Summary: In this article, we’ll share the ultimate guide to house hacking for investors. Topics also include what is house hacking, creative house hacking strategies and ideas, the benefits and drawbacks of house hacking, financing options, pitfalls to avoid and the BRRRR strategy.
The term house hacking may sound scammy, but it’s actually totally legitimate and is used by both new and experienced investors as a way to build wealth. Is house hacking worth it? For many investors, the house hacking strategy is a relatively easy way to get into real estate. Low-cost financing, reducing or eliminating your cost of living and positioning yourself to take on more advanced real estate investments are just a few of the reasons house hacking can be an excellent strategy–especially for beginners.
What is House Hacking?
House hacking is where you buy a single-family or multi-family property as a primary residence, live in one of the units and rent out the others. The goal of this investment strategy is to live for free, using the rental income generated from your tenant(s) to cover the entire mortgage.
House Hacking properties could include a duplex, triplex or fourplex. It’s also possible to House Hack with extra rentable space, like a guest house or basement apartment.
When you move out, you can hold onto the property and continue getting rental income every month.
House Hacking Strategies/Ideas
The “Traditional” House Hack
The traditional, or most common house hacking strategy involves buying a two- to four-unit property. Investors can choose a low down payment, residential loan. Traditional House Hacking works best with properties in lower-priced markets.
Examples of traditional House Hacking properties include:
The “Rent-By-the-Room” House Hack
In college, I had a friend who bought a single-family home and rented out the extra rooms to friends or other students. He essentially lived for free, while his tenants covered the mortgage. For single people, this is a great way to reduce your cost of living and build equity for practically nothing. Not only can housemates cover your mortgage payments, they can also split utility bills with you. House Hackers that choose to rent out rooms will be giving up a certain amount of privacy and space, but for many, that’s a small price to pay compared to the long-term reward.
The “Accessory Dwelling Unit” House Hack
Accessory Dwelling Units or ADUs are single-family homes that have converted “extra living space” into a rental unit. ADUs may include the following:
- Garage apartment
- In-law suite
- On-site guest house or casita
These ADUs must have their own kitchen or kitchenette, full bathroom and ideally a separate entrance.
Other Creative House Hacking Strategies
- Airbnb / short-term rentals
- Mobile home or RV rentals
- Rent parking spaces
- Live-In Flip – buying a distressed property with the intention to move in, fix it up and then rent it out is another way to House Hack. And you can avoid capital gains taxes if you live in the property for at least two years before selling. .
Benefits & Drawbacks of House Hacking
7 Benefits of House Hacking
#1 – Live for Free
Successful house hacking should allow owners to live for free, or at least at a greatly reduced cost. Although a multi-family property may cost more initially, the ability to rent out multiple units to cover the mortgage is a huge upside.
#2 – Great for Real Estate Investing Beginners
House Hacking is considered one of the best real estate investing strategies for beginners. It allows you to buy real estate that acts as both a primary residence and investment property. House Hackers take on less financial burden of carrying a mortgage on their own, thus lowering risk.
#3 – Monthly Cash Flow / Passive Income
The monthly cash flow received from rent helps investors pay down their mortgage, sometimes a lot faster. Once the mortgage is paid off, the property can become a completely cash flowing, passive investment.
#4 – Build Equity & Wealth
Building equity through real estate is a beautiful thing–especially when it doesn’t cost you a dime. If the cash you get from rental income is enough to pay your entire mortgage, your property is essentially building equity using other people’s money.
#5 – Flexibility
In the wise words of Bob Dylan, “The times, they are a-changin’ ”. That’s why flexibility is more important now than ever. For example, let’s say you suddenly need to move home to care for an aging parent. Or your company transfers you to a different city. You can simply rent out your unit and keep earning passive income.
#6 – Get “Landlording” Experience
House Hacking is going to give you experience being a landlord, whether you like it or not. Because you’re right next-door to your tenants, it’s much easier to keep an eye on how your property is being treated, monitor noise levels, and quick accessibility in case an emergency repair needs to be made. Managing rental properties is much easier when it’s in close proximity.
#7 – Tax Benefits – Depreciation
Owning rental property can come with huge tax benefits. House Hacking investors benefit most through depreciation and a mortgage interest tax deduction. Depreciation is simply the wear and tear a property goes through over time. Because this wear and tear decreases the value of a property, investors can save a lot of money in taxes with depreciation. Owning this type of property also reduces your taxable income thanks to the mortgage interest deduction.
6 Drawbacks of House Hacking
#1 – Live Next to Your Tenants
For some people, living so close to your tenants can be a real drawback. If it’s a multi-family home, you’ll be sharing a wall with one or more of your tenants. Lack of privacy can play a major role in deciding which type of house hacking strategy to pursue.
#2 – You Have to Be a Landlord
Most of us have probably heard a horror story or two about landlords dealing with difficult tenants. Sometimes, being a landlord isn’t a very “passive” investment. There may be times when landlords will have to do very little. And other times where it will require more work and time. Either way, house hacking usually requires you to be a landlord.
