The subject of cost is one that every investor should thoroughly understand. In syndicated real estate, cost is referred to as “load.” Properties are identified and purchased by a Sponsor, packaged as a security, and offered to investors through registered representatives or investment advisors. Built into the investment is a margin for the Sponsor, and the costs of putting together the investment offering, including commissions, legal, financing costs associated with the loan, marketing and other costs. Institutional investing is not philanthropic, everyone in the deal expects to be paid for their investment in time, experience or cash investment, in the case of the individual investor.
Load averages 8 to 12 percent and is calculated based on the cash invested, not the entire purchase price of the DST. Some investors initially view load as a penalty. The thought is that 10 to 12 percent of their investment is going to disappear the moment the deal is done. In fact, load in DSTs is much more analogous to costs born in all real estate transactions when acting as the buyer. Let’s look at an example.
An investor is selling two properties worth $5 million. She has loans of $1.75M. She pays a total of six percent commission to her agent and the buyer’s agent, and one percent in other closing costs calculated on the selling price of the property. She’s spent seven percent of $5 million to sell this property, or $350,000.
Whoever buys her property doesn’t feel that they are at a disadvantage because she paid all that money in sales expenses. In actuality, if they bought the properties for $5 Million, $350,000 of their payment into escrow covers the commissions and closing costs, however buyers don’t think they’re being taken advantage of by spending $5 Million and receiving $4.65M in investments.
When graduating up to institutional investments structured as DSTs, the investor is buying a package of benefits that he or she would never have access to alone, not just a property. Those benefits include participation in institutional grade investments, property selection, hands off management, potentially higher cash flow before and after taxes, potential additional depreciation and appreciation, non-recourse loans and many other benefits provided by investing in DSTs and explained throughout this site.
Just like any other real estate, cash flow is calculated on equity investment. Hypothetically, if an investor puts $100,000 cash into a DST, and the first year cash flow is projected to be a hypothetical 6.25%, the investor is projected to potentially receive 12 monthly payments of $520.80, or potentially $6,250 in the first year. The projected income is based on the full $100,000 invested.
The real key with the costs of any investment is how long it takes to recapture the cost based on the projected rate of return. How fast will the investment get to a breakeven point? Assume a Sponsor has historically returned 13 percent annually, on average, over all the properties they bought, operated and sold for their investors. The historical 13 percent internal rate of return (IRR) represents cash flow, appreciation of property, and pay-down of loan, and is calculated net of all expenses and fees. If a hypothetical DST investment tracks to the Sponsor’s historical 13% rate of return in the first year, when compared to a 10-12% percent load, the investor will burn off the load before the first year is over. Naturally, past performance does not predict future performance and rates of return are not guaranteed.
Load is disclosed in the Private Placement Memorandum (PPM) and should be discussed fully with your advisor and clearly understood. A good offering motivates everyone to pull together towards the same goal to make it as successful as possible and costs and commissions are just part of it. Like when you want to play tennis, you have to buy a racket and sneakers, it costs something. The benefit is you get to play tennis. The benefit of DSTs is you get to graduate to a hands off, institutional grade diversified portfolio of investments.