DST Reserve Sizing: How Much Reserve a DST Should Hold

Because the trust can never ask you for more money, the reserve is decided once, at the offering

The ruling lets the trustee establish a reasonable reserve for expenses of holding the property, payable out of trust funds, and bars it from accepting additional contributions of assets, including money. Freddie Mac's DST memo lists accepting contributions after the offering period among the prohibited acts and tells lenders investors will not have to make any additional investment.

A filed DST trust agreement shows the one opening: the trust may accept investor capital at the offering if it is used to pay offering costs, to fund reserves or to redeem the sponsor's interest. After that, the reserve can grow only by holding back cash that would otherwise be distributed. How repairs are paid from these pots is at how a DST pays for repairs without new capital.

Lenders size their reserve from a property condition assessment, and published ranges show the scale

Freddie Mac's floating-rate term sheet lists a replacement reserve deposit and tax and insurance escrows as generally required, and its DST memo requires a sufficient replacement reserve at origination that the master tenant can draw on for repairs and renovations.

The amount follows the property's condition. For seniors housing, Freddie's Guide Chapter 21 has the consultant project repairs and replacements over the loan term and set a per-unit range: $150 to $250 per unit per year for age-restricted property in excellent condition, $250 to $350 for adequate condition and $350 to $450 for fair condition, with Freddie setting the final amount. For manufactured housing, Chapter 22 sets a floor of $50 per home site and $250 per borrower-owned home per year.

Under Chapter 39 the lender holds a security interest in these reserves and may apply them to the loan on default. Lender reserves protect the lender first.

A filed master lease shows three separate pots, and only one of them belongs to the trust

The filed form of DST master lease divides the money. The master tenant may draw on lender reserves for repairs. It may set up its own capital reserve account, but those funds belong to the master tenant and go to it when the lease ends. The trust establishes a supplemental trust reserve from its private placement proceeds to pay landlord costs, defined as roof, structure, foundation, exterior wall and parking lot work, plus other repairs.

The supplemental reserve has a ceiling and a floor. Above the ceiling the trust may withdraw the excess and distribute it to investors. At the end of each calendar year it must hold at least a stated floor; if it falls short the trust replenishes it, and if the trust does not, the master tenant may fund the gap and offset the amount against rent. The dollar amounts are blank in the form and filled in per offering.

Floating-rate loans add one more. Freddie's Guide Chapter 11 requires monthly deposits building to 125 percent of the estimated cost of a replacement interest rate cap when the cap expires before the loan; see floating-rate debt and rate caps.

A hypothetical floor breach shows how a reserve shortfall becomes a distribution cut

Hypothetical figures, rounded. A trust starts with a $300,000 supplemental reserve and a $150,000 year-end floor, and has $400,000 a year of cash available for distribution. A $200,000 roof replacement drawn from the reserve leaves $100,000. To restore the floor the trust withholds $50,000, and that year's distributions fall from $400,000 to $350,000, a 12.5 percent cut.

If the same job had cost $450,000, the reserve could not pay it and the floor would need $300,000 of withheld cash, three-quarters of a year's distributions. That is why the size of the reserve against the age of the roof, the parking lot and the mechanical systems is the question, not the reserve as a percentage of equity. Run your own numbers with your CPA using the offering's figures.

Size the reserve against the third-party report, not against other offerings

Ask for the property condition report and its replacement schedule, then compare the cost of everything due during the projected hold with the total of the lender reserve, the trust reserve and any master tenant commitment. Ask who owns each balance at sale and whether unused trust reserves are distributed. The OCC's Commercial Real Estate Lending handbook warns that inappropriately administered reserves can mask a poorly performing project; a reserve that props up distributions is the version to watch for.

Where the reports come from and how to read them is at third-party DST due diligence reports; how the reserve line feeds your check is at how DST distributions are calculated.