DST vs. NNN Lease: Two Paths to Passive Income

Sell an investment property at a gain and the tax bill can be steep. A 1031 exchange - named for the section of the tax code that allows it - lets you defer that capital gains tax by rolling the proceeds into another investment property, as long as you identify the replacement within 45 days of the sale. For a landlord who wants the income without the maintenance calls, two replacements do that job in very different ways: a triple-net (NNN) lease, where one tenant covers the property's operating costs, and a Delaware Statutory Trust (DST), a fractional stake in property run by a professional sponsor.

Quick comparison

How NNN works as a 1031 replacement

You buy a property outright and lease it to a single tenant under a triple-net lease. "Triple-net" means the tenant pays the base rent plus the three big carrying costs: property taxes, insurance, and maintenance. You collect the rent and handle almost nothing else.

Typical tenants are national credit retailers like Walgreens, Dollar General, and AutoZone; quick-service restaurants like Chick-fil-A and McDonald's; and essential-service businesses like medical offices and convenience stores.

Because you hold the title, you can mortgage the property and decide when to sell. At exit, you can run another 1031 exchange or sell outright.

How DSTs work as a 1031 replacement

A Delaware Statutory Trust is a legal entity that holds title to real estate and sells beneficial interests - fractional stakes - to investors. Buy in, and you own a slice of the trust's property or properties.

The sponsors are usually large real estate firms. They acquire institutional-grade assets - Class A apartment complexes, medical office portfolios, industrial distribution centers, net-leased retail - and package them as DST offerings for 1031 exchangers.

You contribute your exchange equity (typically a $100K to $200K minimum), collect monthly distributions, and wait for the sponsor to sell, usually in five to ten years. When the trust sells, you can exchange again into another DST or into a property you own directly.

Income and returns

NNN yields typically run 5.0% to 7.5%, expressed as a cap rate - the property's yearly net income as a share of its purchase price. Where a property lands depends on the tenant's credit, the years left on the lease, and location. An investment-grade tenant on a long lease commands a lower cap rate, which means a lower yield for lower risk; a weaker tenant or a shorter lease pays more and carries more risk.

DSTs typically target 4.5% to 6.5% in cash-on-cash distributions - the annual cash paid out relative to the cash invested - depending on the offering. Layers of fees (acquisition, asset management, disposition) trim the net return compared with owning directly. In exchange, a DST can reach larger, higher-quality assets and borrow at the trust level.

Total return is where the two diverge in character. An NNN property's return rides on its own rent growth and appreciation; a DST's rides on the sponsor's management and when it chooses to sell. Over a seven-to-ten-year hold, a carefully chosen NNN property and a well-run DST can land in similar territory, but the outcome for a single NNN property swings wider.

Risk profiles

NNN carries these risks:

• One tenant, one income stream. If that tenant leaves, the rent goes to zero until you re-lease.
• Re-leasing risk: single-purpose buildings can be hard to fill.
• Every property decision is yours - when to sell, how to maintain, whether to re-lease.
• Swings in market value hit your equity directly.
• Everything is concentrated in one property and one market.

DSTs carry these risks:

• Sponsor risk: the management company's competence and integrity matter enormously.
• No control: you can't vote to sell, refinance, or change strategy.
• Illiquidity: most DST interests have no secondary market, so you wait for the sponsor to sell.
• Fee drag: acquisition fees of 1% to 3%, plus annual management and disposition fees, reduce the net return.
• Structural limits: by rule, a DST can't take on new debt, make significant improvements, or accept new capital contributions.

Which fits your situation

Where NNN tends to line up:

• You have $500K or more in exchange equity.
• You want direct ownership and control.
• You want to finance the purchase with a mortgage.
• You're comfortable selecting and evaluating individual properties.
• You may want to run another 1031 exchange in five to ten years, on your own timeline.

Where DSTs tend to line up:

• Your exchange equity is under $500K, or you want to spread it across several offerings.
• You want genuinely zero involvement.
• You need to close fast: DSTs settle in days, while NNN transactions take weeks to months.
• You're up against the 45-day identification deadline and need a reliable closing.
• You want a piece of institutional-grade assets you couldn't afford on your own.

Where either can work:

• You're a retiring landlord who wants passive income and tax deferral.
• You're exchanging out of a property you've been actively managing.
• You care most about steady cash flow rather than aggressive growth.

Some exchangers use both, moving the bulk of their equity into an NNN property and the remainder into a DST to absorb the leftover equity and keep the deferral complete.