House hacking is the real estate investing strategy whereby you purchase a property for a low percentage down, live in one part of the property, and rent out the other parts, such that the rent from your tenants (or roommates) exceeds your expenses. By doing this, you have likely significantly reduced or completely eliminated your living expense.
We frequently talk about the advantages of house hacking, such as living for free, building equity in a property, tax advantages. What we rarely talk about are some of the drawbacks. Here’s a list of reasons why you shouldn’t house hack, along with ways to overcome them.
There’s more work involved
House hacking is essentially a small business. While it is mostly passive, there are times where you need to do work. For example, you may need to fill a vacancy, accommodate a maintenance request or keep track of rent and security deposits.
Not only is it more work day to day, but also your taxes become that much more complicated to complete. In addition to the W-2 you get in January, you also have to fill out a Schedule E form and need to remember to account for all expenses for maximum tax savings.
House hacking is more work than renting, but most of this work is upfront or in the first couple of months of buying the property. Once your tenants are settled, you might work an additional three to five hours a month. Would you spend three to five hours a month to save hundreds or thousands of dollars? The work you do for the house hack is hundreds of dollars per hour tasks.
It doesn’t scale
As a way to get started in real estate or acquire your first starter home, house hacking is fine. It’s just not going to scale from an investment perspective. Some lenders also prefer loaning on non-owner-occupied properties. Keep that in mind.
If you do house hack, then move on quickly and make some true investments. Even if you invest in a run-down property, you can fix it up to flip it and make a profit, but you’ll have to deal with capital gains tax.
You have to live with others
One big reason why you shouldn’t house hack depends on how you feel about other people being around. Naturally, you will lose some privacy. Even if you’re not living in the same unit as your tenants, it is likely that you can no longer throw any large parties without first inviting (or asking) your neighbors.
Living with others can especially be a problem if you have a family. Do you want a stranger living in your house with your kids? Unfortunately, it takes only one person to turn a situation into a huge problem. That might not be a risk you are willing to take.
If you are accustomed to living by yourself, living with others can be difficult. But living by yourself can be lonely. If you are house hacking as a long-term rental strategy, make sure to screen your tenants carefully so that you know they will pay their rent on time and they will be good roommates.
For a short-term rental strategy, such as renting out your basement or bedroom through a service like Airbnb, you will have a revolving door of strangers coming in and out of your house every few days. While this may not sound appealing, you get to meet interesting people from all over the world. Most people are really nice, especially travelers.
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You need to keep relationships professional
Another reason why you shouldn’t house hack is if you think you’ll get too close to your tenants. This is more of a problem with house hacking a single-family home and renting by the room. When you do this, there is a lot of ambiguity surrounding whether the people you live with are “tenants” or “roommates.” In many cases, they start to feel like “roommates,” but be careful of this.
You don’t want to get too close to your tenants because they may start to take advantage of you. It can be a real emotional burden on you if you can’t detach.
Keep in mind that when you house hack, your tenants are tenants, not roommates. You can make them feel like roommates by getting along and being cordial, but avoid getting too close. To combat this, be polite to your tenants in passing, but don’t hang out with them too frequently—unless, of course, they were your friends before you started house hacking.
Owning your own home isn’t always all it is made out to be
This is especially true if you are a bit of a minimalist, are just starting out, want to avoid bills, are working toward financial freedom, or love being mobile and traveling.
If this sounds like you, then owning your own unit can become a dead weight. You are responsible for it, and it can hold you back from everything else you want to do. You may be better served by investing in a small multifamily property for the income and renting somewhere else. If you do have the right mindset, house hacking isn’t an issue.
It may involve living in a not-so-great investment property
When you house hack, you’re doing it primarily for the overall financial impact. For that reason, you may consider buying a relatively inexpensive space that you can then charge the highest rents possible. It is likely an inexpensive property because it is either a bit run down or in a less desirable area. Either way, you will be scaling back your lifestyle, such as moving out of the high-rise downtown area.
To maximize your house hacking cash flow, it is best to purchase a place that needs some work. It will likely be in that less desirable location or need a significant amount of work. Purchasing a property that needs work but it is in a decent location is a great value-add opportunity. We call that “forced appreciation.” It’s forced because you enhance the value of the property yourself rather than just relying on market appreciation.
Besides, no rule says you have to buy a dingy property. Your cash flow will probably be lower if you purchase that kind of investment without fixing it up first, but it will be significantly less than if you rented. It’s up to you to decide how aggressive you want to be when purchasing the house to hack.
You could be affected if the market tanks
Typically, a house hack will be your first real estate investment. It’s not easy parting with almost all of your savings and putting it into a property. What if we see another Great Recession and the market tanks?
It’s important to remember that the market does what it wants. You can’t control it, and it is absolutely a risk. If the market plummets the day after you close on your property, that is unfortunate for you.
The market can tank at any time. You need to make sure you will be OK when the market goes up, when it goes down, and when it stays the same. How do you do this? Well, you run the numbers.
You need to make sure that you can afford your place regardless of whether you are at 0% or 100% vacancy. If not, you need to make sure that your rent (including a vacancy factor) covers well in excess of your mortgage, such that if rents were to decline by 10% or 20%, you would be able to stay afloat.
You need to save some money first
When you compare purchasing a house hack to renting, you’ll notice you’re spending a lot more money upfront for the house hack. When you’re renting a place, you are typically responsible for the first month’s rent, last month’s rent, and a security deposit. If you live in an area where rent is $1,000, you should spend $3,000 in upfront costs.
When you house hack, you’ll need to put 3% to 5% down, pay a couple of thousand dollars in closing costs, and then spend even more money to fix it up. You do want that “forced appreciation,” right?
On a $300,000 house, you could be paying $15,000 to $20,000 upfront. Then, depending on how big of a rehab you need, that can climb closer to $30,000. Again, while it’s much cheaper than putting 25% down on a conventional investment property, it involves more upfront costs than renting.
Compared to renting, you need a fairly large chunk of money—$20,000 is not pocket change. This is when you pinch your pennies to get this amount. But there really is no better return on your investment—without creating a full-time job for yourself—than house hacking.
When you purchase a property with $20,000, there is a high probability that you will make that entire sum back in the first year just through cash flow, loan paydown, and rent savings. That’s a 100% return, and we are not even including appreciation or the tax benefits that come with owning real estate.
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You have the worry—what if the tenants don’t pay?
This is absolutely a risk. You are relying on someone else to continuously give you money to make your investment work.
Unfortunately, there will certainly be times where tenants fail to pay. Screening your tenants correctly means you can drastically reduce these missed payments. It is a small price to pay, given the overall return of house hacking.
To avoid having to track down late or missed payments once a month, set up a service where rent can be deducted automatically into your account. There are free services that allow you to enter your lease terms on a website, the tenants connect their bank accounts, and the rent is automatically paid each month.
You have to learn how to run the numbers
Some people think that simply house hacking a property is a good way to go without looking at the specific numbers. You should run the numbers on a house hack exactly as you run them for a normal rental property. This would give you perspective in terms of cash flow and potential profit.
With those equations in hand, run them twice for a house hack. Do it once as if you were renting out the entire property and once with just the income from the units other than the one you will live in. This will give you an idea about your cash flow returns.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.