House Hacking: Beginner’s Guide to Making Money in Real Estate
House Hacking is a way of living in which you rent out a multi-unit rental property while living in one of the units. By renting out the remaining units, you essentially cover all your housing expenses from the rent that the tenants pay you. So, you effectively live for free!
The whole idea of house hacking is quite simple and logical. However, actually putting the idea into action can take a lot of effort. House hacking involves multiple steps, from finding the right property to achieving financial closure, from finding and managing tenants to taking care of maintenance and taxes. There are multiple things that you, as the owner of the property, need to do to enjoy free housing.
You may feel overwhelmed initially. However, with the right guidance, house hacking is a lot closer to reality than you might imagine. This ultimate guide on house hacking has been written to guide you through each activity that you need to do in order to take full advantage of house hacking.
What exactly is house hacking?
Housing is one of the biggest expenses in any person’s life. Whether you rent a house or purchase one, a significant amount of your earnings go into housing expenses. What if there was a way to save those expenses and invest them instead. That kind of decision can grow tremendous wealth for you over a decade or two.
House hacking allows you to live for free and save big on housing expenses. House hacking involves purchasing a multi-unit property and renting out units in them to rent-paying tenants. You can keep one unit for yourself and live on-site. A house hack property can be a duplex, triplex, even a fourplex, or a multi-unit row house. Mobile homes and garage units can also be multi-unit.
You can either live at a rented multi-unit property or you can rent out all the units and collect the rental income. The surplus income can then pay for your living expenses or go towards long-term investments. Either way, you get to create wealth.
Young homeowners and young adults are ideal candidates for house hacking. The reason is that younger people have more time to let their investments grow. They can build much more wealth by starting early and can even retire early if they are successful.
Benefits of house hacking
Lowering housing expenses:
The biggest benefit of house hacking is saving a large chunk of your monthly expenses. The US Department of Labor found that about 19% of household expenses were rent/mortgage payments. Almost $11,000 per year is spent on housing expenses. In Canada, these numbers are even higher, with close to 29% of household expense going towards housing. Canadian spent more than $17,500 towards housing every year.
Occupant financing has better terms:
The financing to purchase a property where the owner intends to stay is a lot more attractive than a purely investment-type of financing. In house hacking, since the property owner would also live on-site, interest rates on house loans would be a lot lower. And the provisions of the mortgage are such that even if the owner moves out at a later date, the low interest rates would still continue. House hacking not only saves you housing expenses, but also interest expenses.
Lower down payments:
By living on the property that you are planning to purchase, you might be able to qualify for certain types of loans which have a substantially lower down payment than a regular investment loan. Regular loans can require 20-25% downpayment. But with some other loans that can be available for house hackers, the downpayment can be as little as 5%. The lesser the payment that you need to make up-front, the easier it becomes to purchase the property.
A great learning curve:
House hacking is sort of in-between buying a home for yourself and becoming a landlord. Hence, you not only get a place to live, but you also learn the ropes of being a landlord. You learn how to deal with tenants and how to resolve their issues. It gives you knowledge and confidence in becoming a full-time real estate investor. It is a relatively lower-risk way to learn.
By living in the rental property yourself, you also gain the perspective of a tenant. You understand what makes a property attractive for a tenant and what are some things which put-off tenants. Once you have this knowledge, you can use it to acquire other properties in the future. You will know which properties are a no-go and which ones are worth paying a premium.
Steps to buying your first house hacking property
If you are convinced about the benefits of house hacking and how it can work for you, then the next line of action is to act on that desire of yours. Below are the steps which you can take immediately to move towards acquiring your first house hacking property:
1 – Prepare yourself mentally
You need to be mentally and financially committed to the idea of house hacking. If you have a partner or a spouse, then this is the time to speak with them about your desire to purchase a property for house hacking. Discussing this with your near ones is important because you all will be living in that property. Everyone’s life will change. If there are any objections from your partner or your family, then hear them out. Try to address them. You do not want to be house hacking while having a family dispute over it. Getting the relevant people on board is key.
Commitment towards the concept of house hacking will give you the energy to push through all the challenges that may arise when you buy, fix, and rent out the property. If you find out that house hacking isn’t right for you, then there is no reason to feel disheartened. There are plenty of other ways in which you can invest in real estate. You simply have to explore other options.
