange documents from the QI.

AFTER CLOSING THE SALE OF THE RELINQUISHED PROPERTY

Step 4: Escrow closes on the relinquished property, with the closing statement showing the QI as the seller, and sales proceeds from the relinquished property are sent to the QI and placed in a separate segregated trust account.

FAILURE TO SEND SALES PROCEEDS DIRECTLY TO QUALIFIED INTERMEDIARY FROM ESCROW WILL RESULT IN INABILITY TO EXCHANGE.

Step 5: Within 45 calendar days of the close of escrow of the relinquished property the exchanger identifies one or more replacement properties and sends written notice of this to the QI.

Step 6: The exchanger executes a purchase contract with the seller of the replacement property, making sure the cooperation clause is included in the purchase contract, and naming the QI as the buyer of the replacement property.

Step 7: Within 180 calendar days of the close of escrow of the relinquished property, the exchanger instructs the QI to transfer funds to close escrow and sends 1031 exchange-related documents to the escrow company, and the sale closes with the closing statement showing the QI as the buyer on behalf of the exchanger.
- After the replacement property has closed escrow, the QI will send a final accounting statement to the exchanger. The statement will show that funds have come from one escrow directly into another, all without the taxpayer having constructive receipt of the funds.
- Real estate investors should note that although the qualified intermediary is indicated as the seller and buyer on the purchase contracts, the deed and title are always from the taxpayer to the buyer, and from the seller to the taxpayer.
What qualifies as a “like-kind” replacement property?
- The definition of a qualifying like-kind property is very broad, for both the sold property and the replacement property: real estate used for investment or business purposes. Personal use property is not eligible.
- Investment real estate (held for either appreciation or for rental) can be exchanged for real property used in a trade or business. Partial interests such as TICs or DSTs, are exchangeable with other types of real property.
How is a replacement property identified?

A like-kind replacement property is identified if it is designated as replacement property in a written document signed by the exchanging party and received by the QI before the end of the 45-day identification period. Every QI uses their own form of documentation. Please consult with your QI to determine the exact procedure they require.

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Authored By: Karen E. Kennedy

President & Founder • NAS Investment Solutions

Karen E. Kennedy's over-40 years experience spans various areas, including 1031 Exchanges, Delaware Statutory Trust (DST) structured investments, fractional interest ownership, Tenancy-in-Common (TIC) owned properties, property acquisitions, portfolio management, and investor relations. See Full Bio