ADISA Video: The New 1031 Best Practices
The DI Wire’s publisher, Damon Elder, interviewed Greg Mausz, chief operating officer and senior managing director at Skyway Capital Markets., to discuss the Alternative & Direct Investment Securities Association’s newly published manual that’s designed to highlight certain best practices related to Delaware statutory trusts, the preferred structure used to facilitate securitized 1031 exchanges, A Guide to DST 1031 Best Practices (2022).
With new interest and sponsors in the constantly changing market, ADISA saw the necessity of having an updated guide for best practices, as The DI Wire previously reported. The original guide was published in 2006, raleted to the then-dominant tenant-in-common structure for securitized 1031 exchanges, but DST structures have become much more popular in the last ten years. Mausz explains how 1031’s allow investors to take an investment property and sell it without paying taxes as long as the money is placed in another investment property with certain qualifications. The new guide includes the entire process for DST structures and new opportunities that are offered to investors.
Video Transcript
Damon Elder 00:09
Welcome to another edition of Focus on Alternatives hosted by ADISA, the Alternative and Direct Investment Securities Association. I’m Damon Elder publisher of The DI wire.com and I’m joined today by Greg Mausz senior managing director of Skyway Capital. He’s also a longtime member of the board of directors of the ADISA. So great today we’re going to talk about a project that’s near and dear to your heart. As a member of the board of directors of the ADISA and that’s a newly published new guide to best practices for Delaware Statutory Trusts, designed for 1031 exchanges which ADISA just put out earlier this year. So, let’s talk about it, DSTs are fairly new but 1031 is not 1031 exchanges have been around for over 100 years, huge industry. Most 1031’s are structured as real estate transactions, but the securitized portion of that industry has grown to more than 10 billion. Has become huge, so why did the ADISA feel the need to put out a new best practice?
Greg Mausz 01:05
Well, there’s lots of new entrants, new sponsors in the market and the market is constantly changing. And there’s new features new benefits. And we wanted to really grab the kind of the best practices, the industry intelligence and propagated out there. So that everybody can benefit from the really the best-in-class way of doing things. And again, it’s all about structuring quality deals so that investors have good choices and have protections.
Damon Elder 01:37
So, what was the process you know, who’s behind The Who wrote the new best practices and and what was the process to have a decent to publish in them and approve them and promulgate them to the industry?
Greg Mausz 01:47
Yeah, so it was a bunch of experts. From sponsors from law firms from third party due diligence that came together under the adisa banner. There’s also the AI betterment committee alternative investment betterment committee where ADISA is trying to constantly look at areas where they can put forth best practices, but it was really a collection of experts.
Damon Elder 02:10
So, there was was there a comment period, the the industry as a whole participated in some fashion?
Greg Mausz 02:17
Yeah, absolutely. So, the original best practices that we published was actually back in 2006 and so it was long overdue…
Damon Elder 02:25
Back in the TIC days.
Greg Mausz 02:26
…Yeah, long overdue for a refresh. And the old best practices really didn’t address DST’s which is that’s the primary vehicle for 1031 securitized transactions these days.
Damon Elder 02:38
Yeah, I mean there are very few TICs now but like I said over 10 billion this year in DST, so definitely has become the preferred medium for 1031 exchanges. So, who I mean I think some obvious folks obviously the sponsors and some of the broker dealers that specialize in DSTs or that offer them their clients will probably find some value in these best practices. But what who else would be interested in these best practices who are they designed for who will they help?
Greg Mausz 03:03
Everybody, the whole ecosystem. So, the law firms that are writing this, they they now have a document to reference the sponsors but the financial advisors when it comes to sales best practices the broker dealers when it comes to supervising these transactions. The due diligence process so everybody in the whole ecosystem can can really read absorb and get takeaways from this document.
Damon Elder 03:26
Why don’t we take just a brief step back, because I think maybe we put the cart before the horse just a little bit here. I’m obviously you and I are very familiar with 1031’s, anyone in the illiquid non-traded alternative investment phase are probably very familiar with 1031’s. But it’s still relatively small part of the investment world. So why don’t you kind of give us a little bit on what 1031’s are why DSTs have become so favored you know where are we in the industry’s life cycle?
Greg Mausz 03:52
So basically at 1031 allows you to take one piece of investment property, sell it not pay taxes on it as long as you place it into another investment property. Um and you must match the equity and debt as you do that process. But it’s a way to roll over gains and defer taxes in real estate. And there’s two kind of structures for doing this we mentioned tenant and common are tick but the dominant is the Delaware statutory trust the DST. And that allows for bigger pools of investors to participate in the DST 1031 structure.
Damon Elder 04:31
TICs were limited to…
Greg Mausz 04:32
35 total investors.
Damon Elder 04:33
35 total investors which meant the minimums were very large.
Greg Mausz 04:35
Right.
Damon Elder 04:36
Compared to a DST DST can have thousands and thousands, right?
Greg Mausz 04:40
Not quite that many, but it does allow for a couple thousand and investors to to be in there. Which allows for smaller ticket sizes, which allows for financial advisors to be able to put together a portfolio of properties as part of a 1031 exchange.
Damon Elder 04:57
What were some of the… why has there been again… TICs early late 90s into the mid 2000’s became very popular as a securitized medium for 1031 exchanges. I think they maxed out around 2006 2007 at around 3 to 4 billion. Now again DST structures have completely dwarfed them, and they’ve gotten enormously popular. Every year the equity raise is growing and growing and growing. Why was there that shift from TICs to DST. Is DST a better structure for 1031 exchange, you know why this massive change and again the explosion in popularity of the DSTs?