2- Research and study your market
Research your interest areas and geographies. It is important to study the market before making any investments. While you can begin doing preliminary research yourself, it is important to work with an expert. Real estate agents or professionals who do real estate deals for a living will know the nuances and the ins and outs of specific geographies. Work with a person who understands property as an investment.
When you look at different locations within a city or town, you want to focus on fundamental metrics like job growth, population growth, quality of the neighborhood, connectivity, and proximity to amenities and areas of interest. Communicate your expectations on these metrics to your agent.
Then, start visiting properties which fit your expectations. Ask your agent to show you the type of properties and with the ticket size that you are comfortable with. Work out how much rent you can charge for those potential candidates. Estimate the operating expenses for those properties. Run a financial analysis (as discussed below in this article) and check if the net operating income is sufficient for you to make an investment in the property. The net operating income and mortgage payments have to be in sync with each other.
If the numbers do not add up, then either change your expectations regarding the fundamental metrics for selecting a location. You might have to look at alternative markets to make the financials work. Do not be afraid to walk away from a property where the numbers don’t add up even if everything about that property is great. Good investments are not widespread. You have to look carefully and patiently for them.
3 – Get the financing in place
If you go to a golf course without your golf clubs, then you won’t be playing any golf. You will simply get bored with watching others play. If you find a great stock to invest in, but do not have the money to put into the investment, then there is no point of doing the research on that stock.
Similarly, if you do not have the finances in place for purchasing real estate, you won’t go anywhere. Learn about the various financing options for purchasing a house hacking property. Some of them are discussed below in this article. Once you know your options, speak with your banker. Talk to a few banks, money lenders, or any sources of financing that you can think of. Get a mortgage pre-approval or some sort of financial closure before you go deep into finding deals.
4 – Deal sourcing
You have done your research, partnered with an agent, and even discussed your plan to purchase a property with a banker. The next step is to start sourcing deals. If you are working with an agent, then he/she might look at MLS services. MLS stands for multi-listing service. It is an online database of properties that are up for sale. Normally, only agents can access such databases. The listings can be filtered as per your preferences and alerts can be set up to inform you (or the agent) when a suitable property becomes available.
While relying on databases and agents is a good practice to follow, you can also start searching on your own. There are a few ways in which you can proactively hunt for deals:
- You can walk through neighborhoods or drive through streets looking for interesting properties. Sometimes properties have a contact number for anyone interested in purchasing them. Call those numbers and start the conversation. Alternatively, you can speak with the neighbors of an empty property and try to track down the owner. You can leave your contact info or business card with neighbors or at the property front door. Follow your instinct and try to get in touch with the property owner in whichever way you can.
- Another great way to contact property owners is to write them letters. In the age of emails, writing physical letters might seem unfashionable, but it works. You might have to send tens or hundreds of letters before you get a few interested parties. There are letters not just to owners who have put up a “for sale” sign. These are letters to property owners who may not be selling but who might find the idea of selling tempting. It is a bit like cold calling, totally out of the blue. You have got nothing to lose in these situations except the postage stamp money.
- Lastly, if you are on the lookout for a property, discuss your desire with close associates. The more people you tell, the higher the likelihood that someone might help you out. If you share your wish to purchase a house hacking property, then you will have multiple eyes looking out for property owners that want to sell. If you don’t share your thoughts, then only you (and maybe your agent) will be the ones searching. Leverage your contacts.
5 – Act fast and manage your time
All your research and effort will only count when you actually act on them. You have to get away from the computer and get out of the house. All the traveling and meeting people will take up a lot of your time. Hence, you need to create a schedule for yourself and carve out the time that you need to pursue your property deal.
Even after you have purchased the property and have rented out the units to tenants, you need to dedicate enough time to make sure that the whole setup runs smoothly. Many aspiring house hackers begin the work and do all the right things until their schedule starts stretching them. Ultimately, many of the aspiring investors give up. You do not want your dream to halt midway. You want to take the entire process to its logical conclusion. For that, you need to manage your time well.
