June 10, 2022
House Hacking Explained
Over the last couple of years housing prices in the U.S. have skyrocketed to new levels. With a housing supply that is getting lower by the day, the housing market has exploded to a point that many people are finding purchasing one nearly unattainable. Add to that the impact of all-time high mortgage rates. These changes have led aspiring home-owners to be completely priced out of the market. This has allowed many existing homeowners to put their property or its amenities to use for others who are either priced out or to homeowners who lack all the features in their homes. It can also help bring the homeownership costs down if you are will to let others use it for their personal use, generally for a payment.
In other words, house hacking is a method that can be used to cause features of your home to become much more affordable, and accessible to others. Whether you are an aspiring real estate investor, or someone looking to live affordably, the house hacking strategy is a method that can provide significant economic benefits if you apply it wisely.
- House hacking is a real estate strategy for rental income properties
- Planning and budgeting makes house hacking simple
- Renting out extra rooms, living in a flipper home, or accessory dwelling units are types of house hacking
What is House Hacking
Generally speaking, the definition of house hacking is when you use your house to make money. There are various ways to do this, and all depend on the property you choose to use to accomplish this goal.
Let's walk through a house hacking example. Let's say you buy a multifamily property for $500,000 and put 20% down with a mortgage rate of 5%. Based on this, you would have a mortgage payment of approximately $2,281. Adding potential fees from property tax, homeowner's insurance, and HOA fees could render monthly payments up to approximately $3,000+ a month. House hacking allows for these monthly payments to be significantly reduced, or eliminated. In this example, say you rent out two rooms in your property for $2,000 a month each. With this income, you will be able to cover all monthly costs associated with the house, and also pocket some extra money. Beyond monthly payments, if your house appreciates in value and you choose to sell, you will be able to further gain profits. This strategy can afford more financial stability and for some, provide further opportunities to repeat the process. Through house hacking the money needed to purchase a house is effectively only the down payment, and much of the profit you can gain when selling the house will be pocketed by yourself.
Overall, house hacking seeks to achieve income on properties while you live in it, and the following methods are commonly used by investors to house hack.
Renting out rooms
The most common and well known form of house hacking is renting out rooms/part of your house, or renting out an entire unit in a multi family home. It is an easy concept to understand and allows for owners to have a large amount of control and flexibility.
Going by this approach, many investors purchase a multi-family property, as the designated space for tenants is easily identifiable and it allows for a larger or the more preferable unit to be retained by the owner, if so desired. Yet there is a huge amount of flexibility when it comes to the types of spaces and homes that can be put to use. For instance, investors can purchase smaller homes and still be able to successfully house hack. Or, an investor can purchase a single family home with a basement and utilize the basement as space for tenants. Some also use their living room as a bedroom and rent out other spaces in their house. The level of comfortability and space you use is what dictates how you want to house hack.
One can have varying levels of commitment when renting out rooms. You can choose to sign long-term rentals ensuring guaranteed income and having a consistent daily routine. Yet you can also focus on the short term, possibly renting out extra rooms on sites such as Airbnb which result in having much more flexibility yet variability when it comes toward incomes. The demand for the two largely depends on the area in which you choose to buy your house in. In large cities, renting rooms out through Airbnb is viable with demand for temporary housing concrete, but in suburbia long-term rentals would have the highest chances of success. A rental income calculator can be useful in determining the profitability of renting out a room.
Live in Flip
A live-in flip is slightly different from flipping houses. When flipping houses, owners start construction immediately hoping to resell the home as quickly as possible. Many people who flip houses have experience within the market, and have the capital to repair the house no matter the cost. A live-in flip is different. Both strategies have the same end goal, but the process of a live-in flip is vastly different. Say you buy a home with $200,000, and invest $25,000 in repairs, you will be able to sell the house for $250,000. When flipping houses, the goal is for the repairs to be done as quickly as possible so the house can be put back on the market. Yet when attempting a live-in flip you must live in the house while repairs occur. This is mainly for two reasons. People attempting a live-in flip do not have a primary residence, and must use the home as their residence regardless of the condition of the house. The second reason is for tax reasons. Living in a house for a minimum of two years allows for both the down payment when buying and taxation when selling to be significantly lower in comparison to flipping a house. You receive a lower down payment and better loan terms with lower interest rates when orchestrating a live-in flip. Furthermore, when living in a house for two years you avoid the income tax and instead pay capital gains taxes, which in turn allow for much of the profit from a future sale to be pocketed. While you face the risk of having to live in a construction zone, a live-in flip allows for a guaranteed residence and profit after the time and investment has been put in.
Accessory Dwelling Unit (ADU)
ADUs have become increasingly common as house prices continue to increase. An ADU is an extra room that is constructed anywhere on a property. There are various ways to construct an ADU largely depending on how you want to utilize the space and how much space you can afford to give to one. ADUs can be constructed nearly anywhere on and off someone's current house, from converting a garage to constructing a bedroom separate from the original home. ADUs have gained popularity as people's children struggle to find housing, many homeowners construct ADUs for their children to live in, but also as a potential source of income. ADU's can be extremely useful as they allow for renters to be completely detached from the original home, offering freedom and flexibility for both the owners and the renters.
What to Watch Out For
As with much of real estate, budget is a significant detail you must keep an eye on when house hacking. There are a number of expenses that arise through tenants, but luckily many of them you can be prepared for. There are a few base expenses that must be paid. Water, electricity, insurance, and taxes must be paid at the bare minimum. Additionally, if you choose to employ a property management team, you will also have to set aside money in order to retain their services. If you choose to expand or change elements of your house to fit the house hacking model (ADU) you will also likely incur permit fees or architectural+engineering fees. House hacking is an effective process but your house may not be built to properly fit the demand. Beyond the base payments, there are a few wildcard instances in which you will also need to account for. Some of the most common unexpected expenses you will face will be maintenance repairs. There are a number of things that can potentially go wrong at any time, and it is essential that you have money set aside in order to take care of any problems. Beyond just simple maintenance repairs, any capital improvements can wreck your expected budget. Upgrading any structural elements of your property, or having any of them break will be a huge expense. Keeping track of all of these expenses, and having money set aside in case anything goes wrong is essential when house hacking.
There are a host of problems that arise when dealing with tenants. While many people choose to employ property management teams to maintain properties, there are a number of issues that exist no matter how you approach tenants. A property manager has a number of duties. They are expected to collect rent, maintain the property, and ensure that the property is filled for the right price. Yet when appointing property management teams there are potential areas of conflict you will have to look out for. You run the risk of a lack of communication, high employment expenses and maintenance costs, and the danger of placing a harmful tenant within your property. Most importantly, property management teams are frequently employed in properties managed from afar. Regardless of how your property management team is set up, there is a level of privacy you do not have access to when living in a house you are partially renting. It is essential to set boundaries between you and your tenants, along with having the proper structure in place to continue to maintain a flow of tenants.
The Bottom Line
House hacking is a viable method in order to achieve financial freedom, yet there are a few things you have to watch out for before you become fully invested in the process. When going through the process of house hacking you slowly realize there are an infinite amount of details you will have to account for. But as long as you keep an eye on your budget, and are aware of the potential headaches down the road, you will have a much more enjoyable experience when house hacking for the first time.