BD vs. RIA: Who to Consider for a 1031 Exchange

Investors looking to speak with a qualified professional about their 1031 exchange investment options can opt to work with a broker-dealer (BD) or registered investment advisor (RIA). While both BDs and RIAs can typically offer similar services, the scope of their expertise and fees can vary drastically. In this article, we define the difference between a BD and an RIA in the hopes of helping you determine which professional is a better fit for you.

What’s the difference?

RIAs are individuals or firms that typically focus on offering general financial advice, managing clients’ accounts, and executing stock trades for clients. RIAs generally charge an annual fee equal to a percentage of the assets they manage on behalf of their clients. 

BDs, on the other hand, primarily work to facilitate investment transactions for their clients. Fees are generally commission-based, meaning BDs typically charge a one-time fee for each transaction they facilitate rather than an ongoing fee.

The Relevance of a 1031 Exchange

Investors looking to sell their real estate and trade into a like-kind alternative investment should work with a qualified professional – either a broker-dealer or a registered investment advisor.

Today, one of the most common examples of a 1031 exchange is trading from a real estate property into a Delaware Statutory Trust (“DST”).

A DST “is a legally recognized real estate investment trust in which investors can purchase ownership interest. Investors who own fractional ownership are known as beneficiaries of the trust – they are considered passive investors. … Properties held in DSTs that are considered ‘like-kind’ include retail assets, multifamily properties, self-storage facilities, medical offices, and other types of commercial real estate.”

These one-time transactions enable investors to sell their real estate and buy into a qualified investment while deferring capital gains. Furthermore, by trading into a DST, investors can access institutional quality assets they otherwise may not be able to purchase, leverage excellent financing obtained by a DST sponsor, access passive income potential that is management free, and limit their liability in the investment.

To better understand how trading into a DST works, it’s best to compare a DST to a real estate exchange rather than an equity purchase – there is a significant difference between the two when determining how much an investor should pay in fees.

Avoiding Potentially False Claims

Why is this important when deciding who to work with – an RIA or BD?

Today, many claims are often presented in an effort to win business from investors in a 1031 exchange or from those looking to place cash into a DST. Many RIAs claim it is cheaper to work with them than a BD because their commissions are waived. However, this claim ignores the fact that RIAs typically charge clients an ongoing annual fee. This fee has the potential to cost you more over time. It’s important to do your research to find out what the ongoing fee is, as well as what, if any, additional services you are receiving for that fee. Of note is the fact that the ongoing fee is typically calculated as a percentage of the value of the assets. That means that if the asset appreciates, you will be paying more, and if the asset depreciates, you'll be paying less.  As a result, it isn't possible to determine the exact cost of the advisory fee over time.

Let’s look at an example.

Say that an investor trades out of a retail property into a DST, an investment that will generally last for five to ten years before the investment is sold and the investor can do another exchange. Assume the investor puts $1 million into the DST. Now, let’s look at how much a BD would cost versus an RIA. If the BD charges a 6% commission on the investment, that results in a commission of $60,000 on the transaction. An RIA, on the other hand, charges a percentage of the assets under management (AUM) – in this scenario, the AUM is $1 million. Now, let’s say the RIA fee is 1.5% of the Assets Under Management (“AUM”). An investor would then pay $15,000 per year to the RIA for the investment (assuming the asset value remains stable). Based on the average holding period of a DST (five to ten years), the investor would pay between $75,000 and $150,000 for the exchange! Of course, in the event the DST sponsor exits early, or you are presented with an opportunity to liquidate/exchange early, that could result in a potentially lower fee.

Broker-Dealers May Cost Less than Registered Investment Advisors

The above model simply shows the cost difference between working with a BD and an RIA and outlines how working with a BD may be less expensive than working with an RIA. In the above scenario, the investor pays 50% to 250% more to work with an RIA than a BD. Imagine if an investor had millions to invest.

Don’t Pay Annual Fees on Passive Investments like DSTs and Other 1031 Exchange Investment Options

DSTs and other 1031 exchange investment options are set up as management-free investments, meaning no management responsibility is required of the investor or the one representing the investor in the transaction. Instead, sponsors manage these alternative investments on behalf of their investors completely; therefore, they are entirely passive. Why pay an RIA to “manage” your DST investment when it is already being managed for you?

Understanding the Options in a 1031 Exchange

Before jumping into any investment, an investor should conduct due diligence to fully understand the available options and associated fees. If an investor is choosing between an RIA and a BD, they should ask themselves who has more knowledge about the investment and whose fees align with the type of investment they are considering. These questions may help investors protect themselves and their capital in future investments. 

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only, and should not be relied upon to make an investment decision. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

• There is no guarantee that any strategy will be successful or achieve investment objectives;
• Potential for property value loss – All real estate investments have the potential to lose value during the life of the investments;
• Change of tax status – The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;
• Potential for foreclosure – All financed real estate investments have potential for foreclosure;
• Illiquidity – Because 1031 exchanges are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.
• Reduction or Elimination of Monthly Cash Flow Distributions – Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;
• Impact of fees/expenses – Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits