Ep 3. Cross-Collateralized Loans - Managing Debt in a DST Portfolio

Hello and welcome to Exchange Insights, your resource for 1031 market intelligence and education. My name is Tom Wall, partner here at Anchor1031. This is episode three of our Managing Debt in a DST Portfolio series. Today, we're discussing cross-collateralized loans and why they matter for DST investors.

So, what is a cross-collateralized loan? A cross-collateralized loan is a single loan secured by multiple properties. Instead of each property having its own separate loan, the lender groups them together under one loan, and all the properties serve as collateral. This structure is commonly used for portfolio DSTs, where a sponsor acquires multiple properties and bundles them into a single investment offering.

So, why do sponsors use cross-collateralized loans? There are some real benefits.

First, sponsors can often get better loan terms. Lenders may offer lower interest rates or more favorable conditions when they have multiple properties as collateral.

Second, it simplifies the financing. One loan means one set of documents, one closing, one payment. This can be more efficient for both the sponsor and the lender.

Third, it allows for economies of scale. The sponsor can acquire a portfolio of properties and manage them more efficiently together.

But here's the risk: cross-collateralization can make your portfolio less diverse than it appears.

Let's say you invest in a portfolio DST with 10 properties. You might think you're diversified across 10 different assets. But if those 10 properties share a single cross-collateralized loan, the financial health of each property is linked to all the others.

If one property underperforms, it can trigger consequences for the entire portfolio. For example, remember our discussion of cash flow sweeps? If one property in a cross-collateralized portfolio has issues that trigger a sweep, the lender can sweep cash flow from all the properties in that portfolio. Your well-performing properties may have their cash flow redirected because of one problem asset.

Similarly, if the portfolio as a whole violates a loan covenant, the lender has remedies against all the properties, not just the one causing the problem.

So, how should investors think about this?

First, understand the loan structure before you invest. Ask if the DST uses cross-collateralized debt. If so, understand how the properties are linked.

Second, evaluate the portfolio quality. If you're investing in a cross-collateralized portfolio, the quality of every property matters, not just the best ones. One weak property can drag down the whole portfolio.

Third, consider true diversification. If you're sensitive to this risk, you might prefer to invest in multiple single-property DSTs from different sponsors rather than one portfolio DST. This gives you true diversification where the performance of one property doesn't affect the others.

Cross-collateralized loans are not inherently bad. They can provide benefits like better loan terms and economies of scale. But investors should understand how they work and how they can link the financial health of properties in a portfolio.

In summary, cross-collateralization is an important consideration when evaluating portfolio DSTs. Make sure you understand the structure and factor it into your due diligence.

Thanks for watching. If you'd like to learn more about DSTs or schedule a consultation, please visit anchor1031.com.