What is a DST (Delaware Statutory Trust)?

A DST is a legal entity that holds fractional interests in real estate properties, allowing investors to participate in large commercial real estate investments passively. DSTs function as securities, providing a method to meet 1031 exchange requirements for like-kind property, deferring capital gains taxes, and offering access to institutional-grade assets.

Are DSTs Suitable For Retail Investors?

DSTs maybe problematic securities and are subject to significant, multi-layered risks that stem from the DTSs fundamental structure:

Extreme Liquidity: DST investments are inherently illiquid, a core characteristic that presents one of the most significant risks. Unlike publicly traded stocks or mutual funds, there is no active secondary market for selling one’s interest in a DST. The holding periods are typically fixed and can range from 5 to 10 years or even longer, locking an investor’s capital into the trust for an extended period.

The passive nature of the investment means that the investor cannot compel an early sale or liquidation of the property. While an early exit is “theoretically possible,” it is “extremely rare” and is dependent on the sponsor’s decision to sell based on market conditions or unforeseen events, such as a major tenant’s bankruptcy. Even if an investor finds an alternative route to liquidate their interest, such as through a limited secondary market, they will almost certainly be forced to sell at a steep discount. This means the investor may be unable to access their funds in a financial emergency and may face substantial losses if they are compelled to exit the investment prematurely. A DST essentially replaces the illiquidity of a single direct-ownership property with a new form of illiquidity: the inability to sell even a fractional interest.

Lack of Investor Control: A key component of the DST’s tax-compliant structure is the legal requirement that the trust be passively managed by a sponsor. This means investors have no voting rights and no say in any operational or major financial decisions regarding the property, including its management, leasing, or eventual sale. This total loss of control is mandated by a set of prohibitions known as the “Seven Deadly Sins”.

The trustee, or sponsor, cannot renegotiate existing loans, raise new funds, or reinvest the proceeds from a property sale. This structural rigidity poses a critical threat if the property encounters a downturn. For example, if a key tenant defaults or a market shift makes the property unprofitable, the sponsor cannot raise additional capital from investors or obtain new financing to stabilize the asset. While some DSTs have a “springing LLC” provision that allows the sponsor to convert the trust into a more flexible entity to save the asset, this action could potentially trigger a taxable event for the investors. The DST’s passive structure, which is marketed as a benefit, is in fact its greatest vulnerability. It is a legally mandated design flaw that prevents the very actions necessary to mitigate risk in a crisis.

Sponsor Risk and Financial Misconduct: The complete reliance on the DST sponsor makes their integrity, track record, and financial health makes the investment problematic. The lack of investor control and asset illiquidity create an environment that can be ripe for sponsor misconduct. The Private Placement Memorandum (PPM), the document outlining the investment terms is created by the sponsor.

Opaque and Layered Fees:

The fee structure of a DST is a significant drag on returns and is a source of a fundamental conflict of interest.  DSTs involve numerous fees, including acquisition, loan origination, management, and disposition fees, which can diminish returns.  At times, fees are pre-calculated and can be anywhere from 5-10% on the backend, depending on the portfolio.  The median “load-to-equity” for a DST could be as much as 20%, encompassing sponsor compensation and selling commissions.

This fee structure often incentivizes the DST sponsor to focus on closing new offerings and collecting upfront fees rather than prioritizing the long-term performance of the underlying assets. Unlike traditional syndications where the sponsor’s profit may be tied to a “waterfall” or “promote” at sale, the DST structure can give sponsors a consistent stream of revenue regardless of whether the property appreciates. This creates a powerful incentive for the sponsor to recommend a product that may not be in the investor’s best interest. The investor’s returns are directly diminished by these costs, which are essentially paid regardless of the investment’s ultimate success.

A brokerage firm recommending a DST to an investor is legally and ethically bound by a clear set of rules.  Among FINRA rules, Rule 2111 (Suitability) requires that a broker-dealer have a “reasonable basis to believe” that the recommended investment or strategy is suitable for the customer, based on their investment profile, goals, risk tolerance, and liquidity needs. The broker-dealer is also obligated to perform “adequate due diligence” on the product itself.

The Securities and Exchange Commission (SEC) Regulation Best Interest (Reg BI) further obligates a broker-dealer not place their financial interests ahead of the interests of a customer. The high commissions and fees associated with DSTs, as high as 10%  create a powerful incentive for brokers to recommend them over other, potentially more suitable alternatives. This dynamic leads to a direct conflict of interest between the broker’s compensation and the investor’s financial well-being.

Sellers of DSTs have obligations to adequately explain that DSTs lack a secondary market locking investors into holding periods of 5 to 10 years without an easy exit.  In addition, the following risks must be adequately disclosed:

Fees and costs – Upfront fees (10-20%) and ongoing management fees (1-2% annually) erode returns. These fees are often obscured in marketing materials, making DSTs less cost-effective than direct real estate investments.

Loss of control – Investors have no say in property management, leasing, or sales. This leaves them vulnerable to mismanagement by the sponsor, especially in volatile sectors like senior housing.

No guaranteed returns – Returns are not guaranteed and are subject to real estate market volatility, tenant issues, or sector-specific challenges (e.g., staffing shortages in healthcare).

Tax implications – While DSTs defer capital gains taxes, liquidating an investment can trigger deferred gains and potential depreciation recapture. Non-compliance with IRS rules can also void the exchange.

High commissions – Broker-dealers earn high commissions (5-7%), which can incentivize unsuitable recommendations, especially when investors are under time pressure with a 1031 exchange. This can happen without thorough due diligence on sponsors.

Lack of regulatory oversight – As Reg D private placements, DSTs face less SEC oversight, increasing the risks of misrepresentation or fraud. Sponsor issues, such as the 2025 collapse of Inspired Healthcare Capital, can also lead to significant losses for investors.

The Importance of Selection of Experienced Securities Counsel – DST Attorneys

Retaining an advisor misconduct attorney and law firm is an important decision made with great care. Please review our website, experience, and credentials. The choice of an advisor misconduct attorney may be the single most important decision a litigant makes either before or after a dispute arises. Read more about The Importance of Selection of Counsel.

If you are an investor that lost more than $100,000, you should consider all legal options including FINRA arbitration. Contact Bakhtiari & Harrison.