1031 And DST Tax Benefits For Multifamily Investors, With Rob Johnson

Savvy investors who have had success in real estate, including in multifamily, can see powerful tax benefits if they use the right financial tools. On this episode, we explore 1031 exchanges and Delaware Statutory Trusts (DSTs), with the help of Rob Johnson, Head of Wealth Management for Realized.

This episode was recorded live from the ADISA Spring Conference 2022 in Orlando, Florida.

Click the play button above to listen to the conversation.

Episode Highlights

  • What benefits a 1031 exchange or DST can bring a multifamily investor.
  • The story behind Realized, and how they fit into the multifamily landscape.
  • What the Realized Marketplace is, and how it provides significant help to investors.
  • Compelling trends in the wold of DSTs and 1031s.
  • Some of the pros and cons for DSTs and Opportunity Zones for investors.
  • What notable financial goals typical investors who come to Realized have.
  • Rob’s insights on the future of 1031s and DSTs.

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Realized gives you the tools and knowledge to manage your investment property wealth with the same sophistication used to manage stocks and bonds. With Realized, you can:

Transition tax efficiently from individual properties to a diversified portfolio of passive investments. Build a portfolio tailored to your individual needs and risk appetite. Keep your hard-earned wealth invested and working for you. Create more after-tax income potential. Because it’s not about the money you make — it’s about the money you keep.

About The Multifamily Investor Podcast

The Multifamily Investor Podcast covers trends and opportunities in the multifamily real estate universe. Host Scott Hawksworth discusses attractive offerings in the space, including direct investments, DSTs, opportunity zones, REITs, and more.

Show Transcript

Scott: Hello, and welcome to another episode of MultifamilyInvestor.com, the podcast. And today we are once again live from the Spring ADISA Conference here in sunny Orlando, Florida. I’m so happy to be joined by Rob Johnson, who is the Head of Wealth Management for Realized. And today we’re going to be talking about 1031 exchanges, DSTs, talking about your platform, and more.

And before we get into all of that, I always kind of like to start with a high-level question. So why are 1031 exchanges and DSTs, I guess, so compelling for savvy investors?

Rob: Yeah, that’s a great question, Scott. So, what we’re finding is when clients approach us and they need help conducting a 1031 exchange, it’s the opportunity to migrate away from direct property concentration. In most cases, it’s one property that they’re selling, and we’re giving them the opportunity to diversify out to multiple replacement properties in a passively invested manner, which is wonderful, because it’s taking all of the work and ongoing responsibility off their shoulders and putting it on the shoulders of a commercial real estate sponsor.

So, it essentially will give them the opportunity to enjoy, potentially, their retirement years, their golden years. For a lot of clients, they’ve spent decades caring for a property or being responsible for, you know, tending to the ongoing management responsibilities, and now they’re looking to migrate to an environment where they have more free time.

They want to enjoy their golden years, they want to have more time to travel, more time to spend with kids and grandkids. So it’s really supporting a lifestyle change. And we see that from time to time, clients wanting that, you know, quality of life increase.

Scott: Right, yeah, and, you know, fewer headaches because there can be some challenges when you’re directly managing a property. And then, you know, you were speaking to this, that sort of diversification aspect of it as well, which, when you’re trying to, you know, protect and grow wealth, there’s a lot of benefits there, right?

Rob: Oh, completely. So, the opportunity to sell your property, you know, generate a lot of gains from your original investment, but not be subject to the taxation, right? So through the 1031, you take that replacement value, and you migrate it over into a, you know, replacement vehicle, you’ve essentially deferred your taxes, you’re continuing to allow for appreciation, right?

Because it’s going to be invested in commercial real estate properties in multiple regions, multiple sectors, markets, sub-markets, so you’re getting diversification, and you’re letting it grow, while also generating income off of the investment that so many individuals need in retirement. And then also, they’re looking to fill that income gap that they previously had with the property and now they can potentially increase in a replacement property.

So, you could go from one region, one sector to another region in a sector that’s growing. So it’s also allowing them to enter into a market cycle that’s not overvalued. It’s on its way up. And they have potential appreciation over, you know, the next five to seven years. So, it’s addressing a lot of their needs and potential concerns at the same time.

Scott: Right. Absolutely. There’s a lot to dig into there. And I want to cover as much as we can. But before moving forward, can you share a bit about the story behind Realized and where you guys really fit into this, and specifically when we’re talking about multifamily as well, because that’s, you know, we’re the “Multifamily Investor” podcast here.

