What Happens to the Money When a DST Sells: The Sale Waterfall

The sponsor chooses the day, and the trust ends when the property is sold

Under Rev. Rul. 2004-86 the trust terminates on the earlier of its stated term or the disposition of the property, and the trustee may not reinvest the proceeds or buy new property. A REIT's Form 10-K says its DST manager has the sole power to determine when it is appropriate for a trust to sell its property, and is reimbursed for certain expenses of selling to a third party.

So there is no investor vote on price or timing in most programs. What you control is where your share goes, which needs to be settled before the closing date; the timeline is at what happens when a DST sells and your next 1031 and the voting question at who controls a DST.

The lender is paid before any sponsor fee or investor, including any prepayment premium

The loan is secured by the property, so the lender's balance comes off the top at closing. What else it collects depends on the loan's prepayment terms. Freddie Mac's fixed-rate term sheet describes yield maintenance until securitization, a two-year lockout, defeasance after that, and no prepayment premium in the final 90 days of the term. A filed DST loan agreement likewise has a prepayment lockout period and a prepayment premium.

That makes the sale date and the loan's open window part of the same decision. A sale during a yield maintenance or defeasance period can cost investors a meaningful share of the equity; a sale near maturity usually avoids the premium but runs into the trust's inability to refinance. Ask for the prepayment schedule in the loan summary; the lender documents are covered at DST lender documents and carve-outs.

Sponsor fees at sale come out of the investors' share, and the memorandum fixes them in advance

A REIT's registration statement says its DST manager may earn a disposition fee of an agreed percentage of the gross sales price of any property sold to a third party, which it may reduce or waive. A net-lease REIT's Form 10-K says disposition fees on its affiliated sponsor's DST portfolios are estimated at a maximum of 2 percent of the purchase price, calculated on the selling or merger price, and are paid solely by the DST investors from their net proceeds.

Some programs give the sponsor a share of the upside in other ways. A sponsor's 10-K describes master lease rent as debt service plus additional rent, so the master tenant keeps income above that level during the hold, and the same net-lease REIT discloses that a guarantor of its sponsor's master leases is entitled to half of the net disposition fee when a trust it backs is sold. Read the compensation section of the memorandum for every fee triggered by a sale, and compare them across offerings using DST fees and loads.

Master lease terms and reserves can add to or subtract from the investors' share

The master lease ends when the property sells. The net-lease REIT's 10-K says the master lease rental obligation terminates on a sale or merger of the trust. The industrial REIT's 10-K adds a protection in its program: if the property is sold to a third party for less than its fair market value with the master lease in place, the master tenant pays the trust the difference. Look for whether your offering has a similar clause, and who stands behind it.

Reserves the trust still holds are investors' money. In a filed option agreement setting a buyout price for a trust's interests, the formula is the property's appraised value plus funds left in the reserve account, less loan principal and accrued liabilities. Part of the reserve may be held back after closing for final bills, as explained at DST wind-down and final distributions.

Run the waterfall on one hypothetical sale before you rely on a projected sale price

Every figure is hypothetical; the sale price depends on the market, the exit cap rate and the remaining lease term, and can be lower than the trust paid. If a prepayment premium applied, or the price fell 10 percent, the 5 percent owner's share would shrink by far more than 10 percent because the loan is paid first. Run your own numbers with your CPA, and test the sale assumption at exit cap rate assumptions.

Because you are treated as owning an undivided interest in the property, your share of the sale is your own sale of real estate and can be exchanged under Reg. section 1.1031(k)-1 if your intermediary receives it. If it is paid to you, gain is taxed, including depreciation recapture, on your own return.

• Gross sale price: $25,000,000.
• Less closing costs and reimbursed sale expenses of 2 percent: $500,000.
• Less loan payoff: $10,000,000, with no prepayment premium because the sale falls in the open window.
• Less disposition fee of 2 percent of the price: $500,000.
• Plus reserves released: $300,000.
• Net to investors: $14,300,000; a 5 percent owner receives $715,000, wired to a qualified intermediary if exchanging.