Maximizing Cash Flow in a 1031 Exchange

[Max Benas]

Hello, I'm new around here and hoping to benefit from the wisdom in this community.  I would very much appreciate some experience-based feedback on this situation.

I'm preparing to relinquish a commercial rental property in Denver through a 1031 exchange. For the sake of round numbers, let's say it sells for $650k, with $150k in debt. The working plan is to buy a handful of SFR/small MFR properties, probably turnkey, in a solid rental market. Memphis looks like the current front-runner for reasons I'm comfortable defending...feel free to try and talk me out of it if you must.

The goal is simply to maximize cash flow and passivity.  I’d like to net no less than $2,000/mo, obviously the more the better.

So first, is this a decent strategy for these goals?  Are there other options I should be considering?

Assuming we go ahead, how hard should I leverage the $500k in equity?  I would lean towards using it as a down payment on something like $1.5M of inventory, but I really don’t know what kind of numbers are realistic.  I built a little calculator to play around with purchase price, expenses, and rents as % of PP, and it seems like I need to hit gross rents at .8% of PP and expenses at 30% of rents (everything but mortgage) for a high-leverage deal to make sense. If either of those numbers get much worse, my cash flow starts to look MUCH better with less debt.  I am assuming 5.5% interest on the loan.  Let’s also assume I go with a VERY good turnkey company, meaning gross rents as a % of PP may be lower, but maintenance/vacancy shouldn’t be much over 10%.

Can anyone tell me if these numbers are realistic?  I would love to hear what your actuals for turnkeys look like on the ground in Memphis or similar markets.

Sorry for the long post, and thanks in advance for your insight!

[Dave Foster]

@Max Benas, The three biggest things that will destroy your cash flow are vacancy, Cap ex, and vacancy repairs. Debt can certainly boost the ROI but leaves you very vulnerable on more levels to nasty surprises. Just another thing to factor in and be prepared for.

In a 1031 exchange you must purchase at least as much as you sell and use all of the proceeds from the sale in the next purchase or purchases.  But you can allocate the cash in any way you want.  So you may be able to use this to your advantage.  Instead of looking at equal down payments to maximize your leverage and risk at the same time.  Use enough cash to eat up the leverage you need ($150K) and use the rest of the cash to buy assets with no debt.  It's all in what your proformas show you but this might give you the best of all scenarios.

Honestly, there a bunch of very low risk ways to get to your desired number - with or without debt.  You're not being unreasonable in your expectations.  My encouragement is to make sure that the allure of much higher numbers don't tempt you into a situation fraught with more risk than you realistically want.