So…

Rob: Yeah, no, that’s a great question. So Realized is based in Austin, Texas. So, founded by David Wieland and David Dahill back in 2015. They had spent their careers in real estate. David Weiland directly had been very active in the DST space, the Delaware Statutory Trust space, creating some of the first DST, you know, early on in the 2000s.

And so when they founded the company, they were doing so with a goal, and that’s a goal to provide investment property wealth management to individual investors, retail consumers, who, just like them, knew real estate, but weren’t keenly aware of the opportunity to migrate into a passive investment that could be diversified.

What it really ended up being was the opportunity to provide individual investors with the same benefits that a 1031 exchange has been providing for 100 years but, again, moving towards a passive hold period, looking for something that would diversify them, provide them with income in retirement, and not just for them but, you know, future generations for their family.

So we will go through a planning process where we’re not necessarily looking at what’s going on right now but what is to come. Do they have interest in migrating back to direct property in the future? Are they looking to unwind these assets? Is it an estate planning construct where they’re looking to have funds, you know, five, 10 years down the line be provided to their kids?

Grandkids? Do they even need income? In some cases, income is not a goal, they just want to maximize the appreciation over time. So working along a investment planning construct in a custom fashion. Every one of our clients is completely different.

Scott: Okay, custom fashion. I mean, that’s pretty big. That’s powerful.

Rob: Yeah. So it’s impossible to create the same portfolio for two clients, depending on where they come in over the course of the month or the quarter, what their leverage requirements are, their debt requirements when it comes to the 1031 exchange, and what their goals are, and what sector sector they’re interested in using. So you mentioned multifamily.

Scott: Yeah.

Rob: Multifamily is a core sector for portfolio construction for us. We are a strong believer in the benefits of multifamily, now, and going forward, based on what we’re seeing in the market trends and outlook. So, multifamily, as we look at it should be a component of everyone’s portfolio for diversification purposes.

Scott: Sure. And I 100% agree with that take, obviously. I want to get this right, because you also have…you have a Realized marketplace. And I just found that very interesting. Can you speak a bit more to what’s the story behind that and how that functions?

Rob: Yeah. So, our Realized Marketplace is a marketplace of Delaware Statutory Trusts that are open architecture and non-proprietary. So, we don’t have any of our proprietary DST, we just don’t do that. We’re focused on serving our clients, their needs, their long-term objectives.

So we go out to the market, we’re going to conduct due diligence and research on the sponsor, the individual offering on the real estate sector, market, sub-market, and through that process, we’re going to determine what solutions are best to use in portfolio construction for clients, but we’re putting the client first.

Ultimately, their goals, their objectives drives the process. And ultimately, we want them to be part of that exercise, part of the planning process. So, our marketplace will allow clients to go in, review all of the offerings that we have approved on our shelf. They’ll be able to screen and filter depending on what speaks to them or what they believe supports their longer-term goals and objectives.

And then it will essentially be a planning process where we talk about allocations, diversification throughout different markets, different regions, and it could essentially be solely multifamily, but looking at multifamily in different areas of the United States. And ultimately, what we will do through the marketplace is have more constructive conversations that create the back and forth that we use as the cornerstone and foundation for our planning process, is making sure what the client wants and needs is met, now and longer term, and it also is important in the education phase.

We want our clients to understand what a Delaware Statutory Trust structure is, how it can support their longer-term goals. And then, ultimately, when we go through the planning process, we come out the other side, the client is very comfortable with what the suggestions are, we know that we’re addressing their needs, and other components come up that are essential to the long-term planning process.

Do they have liquidity needs?

Scott: Right.

Rob: You know, they may be perfectly fine with respect to ongoing income, but are they looking to unlock some of that value over time? And if that happens, we can talk about other objectives, other solutions, such as the Umbrella Partnership Real Estate Investment Trusts, which is gaining in popularity now. And that helps them further diversify and unlock that value over time. So, the marketplace is a tool, but it’s a valuable tool for really coming into client conversations, where their, you know, eyes are wide open, they’re asking the questions because they have all of the materials in front of them.

Scott: Right. And I think there’s a piece of this, too, you know, these are clients who, you know, they’ve managed a property for years, and they’ve had success. So they have some built-in real estate knowledge. So it makes sense to me that when you’re looking at your marketplace, you know, they want to decide on some properties and have something that speaks to them and be able to still feel, I guess, that they’re a part of the whole process, right?

