Photo by Tierra Mallorca
Originally Posted On: https://medium.com/@benmizes/house-hacking-the-best-investment-you-can-make-21f6b889f1b2
For the average American, one of their biggest expenses is their mortgage payment, or their rent. This payment is holding them back from accumulating significant savings, and the financial freedom that more capital to invest could provide them. What most people don’t know, is that this payment is optional. It’s possible to own your own building for less than $10,000 down, and never have to make another payment again. It’s not easy, and you’re going to have to put in a lot of sweat equity, but it will save you hundreds of thousands of dollars over 30 years. This investment is called a house hack. If you’ve never heard of house hacking, pay attention.
The concept of house hacking is simple. You buy a duplex, triplex, or quadplex with an FHA loan (3.5% down), and your tenant’s rent covers all or most of your mortgage and other expenses. If it’s done right, you can drastically increase your available capital for investing every month. If it’s done wrong, you can purchase a money pit of a property that’s hard to manage and will cost you more than renting. If you’re not willing to take a bit of a risk, this investment probably isn’t for you.
Before I go into the details, I’ll provide an example of a 4plex house hack based on my own purchase a couple months ago.
Purchase Price — $220,000 — includes closing costs, and a credit for a new roof, sewer, and tuckpointing
Cash To Close — $10,000 — includes down payment, inspections, and $3,000 that the seller didn’t cover in repairs.
Monthly Rent — $2,000 for 3 units, one unit occupied by the owner (me)
Monthly Payment — $1,400 — includes principal, interest, taxes, and insurance
Cashflow — $600
Budgeted Expenses — $600
Net Cash flow — $0
Cash saved from not renting — $8,400 a year
You can get the model I use to forecast cash flow here.
In this situation, the owner now has a stabilized property that allows him/her to live for free, and still have capital to repair their building as needed. The owner is now free to invest the $700 a month they would have been spending on rent, and create over $8,000 in wealth in one year. That’s around an 80% ROI, not including the principal that’s been paid down on the mortgage of the 4plex. In a year or two, the owner can refinance into a traditional mortgage, and house hack a new property. This property would generate around $700 of free cash flow a month once it’s fully rented, or $8,400 a year.
It’s important to note that in this example, my building has newer plumbing, electrical, sewer, HVAC, and a new roof. $600 a month might not be enough of a repair budget for an older building with major capital expenditures coming soon.
Finding Your House Hack.
Finding a good property to house hack isn’t easy, but it can be done if you’re persistent. When i’m looking for deals in my market (St. Louis), I won’t look at a property unless the total rent is at least 1% of the purchase price of the building. I would love to be closer to two percent, but a 1% deal can still cash flow. In St. Louis it’s possible to find deals closer to 2 or 3% price to rent, but they won’t necessarily be in an area I want to live in or manage. If you’re starting out, interview several realtors, and find one that has experience working with investors, and ask them to help you find your first property.
Your realtor should set you up with MLS alerts, so every deal that meets your criteria will be sent to your email. If you like a property, it’s time to schedule a showing. When you view a new property, be sure to inspect the following:
- Age of the roof
- Major cracks
- Water in the basement
- Do doors and windows open easily?
- Condition of the windows
- Is any paint peeling
- How nice are the kitchen and bathrooms (these rent houses)
It’s unlikely that you’ll find a property at a good price where all of these are in good condition, so you need to budget the cost of repairs into your projections. After you view a building you can make an estimate of the major repairs that will be needed, and make a more accurate model of how much to save for repairs and maintenance every month.
While it’s very tempting to offer on a nice property, you can’t get emotionally invested. This is a business, and needs to be treated as such. Only buy something that makes a lot of sense on paper, because it’s probably going to do a lot worse in reality. You want an investment with enough margin for things to go wrong and you still end up OK. Buying a property that barely cash flows on paper is a recipe for disaster.
Once you’ve found your property, a good agent will help you make the right offer. Be sure to include a personal letter to the owner for every offer that you make. If two offers are equal, the offer with a convincing letter is probably going to win the house. You can reuse the same letter on every house you offer on, and just make minor tweaks based on the situation. Assuming the offer is accepted, you’re officially under contract!
Financing for a house hack is a bit more difficult than a conventional loan. FHA properties have to pass a more rigorous inspection, and peeling paint isn’t allowed. While this can limit some potential deals, it’s possible to do the work before you close, or use an FHA 203k renovation loan. A good agent and lender will be able to help you navigate through the FHA financing process. Before you schedule any showings, it’s important to get pre-approved, or your offers won’t be taken seriously.
After you close on your home, you’ve officially entered the world of becoming a landlord. It’s important that you prepare for this before you become a landlord, or you could have some costly problems. Managing tenants and keeping your property maintained is the backbone of a successful house hack, and rental property business.
If you’re thinking about getting started with your own house hack, the following resources were a huge help to me:
- Rich Dad Poor Day By Robert Kiyosaki
- The Book On Rental Property Investing By Brandon Turner
- Biggerpockets.com and the Bigger Pockets Podcast
- Real Estate Rehab Investing Bible by Paul Esajian
- Walking up to every house with a dumpster and asking the rehabber if you can buy him dinner
When you’re ready to buy your first property, my startup, Clever Real Estate can connect you with a local, investor friendly agent to help you find your house hack.