What is House Hacking?
House hacking is the idea of combining your investment property with your personal residence. Although it is possible to do with just a single family house (by doing a “live-in flip”), the phrase is more often used to describe the practice of buying a small multifamily property (a duplex, triplex, or fourplex), living in one unit, and renting the other units out.
My first rental property was a small duplex that I bought for $89,000. The property needed some “sweat equity,” which my wife and I spent a few weeks doing. Then we rented the property out. Although we had stumbled across this “house hacking” strategy accidentally, we quickly realized the power of this method when the mortgage payment of approximately $630 per month was fully paid by the tenants in the other unit who were paying $650 for rent. In other words, the tenants were allowing my wife and I to live for free, before operating expenses.
House hacking has several distinct benefits that make it an especially terrific investment for first-time investors
• Low (or No) Down Payment Financing: When you plan to live in a property for at least one year, financing becomes much more friendly for the borrower. For example, an FHA loan allows for just a 3.5% down payment and the USDA (United States Department of Agriculture) loan allows for $0 down if you are buying in a rural area. Traditional 20% down loans also work in this pricing structure and can do even more for your wealth building plans.
• On-the-Job Training: House hacking is a great introduction to the world of landlording. You buy the property, and suddenly you are a landlord—so you’ll learn very quickly what to do and what not to do!
• Close Monitoring of Your Investment: When you live in your investment property, keeping an eye on the property and making
sure it’s running at peak performance is easy. It’s unlikely that the lawn will get overgrown, the tenants will move in a pit bull, or maintenance will go unreported for months.
• Saved Expenses: Because you live at the property, you can manage the other tenants yourself very easily and don’t have to worry about paying a property manager who will do substandard work!
The following plan that you and I are about to walk through follows a serial house hacker. We’ll pursue the house-hacking strategy for numerous properties to reach our goal. In this case, let’s set a goal of simply “living for free,” so we can save money and pursue other investments in the future.
To start the first year, we will buy a triplex. We’ll start small, because it’s our first property, though we could start with a two or a four-unit property. Triplexes in this area run between $210,000 and $230,000, depending on the condition. However, we are smart shoppers and can get a great deal on a foreclosed triplex for $180,000, and each side will rent for $950 per month. (As before, pay more attention to the concept here than the actual numbers; every area is different.) To get this $180,000 mortgage, we’ll put just 3.5 percent down through an FHA loan.
After the purchase, we’ll invest a few thousand dollars and a few hundred hours making it look fantastic. Think new paint, cleaning, etc.
At this point, if the property were 100 percent rented out to tenants, it would bring in a total of $2,850 per month. But because we’ll be living in one of the three units, we can only expect approximately $1,900 per month in income.
For expenses, we can expect a mortgage—including taxes, insurance, and mortgage insurance—of $1,200 per month. We also know the water bill, which the landlord is responsible for paying, runs roughly $130 per month. We’ll set aside 5 percent of the total gross rent ($2,850) for the vacancy, 5 percent for repairs, and 5 percent for future capital expenditures (CapEx, the big- ticket items that need to be replaced every so often) of about $142.50 each (because $2,850.00 x .05 = $142.50).
At this point, our expenses look like this:
Total Expenses: $1,857.50
If you’ll recall, our total monthly income on this property with the other two units rented out was $1,900.
So our cash flow is as follows:
$1,900.00 – $1,857.50 = $42.50
Now, we are not only living for free, but we are also making a small sum of money each month for doing so! Notice that in the expenses we just listed, we did not include property management. I generally advise that people include property management in their analysis, because they won’t always be able to manage their property themselves. But in the case of house hacking, including this figure is OK, because you will not be living in one of the units forever, either.
Eye on the End Game
Whenever you analyze a potential “house hacking” deal, you should analyze what will happen in two different situations: while in the process of house hacking and after you move out. After all, if the deal only makes sense because you’d be living there, then it really closes off your options for moving someday.
You must buy with the end in mind. So let’s run the numbers on this property as if you are no longer living there. To do this, I’ll double the cost of the vacancy and repairs (up to 10% each) and add in an 11% expense for property management.
Here’s what that looks like:
Total income: $2,850
Total expenses are as follows:
Vacancy (10%): $285
Repairs (10%): $285
CapEx (5%): $142
Management (11%): $285
Total Expenses: $2,427.50
Total Income – Total Expenses = Total Cash Flow
$2,850 – $2,427.50 = $422.50
As we’ve discovered, even after moving out of this property, we could reasonably expect to get around $422.50 per month in cash flow. For putting just 3.5 percent down, that sounds like a pretty great deal to me.
Have you tried house hacking?
Share your experiences below!