Rob: Yeah, that’s exactly correct. It has to be an iterative planning process where there’s back and forth. We will frequently work with the client’s CPA, maybe their other financial advisor, and, of course, any family members that are involved in that process because we want it to be, in most cases, it is, a generational wealth transfer in generating the income and potential appreciation in the short term, but a longer-term stage or phase is really that opportunity to pass those assets on to their kids, grandkids, beneficiaries, charitable remainder trusts, what have you, and number of different entities that come up.

And, again, addressing the client’s longer-term goals and objectives is what it is all about.

Scott: Absolutely. All right. We’ve been talking DSTs. There’s also opportunity zones.

Rob: Yep.

Scott: And we’ve covered those on the show before. And I’m just curious to your perspective, if you could share, kind of, some of the pros and cons of DSTs an opportunity zones and, I guess, some of the other questions that an investor might have when they’re thinking about these types of tax-advantaged vehicles?

Rob: That’s a great question. So frequently, we will have clients that come to us and we always go through the same process, because we’re not going to assume that the client knows things that they just haven’t come into contact with before. So, we will essentially work through a number of questions and getting those, you know, flushing out those answers that can help us make sure the client has every option laid out on the table for them, and they understand what’s best for their longer-term strategy.

So, frequently, when a Delaware Statutory Trust is the vehicle that we end up positioning for a client, it’s because they want full tax deferral, and they want some opportunity in the future to either go back to direct real estate, they want that optionality still on the table. Or when we look at the amount of potential gains that they’re, you know, if they didn’t do a 1031 exchange that they’re subjecting themselves to, it’s a meaningful amount, based on what their overall wealth and what their objective is.

So, when we think 1031 exchange and Delaware Statutory Trust, it’s full tax deferral going into the future optionality to go back to direct real estate, if they want, or, you know, in a holding period, on average of five to seven years, they could potentially start to unwind that position, doing a partial 1031 exchange in the future, provided it meets their overall objectives and timeframes.

It’s also an income play, the DST, for the most part is a stabilized investment. So, that is going to generate income as soon as they close. And that is addressing their income needs, that income replacement that they’re looking to match from their prior investment property. With qualified opportunity zones, the majority of those investments are going to be ground-up development.

So they’re not going to be kicking off the income immediately. And of course, we know from prior conversations that, you know, halfway through that projected holding period, you’re going to have a tax event. So, you are going…

Scott: Right, to have a refire or something like that.

Rob: Exactly. So, for clients that don’t want to deal with any tax consequences, and they want a, you know, full deferral, that’s going to be something that a 1031 to a DST lends itself a little bit better towards. And then also, when we look at the opportunity for, you know, a very long-term appreciation play, through the QOZ, you’re going to get tax deferral on your investment going out beyond that five-year period in the second stage or phase of the QOZ.

So, it really goes back to what’s best for the client, what is their goal? What are they looking to achieve? Do they need income? Do they not need income? What’s the tax implications? And their risk spectrum, where are they?

Scott: Yeah, risk has to be just a huge part of that, right?

Rob: Yeah. Qualified opportunity zone, while we believe it is a very good investment that can provide a client with tremendous opportunity, longer term, you are dealing with something that is ground-up development and, you know, it just has a little bit…when we look at the risk spectrum, we would say the DST is a little bit lower on that spectrum.

Scott: Well, you mentioned, you know, often stabilized already with that kind of income already built in. So, yeah.

Rob: Yeah, it’s stabilized, you’ve got, you know, income that’s being generated, you have a higher occupancy levels, sometimes 80% to 100% with the DST, and you know what you’re investing in, some QOZ frequently will be, you know, blind with respect to what they’re investing in, or semi blind. And when it comes to clients, they just have to be comfortable with that, they have to understand, you know, where their comfort lies with respect to that risk spectrum.

But they’re both invaluable tools, from a planning consideration, and one that, again, we make sure the client understands how each investment vehicle addresses their goals and long-term needs.

Scott: Right. And that’s where the conversations are so critical in the kind of ongoing, you know, relationship there, right?

Rob: Exactly.

Scott: So, when you look across the world of DSTs and 1031s, I guess, what are some of the compelling trends right now when you consider them that are, I guess, worth mentioning?

Rob: Yeah. So, the overall, throughout the United States, currently, I mean, this is not a mystery to anyone, valuations are extremely high. So, you’re seeing a number of individuals who have spent, you know, years and years growing that wealth in that asset, who are taking advantage of these high valuations and looking to sell at the top of the market, and migrate those funds to another investment property.

But they don’t, of course, want the tax consequences. So the 1031 exchange, which has been in place for 100 years, allows them, essentially, to take the proceeds from that sale and migrate it to another real estate property. However, most clients are unable to necessarily find another sound investment at a good value or fair value in these highly-valued markets, – Right.

