NNN DST vs Multifamily DST for Income: Which Stream Fits Your Plan?

Both are built around the same ruling, and the ruling was written for a net lease

The facts in Rev. Rul. 2004-86 describe a single building under a 10-year net lease to one tenant, who pays all taxes, insurance, maintenance, ordinary repairs and utilities, at a rent that is fixed or adjusted only by a fixed rate or an objective index such as the Consumer Price Index, and not contingent on the tenant's sales or profits. An NNN DST is that example almost word for word.

The ruling also bars the trustee from entering new leases except on the tenant's bankruptcy or insolvency, renegotiating or refinancing the debt, or making more than minor non-structural changes. An apartment building signs new leases every month, so a multifamily DST cannot run that way directly.

The workaround is a master lease: the trust leases the whole property to a master tenant, usually affiliated with the sponsor, which then subleases units to residents. One filed Form 10-K for a multifamily REIT's DST program describes exactly this arrangement, with the master tenant responsible for subleasing to residents.

Income behavior: a contractual line against a market-linked one

In an NNN DST, your income follows the lease. Rent is set in advance with scheduled or index increases, and because the tenant carries operating costs, the trust's expenses are small and predictable. The trade is that rent cannot rise faster than the lease allows, even if the market does.

In a multifamily DST, the master lease rent to the trust is fixed by contract, but what supports it is resident rent on leases that the same 10-K says are generally one year or less. Those leases reprice often, which can lift income in a rising market and cut it in a falling one, and the property bears its own taxes, insurance, repairs and staff.

The master tenant stands in between. The 10-K states that the master tenant bears the risk that property cash flow is less than the master lease payments. That cushion is only as strong as the master tenant and any guarantor behind it, so read who guarantees the master lease and how well capitalized they are. Our page on master lease risk covers the questions.

Taxes on the two streams look similar on paper. Each investor reports a share of rent, interest and depreciation from the grantor trust, so the character of income does not depend on the sector. What differs is how stable the taxable figure is from year to year, which follows the cash flow.

Concentration: one tenant's credit against one property's local market

A single-tenant NNN DST lives on one tenant. If that tenant leaves at lease end or defaults while solvent, the trustee cannot sign a replacement, and the trust may have to sell or convert, as our page on single-tenant versus portfolio DSTs explains. Credit rating, remaining lease term and the store's importance to the tenant are the main things to read.

A multifamily DST spreads rent across many households, so one move-out barely registers, but it concentrates on one metro area, one building's condition and one operator. New supply nearby, local rent rules or a property tax reassessment hit every unit at once.

Portfolio NNN trusts with several tenants sit in between. Whichever you choose, splitting an exchange across trusts reduces the damage any one can do; see DST diversification levels.

Leverage, reserves and capital needs: the building type decides how much can go wrong

Because a DST trustee cannot raise new money or refinance under Rev. Rul. 2004-86, every future cost has to be covered by reserves set at the offering. An NNN building pushes most of that to the tenant; an apartment property has roofs, units to turn and systems to replace, so its reserve and the master tenant's obligations matter more.

Leverage cuts the same way in both: the trust's fixed loan is set at closing and must be refinanced or repaid at maturity, usually by selling. The higher the loan relative to value, the less room the income has to fall before distributions stop. Our page on DST leverage and interest rate risk covers how to read the loan terms.

Ask for the reserve amount, what it is meant to cover, the loan maturity and whether the loan's terms allow the property to be sold before maturity without heavy cost.

Exits differ: a lease runway against a sponsor buyout option

An NNN DST's natural exit is usually a sale while the lease still has years to run, since buyers pay for remaining term. When the trust sells, you can take cash or start a new 1031 exchange, as our page on DST sale and the next 1031 describes.

Some multifamily programs run by REITs add a fair market value option. The 10-K cited below describes the sponsor's operating partnership holding the right, but not the obligation, to buy investors' DST interests after a two-year period for operating partnership units or cash. Taking units ends your ability to exchange again under section 1031, because Reg. section 1.1031(a)-3(a)(5) excludes partnership interests from real property; see our 721 UPREIT page.

Read the exit section of each memorandum before you compare income, because the exit decides what the income stream is worth to you.