What is House Hacking and how to do it well?
What is house hacking?
House hacking is the act of buying a house to live in and rent out the additional rooms or units in order to cover some or all of your monthly PITI living expenses. So your tenant lives in the property along with you.
For example, let's say you buy a single family house with 4 bedrooms for $250,000. Before you buy, you use a mortgage calculator to understand your monthly principal, interest, taxes and insurance ("PITI") expense. With a 5% down payment of $12,500 (not including closing costs), your monthly mortgage payment is $1,500 and you budget another $250 per month for maintenance. So your cost of ownership is $1,750.
Prior to buying, you were renting a bedroom in a similar house in the neighborhood for $700 per month. You figure you can rent out 3 of the 4 bedrooms in your new house for $2,100. Every month, your 3 tenants pay you monthly rental income of $2,100. You use that money to pay your monthly PITI expense and you have $350 in free cash flow after setting aside $250 for maintenance. Your tenants are essentially buying your house for you and paying you to live there. This is house hacking.
To execute on this strategy it is ideal to find multi unit properties that will enable you to comfortable live along with your tenants. There are many varieties of house hacking strategies, but the core idea is always the same, you live under one roof with your tenants in order to share expenses. This way, a successful house hacker have lived in one unit and rented the rest of them out to other tenants. Many house hackers also become real estate agent so they can have an informational edge when they decide to start growing their rental portfolio.
After a year, you realize market rent has risen to $750 per bedroom, so you raise rent and your free cash flow increases to $500 per month. Ultimately, the goal, is to live for free in the property after a few years have passed.
When does it make sense to house hack?
House hacking can always be feasible. Even if you have a family and you want privacy, you can buy a duplex, triplex or quadplex and rent out separate units instead of living with strangers in a single family house.
Who can become a house hacker?
Anyone who has enough start up capital to purchase or get a downpayment for a property with multiple rooms, so they can live in one unit or room and rent the remaining rooms out to their tenants.
Is house hacking worth it?
Cash on cash return is arguably the most important rental property investing metric. It is the truest sense of capital efficiency. House hacking produces some of the highest achievable cash on cash returns. Another benefit of house hacking is that you qualify for primary residence interest rates and down payment requirements as well as FHA 203k rehabilitation loans. In total yes, it makes financial sense to house hack, there are many many financial benefits to do it and can put you on a path for financial independence and grow your real estate portfolio.
What are the risks of house hacking?
There are a few risks associated with house hacking. Let's say you buy your property, but you decided to get a fixer upper that needed a lot of work and doesn't have a curb appeal. You might have trouble finding renters to fill your vacancies and you will be left with a large mortgage for all the empty space that you were not able to rent out. Then on top of that, to increate the curb appeal you will have to have cash outlay to supplies and potentially labor (if you are not a professional handyman) to repair the dwelling and bring its curb appeal to the point where its easy to find additional tenant to fill in the vacant space. Let's say you finally fill all the vacancies and after sometime your tenants become a bit too comfortable living along with you and their real habits become an impediment to you or your other tenant. This can scare off your tenants or even worse make your life style a nightmare. While you do have some control over renewals of their leases, that might mean that you will have to put up with their antics until the end of the lease term if their behavior is just "walking the line" and not actually breaking any lease terms.
Additionally, there might be some social risks carries with house hacking, depending on how old you are, your parents, family and friends might have expectations about your social status. It's difficult to be a thirty something and still be living with roommates. Also, dating might be more difficult due to present of tenants. Imagine if you have kids, how would that work if you had several tenants living under one roof along with your wife. These are all important considerations to take into the account as you embark on your house hacking journey. Sometimes it's might be well worth it to endure such situation for several years to gain a solid financial footing that will pave the way for your real estate rental portfolio.
Build your investment property portfolio via house hacking
Many real estate investors start their real estate investing journey with a house hack. Then, when they have saved up enough money to buy a second property, they fill their room or apartment unit and move into the new house and do the same thing over again. If you have a stable source of income and you want to build generational wealth through real estate, house hacking is one of the most powerful tools that you should be aware of. By doing this over and over again, many of them were able to achieve financial independence. House hacking is a great way to kick start a rental portfolio that can earn passive income and lead to financial freedom.
Our thoughts on house hacking are featured in FortuneBuilders.