Because you wouldn’t…if you’re selling with that high value, you wouldn’t want to go in and overpay for something else.

Scott: Overpay, or if you’re in a specific region that is at the top of the market, it’s an opportune time to sell, but what are you going to do? Buy right back into that same market?

Rob: Right, you’ve already extracted all the benefits.

Scott: Exactly. So it lends itself to clients saying, “You know what, how about if I’m out at the top of this market, and I’m able to go into a market that has great fundamentals, is on its way up, is seeing population migration, a lot of employers that are going to that area, and ultimately, I can migrate into that market at a fair value and now lock that value in and continue to grow it?”

So, we’re seeing clients that want to make use of that. So they’re getting out of one market, moving into another, they may be getting out of, you know, one multifamily environment and deciding to go into another multifamily environment. And we’re seeing population trends going into the southeast, we’re seeing a lot of individuals, especially, coming out of the pandemic who now have the opportunity to work from anywhere, they’re not necessarily tied to their employer in one region, they can go anywhere they want.

And that’s leading to, you know, population trends and migration throughout the United States. And we’re seeing a lot of, you know, owners of real estate who, quite honestly, after the pandemic, and all of the fear and concern that they went through kind of throwing in the towel on managing and being a landlord.

You know, they’ve said, “Look, whether this continues or not, it’s enough for me, and I’m going to sell and I’m going to lock in those gains, defer the taxes, and move to a different region,” where, again, it’s a passive investment, they can utilize a commercial real estate sponsor for these projects to essentially conduct the research and due diligence on the property and use their understanding of what’s going on in that region to provide for a project that’s going to lend itself really well to support of a client’s objectives going forward.

Scott: Sure. As we wind down these discussions, I always like to turn the attention to the future. What’s next? So when you look at the future of 1031s, DSTS, I guess, where do you see it all going? What, maybe, innovations, interesting developments may happen or already starting to happen?

Rob:Yeah, that’s a great question. So, I would say even over the past several years, we’ve seen larger institutional players coming into the space. It’s a great space right now, you’ve got a lot of tenured and well-established sponsors. But now, you know, commercial real estate entities who, you know, previous played in the institutional market, they’re coming into this market.

So it’s opening up more opportunities for our platform and investors that we work with to align themselves with a lot of sponsors that just didn’t play in this space before. So, more sponsors are getting into the marketplace, we’re seeing more opportunities, growth of projects, which leads to greater diversification, allows us to do our planning process, quite honestly, even better than we had done years ago when there was less options.

And, you know, that competition creates efficiency. And when we look at the products and solutions that are available, it’s helping to create greater transparency, drive down costs because the products have to be more competitive. So, I see a greater array of sponsors and solutions available in a more timely manner. And we’re also seeing product innovation that leads to, again, more optionality for clients.

There’s the Umbrella Partnership Real Estate Investment Trust option, which provides liquidity to a client earlier than a traditional DST and can lend itself to a tax-managed strategy over time, where they can start to sell operating units on their terms. So, even though these are all passive investments, it’s giving them more of a role and more of a decision in the process.

So, what’s good for the client is always of paramount importance. So yeah, we’re seeing a lot of innovation. And it’s nice to see in a space that is still, I would argue, and it’s, you know, early stages or phases of product development.

Scott: Right. And there’s so much more interest, it sounds like you’re saying as well, on that sponsor level and more, right?

Rob: Yeah, yeah. We’re seeing more sponsors getting into space. And, again, that gives more options. And, again, when we’re looking at a custom portfolio for clients, having more options to choose from always ends up in a better result.

Scott: Absolutely. Rob, thank you so much for joining me today, offering such great insights. And if folks watching, listening want to find out more, they want to connect, want to see how Realized could help them, where can they do that? Where should they go?

Rob: Yeah, our website is a great tool for information. You can go there and look at all of the content and literature that we’ve spent years developing and writing. And most of the material that we’ve written has come out directly from questions from our clients.

Scott: Right, those real conversations.

Rob: Those real conversations. So we are a good resource, I’d say we’re a great resource for information for them. If they want a consultation with one of our advisors on our team, that is always available too. We have a client engagement team, we have and investment property wealth management team, our own research area. So everything that we do is geared towards making sure the client’s understanding and eventual, you know, plan is best for their, you know, experience and where they want to get to.

But ultimately, our website, Realized1031.com is a great source of information and, you know, anything we could do to help clients will do so.

Scott: Fantastic. Thanks, again.

Rob: Yeah. Yeah. Thank you for having me.