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ContinueHouse hacking is a term designated to owner occupied rentals where a landlord rents out part of their own home to cover their living expenses
Very simply, house hacking is when you live in a property and rent out another part of it to cover your expenses. This could be a single-family home where you rent out the spare bedroom, or it could be a duplex triplex or even fourplex. The main goal is to use the rental income to cover as much or even all of the expenses associated with owning the property meaning you get to live there for free while you build equity in your investment property.
This is one of the most common strategies utilized by investors to overcome the initial monetary barrier to real estate investing. Numerous real estate investors get started through house hacking. We have recently spoken to several experienced real estate investors who did just this and now (10-15 years later) own multi-million dollar portfolios.
Housing is one of the biggest costs for every budget, if you can cut that expense then there is an opportunity to save quite a large amount of money which will give you a head-start when it comes to building wealth.
House hacking is ideal for young homeowners who are willing to go through the extra effort to learn the ins and outs of becoming a landlord.
The first big benefit of house hacking is, as I mentioned above, cutting your living expenses. There is a rule, the 30% rule which dictates that you should spend around 30% of your monthly earnings on rent. If you earn $2,600 a month then that’s $800 a month. According to the US Bureau of Labor Statistics though, for most Americans, this figure is closer to 40%. And property costs are just going up. It doesn’t help that most people rent during their younger years where they also aren’t earning as much.
Cutting this figure down then means you will have more money to improve your quality of life and invest in your future. However, this isn’t the only reason this strategy is popular.
You’ve probably heard a lot about the what and why so we wanted to take a look at a couple of real-life examples.
We recently did a podcast episode with Gabriel Hamel. Gabriel Hamel started by house hacking shortly before the 2008 housing crash. This was his introduction to real estate investing. He bought a three-bedroom house, rented out the spare rooms, and lived in the property with almost zero expenses.
His key investment style following the 2008 crash was through seller financing. It’s important to note that he never would have made the leap to full-time real estate investor, built his portfolio, and retired young had he not first shown both himself and others that real estate investing worked via first house hacking.
The first thing you need to consider when it comes to house hacking successfully is determining your strategy. For example, are you going to Airbnb your spare room, convert your garage, or get a roommate? We explore strategies in greater details below, but your eventual choice will depend on what you prefer as well as what your property is suitable for.
The next thing you need to consider when house hacking is ensuring that you manage everything professionally. This means having a lease agreement for your tenant, setting a fair market rate, and carefully tracking income and expenses.
A third aspect and advantage of house hacking are the tax benefits that come with being a landlord. Expenses accrued by the act of renting your property are tax-deductible and you need an efficient system for tracking all your income and expenses so that you can make the most of these advantageous tax deductions. This enables you to mitigate the tax liability of the income earned through renting your property and improve profitability.
This is where a property management software like Landlord Studio comes in. Accurately and easily track all your income and expenses, screen tenants, set important reminders, and even collect payments through the app.
Not every property in every location is suitable for house hacking, however, if you get creative there are plenty of opportunities to create some income from your property to minimize your costs.
To house hack an SFH you will need a multi-bedroom property. Then you need to find a tenant for your spare rooms. When selecting your tenant for your spare room, because you will be sharing a space with them you can be a little pickier in who you rent to. For example, if you’re a woman you might decide that you’d prefer a female tenant. In a traditional rental this would be discrimination.
Alternatively, you might consider using your spare rooms for short term rentals such as Airbnb. This way you could mark times (such as the holidays) where you don’t want a tenant in the property.
When it comes to renting out a room in your house, whether that’s through a platform like Airbnb or a long term tenant, it’s important that you are fully aware of the legal implications and abide by local and state laws.
Read: All About Renting out A Room in Your House
House hacking a duplex (or triplex or even a fourplex) is a popular option. It means you don’t have to share your space with a tenant. Instead, you buy a multi-unit property, live in one, and rent out the other(s).
Having full units attached to your own means you can command a higher rent than just renting out a room yet you can still reap the rewards of low-interest rate and minimal down-payments as you are living in the property.
If you found a property with a large outdoor area you could park a trailer, build a small home, or buy an RV to rent out on the land. You must do your homework with your local municipality if you think this might be an option you want to explore. Not all areas will allow this – for example, don’t expect this to be allowed in all suburban neighborhoods.
When we say space this could be a parking space in your driveway. Check out pavemint.com or justpark.com. Alternatively, you might look at renting out garage space, shed space, or even space for bicycle parking. Take a look at the company neighbor.com for more information on how this might work.
The life in flip strategy is, as it sounds, where you buy a property that needs a bit of work done and completes the work on the property while you are living in it. Then you live in it for at least two years before selling it off for a profit, paying no capital gains tax on the first $250K of net proceeds ($500K if you’re married). The reason you have to live in it for two years is simply that it allows you to avoid paying a large amount of capital gains tax when you sell.
The reason this strategy is worth looking into is that it can be combined with other house hacking strategies. For example, you rent out a portion of the property even as work is being completed on other parts which will help you cover some of the expenses and costs of owning and renovating a property.
Listen to our Podcast Episode on BRRRR strategy investing with Matt McKeever.
By using a Federal Housing Administration (FHA) loan you can bring your down payment to as low as 3.5% of the purchase price and they only require you to live in it for a year. On top of this, FHA loans allow people to purchase multifamily properties with up to four units.
You purchase a fourplex that costs $400,000 where each unit generates $1,200 in rent per month. You use an FHA loan making your down payment only $14,000 and your mortgage payment is $2,000 a month. You then live in one unit and rent out the other three. After paying your mortgage you are still over $1,000 positive per month!
It is important to consider that there are extra costs associated with this strategy, you will for example likely be required to get mortgage insurance which will increase your monthly expenses.
A final advantage of this strategy is that once your income stream has been proven and you’ve paid a portion of your debt you will be able to refinance and reduce your monthly costs, or even leverage your equity to purchase a second property.
When house hacking, especially if you’re house hacking a single-family home, it’s important to know how many people can live in a house. However, this issue is more complicated than one would think as the answer depends upon state and local ordinances.
As a general rule, to determine the occupancy for a house, you can use the 2+1 rule. Each bedroom can hold two people plus one additional occupant. Using this guideline, a two-bedroom house that also has a separate living room could hold five people. Though the number may be smaller than that if the people are unrelated.
You can read the HUD guidelines here.
Occupancy is also reliant on a number of other factors such as:
Because of the number of factors which influence maximum occupancy rates, it’s difficult to determine a “correct” answer to the question; how many people can live in a property? So it is highly recommended to research your local and state laws around occupancy limits when thinking about house hacking to ensure you stay within legal guidelines.
House hacking is an effective strategy to get into real estate investing. It offers an opportunity to learn the ins and outs as well as enabling you to afford that first investment property. This is a form of entrepreneurship, so get excited and go hunt for an opportunity in your location.
Done well, this could be the first investment property of many and could prove an essential part of your wealth-building and investment strategies of the future. However, it is essential to make sure you have the right tools for the job, such as a quality income and expense tracker and an effective way to collect your rent payments from your new tenants. This will allow you to run a professional side-business, maximize cash flow and ultimately help you build wealth and scale your portfolio.
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