What is House Hacking? Real Estate Investment Strategy
One of the most common strategies to invest in Real Estate as a First Time Home Buyer is House Hacking. House Hacking is when you invest/purchase a property to live in and rent out the other units, rooms, basements, etc. to offset the mortgage payments. The idea behind this strategy is to have the renters from the other units or rooms to help offset your mortgage payments. Another step to this strategy is that since you are owner occupying the property, you have the option to put less money down (As low as 3.5% Down vs. 15%-25% for an investor) and you get a better interest rate versus someone who would be buying as an investor. You can always decide to turn it into your investment property but only after living in it for a minimum of 12 months. Using this strategy, there are a few key factors to consider before jumping into what seems like a fool proof investment. In our assessment today we will be shifting our focus to multi-unit homes.
Finances
Finance is obviously the first topic to cover but what do we exactly focus on.
First, we have to figure out what your purchasing power is. You’ve heard me say this over and over, getting pre approved is crucial so you know how much you can afford and what type of figures your monthly payments come out to. By seeing your estimated monthly payments, we can determine whether an investment makes sense for House Hacking. Another note, the more you put towards the down payment, the easier it will be to make a profit.
Rental Market
When buying a multi unit, we must do some research on how much a comparable unit will rent out for. This will allow us to calculate how much rental income to expect so we can deduct that from the estimated mortgage payment. Look to compare these: # of Beds, # of Baths, Backyard Y/N, Parking Y/N, Garage Y/N, and square footage. It’s always better to underestimate the market rents as they lead to reasonable expectations.
Expenses
As a landlord, you have several responsibilities to your tenants. You must keep the place habitable. This means if the toilet stops working or there is a leak, it is the landlord’s responsibility to fix it. Other expenses could be insurances (Earthquake, fire, etc.), or paying for the water if it is on the same water meter. Expenses like these must be considered and it’s always beneficial to put a percentage of your rental income into reserves.
Another expense is maintenance. Maintenance can be gardening, pool cleaning, trash, etc.
Vacancies
The reality of being a real estate investor is that vacancies are unexpected and can occur at any moment. We try to mitigate vacancies as much as possible but its a rule of thumb to account for 3% of your income towards vacancies.
Analysis (Real World Example)
After considering all the costs and figuring out the rental market we crunch the numbers. We will use an example with the template below.
I pulled an active Duplex currently on the market in the Torrance PO area. Currently listed on the market at $679,000 and it’s been on the market for over a month. Two units - each unit is 2 Beds/1 Bath. Let’s say we were able to negotiate the price down and got the property at $650,000.
Financial Mortgage Breakdown
We have 20% down (which prevents Private Mortgage Insurance which is around $200 /month if you have less than 20% down.) and since we are going to be occupying one of the units, you are able to get a lower interest rate. In our example it will be 3%.
Here is the breakdown of the costs.
Purchase Price: $650,000
Down Payment: 20% $130,000
Interest Rate: 3%
Property Taxes: 1.2% of appraised value (Purchase Price): $7,800
Monthly Mortgage Payment (Tax Included): $2,840 /month
Annual Expense Breakdown
Gardener: $840
Insurance: $1200
Repairs: $2500 (Budgeted)
Vacancy 3%: $700 (Considered)
Total Expenses: $5,240 or $436 /month
The monthly rental rate for a 2 Bed/1 Bath is $2200 /unit
Out of Pocket: $1,076 /month
Some of you may be paying more than this for rent. In California it is rare to see duplexes being able to pay off the whole mortgage balance but paying $1,076 /month out of pocket to build equity sounds a whole lot better than spending $2200 /month on rent to somebody else’s mortgage.
Alternate Strategy:
Another alternative would be to put as little down as possible. You can put as low as 5% down on a conventional loan and 3.5% on a Government Funded First Time Buyer Program known as FHA.
For this example we will be using the 5% down.
Purchase Price: $650,000
Down Payment: 5% $32,500
Interest Rate: 3%
Property Taxes: 1.2% of appraised value (Purchase Price): $7,800
Private Mortgage Insurance: Add $200 /month
Monthly Mortgage Payment (Tax Included): $3,450 /month
Out of Pocket: $1,686 /month BUT you get to keep $97,500 of your funds because of the lower down payment.
This option may be better for your financial situation as you get to keep more money in your pocket and potentially leverage to buy another property in a year or two. In both scenarios, you will be positively cash flowing if both units are rented out at $2,200 /month.
Living in a duplex may not be the most ideal or luxurious lifestyle but if you want to stretch your money and stretch it as far as possible, strategies like this will help in the long run. The journey to wealth isn’t always so glamorous and it’s decisions like this that help build towards a future of financial stability.
