Why a 'Fee-Based' DST Investing Sales Pitch Is a Red Flag for Investors
An annual assets under management fee on a Delaware statutory trust can cost investors far more than a one-time commission in the long run. So why are fiduciary advisers proposing it?
Editor's note: This is the first in a two-part series on Delaware statutory trust (DST) investing. The second will cover how property reserve funds work in a DST.
In today's 1031 exchange marketplace, investors are increasingly hearing a clever sales pitch from registered investment advisers (RIAs): Avoid upfront commissions on Delaware statutory trusts (DSTs) and instead pay a 1% annual assets-under-management (AUM) fee.
As the CEO of Kay Properties and Investments, which provides objective, specialized guidance to 1031 exchange investors, I find this alarming.
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Lower upfront costs, alignment of interests and the comfort of a "fiduciary" relationship look appealing at first glance. But when you apply basic real estate logic, the math tells a very different story.
DSTs are real estate investments, so treat them that way
A DST is not a stock portfolio. It is a form of real estate ownership blessed by the IRS as like-kind for the purposes of a 1031 exchange. Investors in DSTs are effectively buying into institutional-grade properties such as apartment communities, industrial facilities and medical office buildings.
The key question investors should ask is, "What is my expected hold period?"
Most DSTs are structured with a projected hold period of five to 10 years, though they may go longer depending on market conditions.
A simple comparison: Rental property vs ongoing RIA fees
Imagine you purchased a rental property or commercial building. Would you agree to pay your broker or real estate agent 1% of the property value every year … indefinitely?
Highly unlikely.
Instead, the standard model in real estate has always been a one-time commission of approximately 5% to 6%. Why? Because over time, a recurring fee structure becomes dramatically more expensive than a one-time fee. This model would drastically eat into potential returns on your real estate purchase.
The same logic applies to DSTs. Traditional DST investments follow a one-time fee structure (typically around 5%, fully disclosed in the private placement memorandum, or PPM).
Under the RIA AUM model, investors pay around 1% per year, every year. At first glance, 1% may seem minimal — but over time, it compounds into a significantly higher total cost.
Case study: A 2008 DST investment (12-year hold)
To illustrate this, let's look at a real example of the first DST investment I personally made — an apartment community DST outside Seattle, purchased in 2008 with a hold period of about 12 years.
Fee comparison over 12 years: The RIA AUM model (1% annually) would have resulted in roughly 12% in total fees (1% x 12 years), while the traditional DST structure would have been around 5% (one-time).
The bottom-line outcome: The RIA model would have resulted in more than double the fees compared to the traditional real estate-style commission. This is not theoretical — it is real-world math based on an actual investment.
The compounding effect over typical DST timelines
Consider typical DST hold periods: At five years, a 1% annual RIA fee totals 5%, which is comparable to the traditional one-time fee of roughly 5%. At 10 years, the RIA fee totals 10% — two times more expensive. At 15 years, it totals 15% — three times more expensive.
Conclusion: The longer the hold period, the more the RIA's "fiduciary" AUM model works against the investor.
How RIA fees destroy monthly cash flow for 1031 investors
Beyond total fees, there is a very real and immediate impact that investors often overlook: Monthly income. Why do investors choose DSTs in a 1031 exchange? To defer capital gains taxes, to eliminate management headaches, and to generate consistent monthly passive income via ACH direct deposit.
The RIA fee structure problem: RIAs commonly structure their 1% AUM fee by having the DST sponsor pay them out of the property's cash flow before the investor receives distributions.
Hypothetical example: For a $1 million DST investment with a 6% annual yield, the traditional DST structure would generate $60,000 annually ($5,000/month). Under the RIA AUM model, after the $10,000 annual fee, the investor receives $50,000 annually (around $4,167/month). That's a difference of $10,000 less per year and roughly $833 less per month.
Impact: The RIA model reduces the investor's monthly income potential by approximately 20%. This raises a fair question: How is this a fiduciary approach to 1031 exchanges?
An even bigger concern: Perpetual non-traded REIT structures
Many RIAs are not only recommending DSTs with annual recurring fees but also positioning clients into DSTs that include mandatory UPREIT structures converting into perpetual-life non-traded REITs.
The key risks of perpetual REITs: They often have no defined liquidity event, can last 20 years or longer, and continue charging around 1% annually.
The math over 20 years: 20 years × 1% = 20% in total fees and potentially more over longer timeframes. This creates a situation where the RIA continues earning fees indefinitely while the investor continues paying fees indefinitely.
A fair question about fiduciary advice
RIAs often emphasize their fiduciary duty — acting in the client's best interest. Investors should ask this simple question: "How is it in my best interest to pay 10%, 15% or even 20%+ in total fees over time while also receiving less monthly income, when comparable DST investments are available with a one-time fee structure?"
The math is simple. The RIA model of charging DST investors 1% per year is typically the more costly fee structure for investors and lowers their monthly cash flow by typically 20%.
What 1031 investors must focus on
When evaluating DST investments in a 1031 exchange, investors must focus on:
- Total cost over expected hold period (not just upfront cost)
- How fees accumulate over time (1% compounds significantly)
- Impact on monthly cash flow (RIA fees reduce income by around 20%)
- Defined exit vs perpetual structure (perpetual REITs have no liquidity event)
The bottom line: Experience matters more than ever
The real lynchpin in this entire equation is experience. Many RIAs and financial advisers offering DSTs today have been working with these investments for a relatively short period. DSTs have only recently become a hot product at large financial institutions.
Advisers and RIAs often lack deep experience with full-cycle DST performance. They may not fully understand the nuances of DST structures, sponsors and 721 UPREITs. The risk to investors is that they can unknowingly become the testing ground for an adviser still learning the space.
Related Content
- What a Delaware Statutory Trust Can Do for Your Kids That Your Will Can't
- Six Risks of Delaware Statutory Trusts in 1031 Exchanges
- DST Exit Strategies: An Expert Guide to What Happens When the Trust Sells
- How to Use DSTs and 1031 Exchanges for Diversification
- How Do You Step Away From Your Real Estate Empire Without Facing a Giant Tax Bill?
