Cash Flow Sweeps - Managing Debt in a DST Portfolio: Ep. 1

Hello and welcome to Exchange Insights, your resource for 1031 market intelligence and education. My name is Tom Wall, partner here at Anchor1031. Today, we're kicking off a new series called Managing Debt in a DST Portfolio. This is a really important topic that doesn't get enough attention. In this first episode, we're covering cash flow sweeps.

Now, what is a cash flow sweep? A cash flow sweep, sometimes called a cash trap, is a provision in a lender agreement that allows the lender to capture the property's cash flow under certain conditions. Instead of that cash flow being distributed to investors, it goes to the lender to pay down the loan or be held in reserve. This can significantly impact investor returns, and it's one of the key risk factors that investors should understand before investing in a DST.

So, what triggers a cash flow sweep? The most common trigger is a decline in the debt service coverage ratio, or DSCR. DSCR measures the property's ability to cover its debt payments. If the property's DSCR falls below a certain threshold, say 1.25, the lender may trigger a sweep. This could happen even if the property is still technically performing and making all its payments.

Other triggers can include tenant changes like move-outs, non-renewals, or credit downgrades. If a major tenant leaves or their credit rating drops, the lender may view that as increased risk and trigger a sweep as a protective measure.

Cross-collateralized portfolios add another layer of complexity. If you have a portfolio of properties that share the same loan, and one property underperforms, the lender can sweep cash flow from the entire portfolio, not just the underperforming property.

So, let's talk about what this means for DST investors.

First, a cash flow sweep can dramatically reduce your distributions. If you're expecting monthly or quarterly cash flow from your DST investment, a sweep can eliminate that income entirely until the sweep is lifted.

Second, the conditions for lifting a sweep can be challenging. The property may need to achieve a certain DSCR for multiple consecutive quarters before the sweep is removed. This could take a year or more.

Third, investors should understand that DSTs cannot refinance. Remember the seven deadly sins: no new loans, no renegotiating existing loans. This means if a DST gets into a cash flow sweep situation, there's limited ability to restructure the debt to get out of it.

So, what should investors do? Due diligence is key. When evaluating a DST, ask about the loan terms. What is the DSCR threshold that triggers a sweep? What are the other sweep triggers? Is the loan cross-collateralized?

Also, look at the property fundamentals. How strong is the tenant? What is the remaining lease term? What happens if the tenant doesn't renew? Properties with strong tenants and long lease terms generally have less risk of triggering a cash flow sweep.

Finally, consider diversification. If you spread your investment across multiple DSTs with different sponsors, property types, and loan structures, you reduce your exposure to any single cash flow sweep event.

In summary, cash flow sweeps are an important risk factor that DST investors should understand. They can significantly impact your income, and DSTs have limited ability to resolve them once they occur. Make sure to ask the right questions during due diligence.

Thanks for watching. In the next episode, we'll cover bridge loans and why they represent another key risk factor for DST investors. If you'd like to learn more about DSTs, please visit anchor1031.com.