Doing the math and getting the numbers right
House hacking is a business as much as a lifestyle. Before you purchase a property, you will have to make a projection of what the cash flows are going to look like. You need to know what your income will be and what expenses you will have to incur to generate that income. The following section will show you the most common calculations which need to be done when you evaluate a property:
Calculating Net Operating Income
Net Operating Income is the final amount of money that will come in your hands after you deduct all the operating expenses related to your house hacking property. It is the income produced by the property before paying interest and taxes. The Net Operating Income will tell you if your property will earn enough money to pay for the mortgage which you will take to purchase that property. In effect, it will give you an idea of whether the purchase price is feasible or not.
Monthly Net Operating Income is:
- Gross Rent (e.g. $1000)
- MINUS Vacancy/Lost Revenue (e.g. 5% at $50)
- MINUS Property Tax (e.g. $100)
- MINUS Insurance Premium (e.g. $50)
- MINUS Maintenance/Repair Expense (e.g. $70)
- MINUS Contribution to common utilities (e.g. $10)
- MINUS Miscellaneous/Other expenses (e.g. $20)
- EQUALS Net Operating Income (e.g. 700)
In the example above, you have $700 of cash flow which can be used to service the mortgage and pay income tax. Hence, you can back-work how much mortgage you can afford and, therefore, the price that you can pay for the property.
Estimating mortgage payments
Your mortgage installment payment schedule is something your banker or lender can provide you with. There are plenty of online mortgage calculators that you can use to estimate the monthly mortgage payment. All you need is the principal amount, the interest rate, and the tenure of the mortgage. If you punch in those numbers, you should automatically get the monthly outgo which will have to be deducted from the $700 NOI mentioned above.
Raising the money
To purchase your house hacking property, you will need to raise significant amounts of capital. While friends and family may help, you will almost certainly have to get a mortgage to pay for the house. A good mortgage is one that has a low interest rate, low monthly payments, a long tenure, smaller down payment minimums, and no nasty surprises/hidden fees.
There are plenty of mortgage options available in the US. However, for house hacking, there are three mortgage options that are particularly attractive.
Federal Housing Administration (FHA) Loans
FHA loans are federally subsidized loans with low down payment requirements (like 3-4%) and it is easier to qualify for these loans as well. The interest rates are pretty low on these loans and the tenure is also quite long (about 25 to 30 years).
The only downsides with FHA loans are the long processing time and the high fees. The processing fees on FHA loans can be higher as compared to the fees charged on regular loans by lenders and private banks. You also have to wait longer to get final clearance on these loans. If you are doing a property deal where time is precious, then FHA loans may disappoint. FHA loans are available banks, credit unions, and mortgage lenders/brokerages.
Veterans Administration (VA) Loans
Next on our list of mortgage options are VA loans. These loans are also federally subsidized and meant for US military veterans only. They have terms which can be even better than FHA loans. No downpayment mortgages are also possible with VA loans.
Qualifying for VA loans is easy if you are a veteran. Multiple loans for multiple properties are also possible. The process is a bit slow as is the case with FHA loans. There is also a limit on the amount of the mortgage depending on your maximum entitlement limit. So, many flip properties may be out of reach. But, VA loans can help you make up a shortfall if you have other sources of finance.
VA loans are available banks, credit unions, and mortgage lenders/brokerages.
Lastly, we have conforming loans. As the name suggests, these loans conform to the rules and guidelines of institutions like Fannie Mae and Freddie Mac. The requirements for these loans are a little more strict than the ones for FHA and VA loans. The downpayment is also higher at 20%. However, the downpayment for owner-occupied loans (if you plan to stay in the property that you are buying) is much lower at around 5-10%. So, for house hacking, conforming loans are a good option. Interest rates are also low and the tenure varies between 15 and 30 years. Conforming loans are available banks, credit unions, and mortgage lenders/brokerages.
The loan options mentioned above may not qualify for properties that need major fixing work. If only cosmetic upgrades need to be carried out, then you may be fine. But the valuations on such “minor-fix” homes will also be high.
As a house hacker, you want properties that are beaten down and priced cheaply. In such a case, what you will have to do is finance your purchase using short-term funds like a line of credit or construction loans (or private money) and then fix it, rent it out, and refinance the property with one of the mortgages mentioned above. A fully fixed and rented property becomes a lot easier to finance than a beaten down property.
We hope you find this house hacking guide useful. Good luck, stay focused, and happy house hacking!
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