#3 – Can Be More Expensive to Buy Upfront
Multi-family properties are typically more expensive than single-family homes. There will almost always be more bathrooms, bedrooms, and square footage in a multi-family home. While there are good loans you can get to make these properties more affordable, especially for first-time buyers, a down payment can still be a stretch.
#4 – Increased Vacancy & Maintenance Costs
Multi-family rental properties can come with more risk for vacancies and higher turnover costs. Not to mention the additional maintenance and upkeep costs. If you are house hacking a property that seems to have a high turnover rate, you may find yourself buried in a whole lot of extra expenses. Most likely that you didn’t account for before going into it.
#5 – You Could Take a Bigger Hit if the Market Drops
All markets, whether it’s stocks or real estate, operate in cycles. While both are not directly impacted by the performance of the other, investors should always count on markets fluctuating. Because house hackers live in their investment property, a dip in the local market could present some major risks–like vacancies.
#6 – Difficulty Keeping Relationships with Tenants Professional
In social psychology, there’s a term called the Mere Exposure Effect. This phenomenon basically says that as humans we feel a preference for people and things that are familiar to us.
Similarly, proximity plays a significant role in who we form relationships with. For example, we are more likely to become friends with the people sitting next to us in class. Or, in this case, the people living next to you.
Because we naturally make connections and get to know the people around us, it can make it difficult to keep things professional with tenants. There’s a fine line between being a friendly landlord and neighbor and being a friend that someone could take advantage of.
Financing Options for House Hacking
FHA loans require lower credit scores (580 or higher) and are meant for first-time buyers. Borrowers only have to put down 3.5 percent and interest rates are generally low. The downside to FHA loans is that they can cost more than other types of loans due to the mortgage insurance premium (MIP). Because the required down payment is lower, lenders charge MIP to offset the risk of lending to people with lower credit scores.
Buyers with credit scores below 580 can qualify for an FHA loan by putting down 10 percent.
FHA 203k Loans
If you are looking to buy a property that needs a lot of work? FHA 203k loans are a great alternative to hard money loans because it lets you borrow up to $35,000 for repairs to the property. There’s a 3.5 percent down payment and a credit score of 620 or higher. For fixer-uppers, this is an excellent option.
Fannie Mae Homestyle Renovation Loans
Borrowers with higher credit scores (680 or higher) may qualify for a Fannie Mae Homestyle Renovation loan. Only a 5 percent down payment is required and distressed properties qualify for this loan. These homestyle renovation loans come with certain conditions and restrictions, so make sure you speak with a lender before moving forward.
If you are a veteran then you’ll most likely qualify for a Veterans Affairs or VA loan. These loans are very low-cost and sometimes don’t even require down payment. There’s no private mortgage insurance and depending on the lender, credit scores must generally be above 620.
Conventional / Conforming Loans
A down payment of 5 percent or higher is required for conventional / conforming loans, with a credit score of 620 or higher. If a buyer puts less than 20 percent down, MIP will be applied, but won’t be as expensive as it would with an FHA loan.
How to Run the Numbers for House Hacking
Running the numbers to determine if a property is a viable house hacking option is actually pretty straightforward–at least compared to some other investment strategies. The Net Operating Income or NOI will tell you how much income, minus expenses the property will generate annually. NOI does not account for taxes, depreciation, loan payments or capital expenses.
NOI – loan principal + interest = total monthly cash flow
Property expenses may include property management fees, maintenance, repairs, utilities and property tax.
How to Find a Good House Hacking Property
House hacking investment properties that usually produce the best cash-on-cash returns may include:
- Properties with sellers looking to offload a property aka “motivated” sellers
- Foreclosed homes
- HUD homes
Investor Tip: Don’t buy a property in a bad neighborhood just because it’s a killer deal. Location alone will make or break your investment.
House Hacking Pitfalls to Avoid
Learning from other people’s mistakes is a good way to avoid them. The following are some common house hacking pitfalls that you should avoid:
- Buying in an undesirable neighborhood or market
- Not budgeting enough money for repairs
- Being unfamiliar with local ordinances and laws
- Getting too casual about landlording responsibilities
- Failing to set proper boundaries with tenants.
What’s Next? BRRRR
Buy-Remodel-Rent-Refinance-Repeat or BRRRR is considered a more advanced house hacking strategy. The idea is to buy a distressed property, below market value, using short-term cash or financing. After the property has been repaired and renovated, investors will then refinance to a long-term mortgage. The end goal is for investors to get all (or most) of their original investment back so they can use it for the next BRRRR property.
Utilizing the house hacking investment strategy is one way to get into real estate and build lasting wealth. Even if you already own the house you live in, there are several creative ways to make money by renting out your extra or unused space. While it may not work for everyone, house hacking can be an extremely successful and lucrative investment strategy.