DST & NNN: Passive 1031 Exchange Alternatives for LA Apartment Owners

A Delaware Statutory Trust is a legal entity formed under Delaware law that holds title to real estate. Multiple investors can own fractional interests in the trust, which is managed by a professional sponsor. The IRS confirmed in Revenue Ruling 2004-86 that DST interests qualify as like-kind property for 1031 exchanges.

How DSTs Work

• Structure: A DST sponsor acquires a property (or portfolio), creates the trust, and sells fractional interests to investors. Minimum investments typically start at $100,000.
• Income: Investors receive monthly or quarterly distributions from rental income, typically 4%–6% annually.
• Management: The sponsor handles all property management, leasing, and operations. Investors have no management responsibilities or decision-making authority.
• Hold period: DSTs are illiquid investments with typical hold periods of 5–10 years. At the end of the hold period, the property is sold and investors can do another 1031 exchange or take the proceeds (triggering deferred taxes).
• Property types: DSTs are available across property types including multifamily, industrial, medical office, retail, and self-storage.

DST Advantages

• 100% passive — no management, no tenant calls, no maintenance decisions
• Low minimums ($100K–$200K) allow diversification across multiple properties and markets
• Professional institutional-grade management
• Access to property types and markets outside LA
• Ideal "boot catcher" for absorbing leftover exchange proceeds

DST Risks

• Illiquidity — no secondary market, cannot sell your interest easily
• No control — the sponsor makes all decisions
• Sponsor risk — quality and track record vary significantly
• Fee structure — upfront fees of 10%–15% reduce effective yield
• Potential for reduced or suspended distributions

A NNN lease property is a commercial real estate asset where the tenant is contractually obligated to pay all operating expenses — property taxes, insurance, and maintenance — in addition to base rent. This structure makes NNN properties effectively passive investments.

Common NNN Tenants

NNN lease properties are typically occupied by national credit tenants with long-term leases:

• Pharmacy/Drug: Walgreens, CVS (10–25 year leases)
• Dollar stores: Dollar General, Dollar Tree (10–15 year leases)
• Fast food/QSR: McDonald's, Starbucks, Chick-fil-A (15–20 year leases)
• Auto parts: O'Reilly, AutoZone (15–20 year leases)
• Medical/Dental: DaVita, Fresenius, dental groups (10–15 year leases)

NNN Cap Rates & Returns

NNN cap rates vary by tenant credit quality, lease term, and location:

• Investment-grade tenants (Walgreens, McDonald's, Starbucks): 4.5%–5.5% cap rates
• Mid-tier tenants (Dollar General, auto parts): 5.5%–6.5% cap rates
• Shorter lease terms (under 10 years): 6%–7%+ cap rates (higher risk)

NNN Advantages Over DSTs

• Direct ownership — you control the asset
• Full depreciation and mortgage interest deductions
• Ability to refinance, sell, or exchange independently
• Greater liquidity — NNN properties sell quickly on the open market
• No sponsor fees or management fees

One of the most effective 1031 exchange strategies combines NNN and DST investments. Here's how it works:

1. Sell your LA apartment building (e.g., $3M sale price)
2. Use the majority of proceeds ($2.5M) to acquire a NNN property as your primary replacement
3. Invest the remaining proceeds ($500K) into one or more DSTs as a "boot catcher" to absorb the balance

This strategy gives you direct ownership and control over the NNN property while using DSTs to ensure you exchange 100% of your proceeds — avoiding any taxable "boot." It's the approach I recommend most frequently to LA apartment building owners who want to transition to passive income.