Greg Mausz 05:31
So, number one more and more people are aware, of them more and more people have access to them so that that’s to the reasons. But the main shift from the TIC to the DST has to do with financing and leverage. When you structure a DST, it is a one loan on that trust and everybody participates in that loan. Versus in the TIC days, I mean each individual of those investors have their own individual loan by a bank, and and banks just aren’t doing the type of lending anymore. So, it actually improves kind of governance control and management of the whole syndicated 1031.
Damon Elder 06:11
The TICs were pretty unwieldy, and then when we got into the Great Recession and you need to do some refinancing and things. Each individual ticket owner or investor was essentially their own they could squash any deal of any real material in the DST this is a much more manageable structure.
Greg Mausz 06:26
Right agreed.
Damon Elder 06:27
OK great. So, let’s dive in a little bit, I was going through the best practices there’s a lot covered in there very comprehensive. What are some of the highlights what are some of the key takeaways what’s new in these best practices as opposed to the ones that came out 15, 16 years ago?
Greg Mausz 06:43
Well really, we addressed the whole process here. I mean from from structuring to sales best practices to investor communications and audits so it’s It’s very comprehensive.
Damon Elder 06:58
And what was the need for the best practices. I mean are we seeing people structuring these things in a way that ADISA and the better sponsors for lack of a better term just felt was not appropriate that would be harmful to the industry as was that one of the reasons why this became a push for a visa?
Greg Mausz 07:13
No there’s just constant innovation, on legal structures, terminology, transparency, fees, and so as different companies are doing different things these are these are private placements. And you know one company can’t necessarily see what another company is doing.
Damon Elder 07:32
Sure.
Greg Mausz 07:33
But eventually there’s momentum around some major themes, and then they coalesce and then it’s good to capture that and then spread it out there and propagate it.
Damon Elder 07:43
So, when I was going through the guidelines one of the two of the things really that struck me as really new and emerging in the marketplace are the 506 C structure. Which allows for general solicitation and while certainly still dwarfed by 506 C or 506 B offerings they’re emerging they’re getting much more popular with, and a lot of broker dealers are becoming more familiar and comfortable with them. Some of the key players in the DST space are raising hundreds of millions of dollars a year we’re using the 506 C so that’s interesting. And then also we’re starting to really see a lot of 721 exchanges which are kind of ancillary to 1031’s but related so kind of walk us through there what we seeing?
Greg Mausz 08:20
Yeah, neither one of these concepts were really in the first best practices, so it was really important to bring them into here. And so, the 721 allows for on the exit of a 1031 exchange for it to be rolled up into a REIT, traded REIT, or a non-traded REIT. But you take your interest in the in the trust and get OP units in a REIT. And then you become part of a bigger diversified pool. And in the best practices it talks about how some companies are giving investors the option do you want to exit for cash or do you want to exit as part of a roll up in a 721? So that’s… that’s new and it’s it’s really exciting times for giving investors these options. And then the 506 B & C the the general solicitation of the C also though then comes with a requirement to verify that they are accredited. So that’s a whole new level of of paperwork and complication but it’s allowed people to talk publicly about securitized 1031’s. Which goes back to your one of your earlier questions allows for there to be more people that know about it and more interest in it.
Damon Elder 09:31
So, let me ask you a question a follow up on the 721. So, if you can have the option to roll into 721 or take cash, what happens with that 1031 investor chooses to take the cash do they have to pay the tax or can they then again roll it into another 1031 or multiple 1031’s?
Greg Mausz 09:47
Absolutely, you hit the nail on the head they can take the cash pay the taxes or move that money into another 1031.
Damon Elder 09:54
So, participating in a structure that rolls into 721 doesn’t require them to then lose that 1031 they can continue to roll if they want.
Greg Mausz 10:01
Right well it’s important that you look for a document that gives you the investor that optionality.
Damon Elder 10:07
Well let’s talk about another side of the coin of the whole industry and that’s obviously the sales process. And that’s one where obviously best practices are probably very important because sales is where you can slip up pretty easily. So, what are we seeing in the new best practices in regard to that process which again can be pretty tricky.
Greg Mausz 10:23
Well, the market actually got really hot lately. And we saw deals coming to market, due diligence being done, marketing being done, and really really compressed time frames. And different firms you know couldn’t respond as quickly as others and it just became a real challenge. And so, we recommend you know different gates where the sponsors doing their evaluation, or they alert the broker dealer where then there’s a due diligence cooling off. And then a marketing cooling off period. So that everybody has the ample time to evaluate deals identify the right clients and work them through the process.
Damon Elder 11:04
Well so Greg, I know this took a lot of time by ADISA and the members of the working group who worked on the best practices and obviously there was a whole process for the industry to communicate with you guys and to really iron it out. So now that it’s out there now that’s been published where can people get this the the best practices?
Greg Mausz 11:21
So best practices are published on the website. So ADISA has this resource library and there’s a lot of great resources, white papers, best practices, articles out there for advisors to engage and learn more about Alts. So that’s the number one place to go, but I want to close by thanking everybody that really put a lot of time intellectual capital into putting together these this this white paper, these best practices. It was really a great combined effort of a lot of people.
Damon Elder 11:53
Well, we’ve been hearing about it for some time> so I know a lot of hard work went into it so. Well thanks to you Greg, and all the work you’re doing at ADISA to try to move the industry forward and stay in the right compliant path that’s always I think great for everyone.
And thanks to you for tuning in for another episode of focus on alternatives. For more information on ADISA to download the best practices and to find a lot of information on all sorts of alternative investment information go to adisa.org. And obviously, visit The DI Wire.com for your Daily News.
Thanks so much.
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