House hacking is a buzzword that popped into the web-sphere not too long ago. It sounds ominous, but trust me – it has nothing to do with men in masks whacking at your door with a crowbar!
In fact, house hacking simply refers to purchasing a multi-family owner-occupied property. You then rent out the other units while staying in one yourself.
To get enough rental income from the other units that it covers your property’s taxes, insurance, utilities and mortgage payments.
Yes, you read that right. By house hacking, you’re aiming to live in your unit for free. Even get some positive cash flow if your smart.
Real estate continues to be a safe investment. It provides not only rental yield but a whopping 7% annual appreciation as well. House hacking is a great way to get started because of the cash flow it can create. With refinancing, you could unlock All this on top of having a free place to live in!
Man, I wish I had known about this when I was first starting out! I could’ve started investing in real estate almost fresh out of college. But alas, I wasn’t smart enough to figure it out. Credit goes to the guys at biggerpockets.com for popularizing the concept and even giving it the name! I got a lot of ideas from their house hacking articles.
In this article, I’ll explain the following things about house hacking:
- Who it’s for
- What benefits there are over other forms of real estate investing
- Requirements to get started in house hacking
- How to look for and finance your multiplex
- How to manage your tenants and the property
Who is house hacking for?
- First time real estate investors – house hacking can provide positive cash flow. This is ideal when you don’t have income from other investments or your income is just generally very low.
- Investors who don’t mind living in the same vicinity as their tenants – you don’t even have to be a people person. Your tenants will be in other units, so you just have to be open to having them as neighbors.
- Investors who are ready to start building equity in one property – if you’re amenable to investing in just one property (there are location risks), then a multi-family property is an even better bet then getting a single family property.
What are the benefits of house hacking?
- You get to keep your privacy – as we mentioned earlier, you don’t have to be communally minded to enjoy living in a multi-unit property. You still stay in your own unit with your own bathroom and kitchen, so you don’t have to share facilities.
- You’re close enough to keep an eye on things – as a landlord, I know how frustrating it can be to pop by at your investment property to find that your tenants aren’t treating it with due care. This can be maddening especially after you’ve toiled long and hard to fix up the house! Tenants are sometimes slow to update you if something’s been broken or needs fixing – this can lead to even bigger issues later!
- There’s less risk of you losing all your rental – with mutliple units
- You learn to be a landlord just by taking care of your own home – think about it, you’re going to be doing work taking care of your own dwelling anyway. It’s not a big step to throw tenants into the mix. This is a great way to get your feet wet and become a landlord quickly.
- Tons of government benefits and owner-occupied loans – You can make the most of owner-occupied loans when you live in your investment property. These owner-occupied loans will give you better financing terms and require smaller down payments
- Multi-unit properties generally appreciate more quickly than single family homes – because multi unit properties tend to have more land area rented out, their values receive a multiplier effect when they increase.
What are the requirements to get started in house hacking?
- You need good credit – or at least don’t have bad credit. You’ll want to pay as much as you can with a mortgage. You also want less monthly payments. All this will help you with your cash flow. Therefore, you should approach lenders with as clean a credit score as you can.
- You should have at least a year of stable income – if your credit score doesn’t cut it, a year’s worth of paystubs can help convince your lender that you’re not a credit risk. Having stable income can also keep you afloat for the first few months after you purchase your property (assuming it doesn’t come with its own tenants.)
- Some free cash that’s readily available – this means liquid cash that you can throw at a down payment or any repairs/maintenance costs that may be required.
- You must live in the property – to make the most of the owner-occupied loans, you need to stay in the property for a set amount of time. So technically, you don’t have to stay, but you’ll want to so that you can pay less than the 20% down payment.
- You can only buy a duplex, triplex, or 4-plex – properties with 5 units or more are considered commercial real estate. As such, you’ll not qualify for FHA loans etc. that way. It’s okay, a 2 – 4 units are enough work. You won’t miss out on much!
Finding and funding your multi-unit investment
Finding a multi-unit investment is pretty easy – use a website like Zillow and filter your search results by the number of units. You can look for properties that are foreclosed or require more repair work. This will help you get a better discount. However, beware – foreclosures are a tricky minefield to navigate. I’d advise you to stay away from them if it’s your first investment!
What you should be looking for in your investment is cash flow. This means your expected rental should cover the expected expenses. Talk to your real estate broker – they’ll likely have some idea one what your expected rental income will be.
Here’s an example of cash flow from a house hacking project by chad carson:
To fund the purchase you’ll need to get a mortgage. Your aim here is to reduce the downpayment and monthly interest that you’ll have to pay. Your interest rate will largely depend on your credit and length of your mortgage tenure. Therefore, I always recommend stretching out your mortgage tenure for as long as you can.
A low barrier to entry (finance-wise) is one of the main draws of house hacking. Therefore, you should take advantage of FHA loans and conforming loans to reduce your required down payments. Currently, FHA loans require a 3.5% down payment, while conforming loans (within Fannie Mae and Freddie Mac threshold) require 5 – 10% on owner-occupied loans. This is far below the 20% that you would get with a regular loan.
Other financing options are a 203k loan which includes the cost of repairs. This can help your immediate cash flow further.
You can also look into borrowing against your 401k balance, or withdraw from the 401k, IRA, or Roth accounts. Bear in mind that you have to pay income tax if you withdraw from your 401k and IRA accounts. Also, you might have to pay a penalty.
In any case mortgage professionals hired by financial institutions can provide you with free advice. You should definitely try to maximize the free advice you can get. However, know that they get paid on commission, so be wary of what they tell you and try to get more than 1 opinion.
Managing your tenants and the property
You can save yourself a bunch of headaches if you choose the right tenants at the outset. It’s always difficult to get a feel of a potential tenant from just one meeting, but doing some homework can help get rid of bad candidates early. Some screening criteria might be:
- Do they hold a steady job and get regular income?
- Do they pass your credit check requirements?
- How many people will be moving in? You don’t want too big a family.
- Get referrals and referees. These can be previous landlords who can vouch for the tenant.
- Can they commit to a tenancy term of at least a year? You’ll want long term tenants as frequently looking for new tenants can be a pain.
After your tenants move in, make sure that the rules and policies are crystal clear. You can even paste written guidelines around the property – for example, you might want to let people know to clean their recycling before putting it in the bin, or you might want the tenants to double bag their rubbish etc.
If you get positive cash flow from the investment, do not spend it all on a night on the town! Stash the extra income to pay for tradesmen. It’s likely that your property will need a coat of paint every few years. Gardening and other property maintenance costs can also be covered by this fund. You’ll also want to save some of the income to tide you over periods when your units become vacant.
House hacking is an exciting prospect, but there are so many nuances to be aware of. I’m far from able to tell you about everything but the basics. Often you’ll have to learn by doing. There are numerous other hacks you can carry out, for example, you can refinance when the home has appreciated in value. This will allow you to take out a larger amount and hopefully you can withdraw 100% of the money you have invested!
Other cool ideas include adding a trailer or mobile home to available space on your property. You can even convert a garage to a spare unit if it’s big enough! Just be aware of zoning codes and how you’re going to service the extra room if you do go down this path.