The word “hack” refers to some kind of scheme that usually falls short of achieving a real goal. That’s why you may have ignored the investment strategy of house hacking until now.
What is house hacking? It’s when you buy a multi family investment property and live in one of the units. The rental income from the other unit(s) should cover all or most of your housing expenses.
It still might not seem doable after reading the house hacking definition. Make it to the end of this guide, however, and you’ll see that it’s actually a great investment strategy for beginners. It might even be one of the best ways to get started in real estate.
Why House Hacking?
The obvious reason to start investing in real estate with house hacking is the fact that, if done right, you get to live in your home for free. Any other creative strategy won’t come close to achieving this.
But let’s start with the facts. The average household in the US makes around $73,573 every year (before tax). As of 2017, an average of $19,884 was being spent on housing every year (owned or rented property). That’s a whopping 27%! Imagine if you were able to save up 27% of your annual income every year and eventually put it into a rental property or even multiple rental properties.
That’s the major benefit of house hacking and it has to do with opportunity cost. Every penny you spend on rent or even mortgage payments for a house you live in- none of it brings you any return on investment. All the while, you’re missing out on money you could be making had you put those pennies into a cash flow real estate investment. It’s a missed opportunity for making money.
So, while the idea of living in a house for free is great, house hacking goes beyond that. It’s about a long-term plan for making money, financial independence, and maybe even early retirement. Buy a property, live for free thanks to rental income, and save those housing funds for a real estate investment that you’ll actually see returns on. No longer has the same connotation as the average “life hack”, does it?
3 Steps to Hacking Your House
House hacking relies on three major things:
- A mortgage with low, fixed interest rates and an affordable down payment
- An affordable or below market value investment property
- High enough rental income to cover housing expenses
All of this has to happen with any one of the types of multi family homes:
- Duplex– a multi family home with 2 units
- Triplex- three units
- Fourplex- four units
As you’ll see, the following 3 steps revolve around these basics of house hacking.
Explore Investment Property Financing Options and Get Pre-Approved
Because most people considering house hacking are new investors in their 20s or younger millennials, the financing aspect is what draws them to this strategy. They realize that real estate investing is a great way to make money. Unfortunately, the lack of money is one of the biggest obstacles when getting started in real estate but house hacking can remedy that in more than one way.
Before looking at your financing options, read this guide on how to get approved for a rental property mortgage to make sure you have the basic requirements that most mortgage lenders will be looking for.
Types of Loans Suitable for Successful House Hacking
FHA Loan
- Down payment of 3.5%
- Credit score of 580 or higher (compared to the typical 620-660 of conventional mortgages)
- For credit scores lower than 580, you can qualify with 10% down payment
- Requires mortgage insurance premium
- Property must meet appraisal standards of the mortgage lender
For more information, click here.
VA Loan
- Must be an eligible US veteran to qualify for this type of loan
- 100% financing with no down payment
- No private mortgage insurance required
- Credit score of 620 or higher (varies by lender)
For more information, click here.
Conforming Loan
- Credit score of 620-640 required
- Private mortgage insurance required for down payment less than 20%, but less expensive
- Down payment of 5% or higher required
For more information, click here.
FHA 203k
- Distressed properties are eligible
- Use to buy a home and for home improvements
- Up to 110% financing
- Down payment of 3.5%
- Credit score of 620-640 required (varies)
For more information, click here.
Fannie Mae Homestyle Renovation Loan
- Distressed properties are eligible
- Down payment as low as 5%
- Credit score of 680 or higher (varies)
- Loan amount of up to 105%
For more information, click here.
Outlined above are the basics of each type of investment property financing. Visit your mortgage lender or work with a mortgage broker to find out which you are eligible for. Start taking steps to get pre-approved. Your mortgage lender will let you know what paperwork you will need and also if your credit score and income qualify you for any of the above loans.
Related: How to Buy a Multi Family Property with No Money
Find the Best Real Estate Deal
Naturally, you won’t succeed at house hacking if you go for over-priced or luxury properties. What you need is a below market value (BMV) property or, at the very least, an affordable one. You might be aware that the US housing market has been labeled as a general seller’s market. So finding either a BMV property or even a budget-friendly one can be a task in itself.
The first way to tackle this is to look for certain kinds of investment property for sale:
If you can find a multi family home for sale that falls under any of these labels, it’s more than likely to be priced below market value. How can you be sure? You need real estate comps to confirm the good deal you’re getting. This requires learning how to conduct comparative market analysis with some online tools or turning to a real estate agent.
Maybe you’d rather just look for a regular, affordable multi family rental. In that case, I can point you in the direction of a tool that can help you find affordable property in any market. It’s Mashvisor’s heatmap analysis tool. Simply type in the city you want to invest in (and live in!) and use the heatmap filter to show you the neighborhoods that have less expensive property. These will be shown in red as in the picture below:
So even if you live somewhere like San Diego, you will hopefully be able to scope out a good real estate deal using this tool or looking for the types of real estate listed above.
Start your house hacking journey here with Mashvisor’s heatmap.
Learn more: How to Find Investment Property for Sale Below Market Value
This Won’t Just Be Your Home, It’s an Investment Property- Analyze It Like One
Finding an affordable multi family home is only the first half of finding a great real estate deal. The next is finding one that is affordable but will actually produce enough rental income for you to hack your housing. This is where you need to perform a basic investment property analysis. Here are the numbers you’ll need to focus on:
Rental Income
You can’t just charge whatever you want as a landlord. There are so many factors that actually go into how much rent you can charge your tenants:
- The rental property itself
- The exact location in the neighborhood and what it is in proximity to
- Economic conditions
- Real estate market trends
- Local real estate prices
- Supply and demand
What this means is that you can’t simply charge more than your mortgage payments for whatever property you buy. You have to analyze properties beforehand to ensure they will make enough rental income. For this, Mashvisor provides an investment property calculator. Every real estate listing on the platform has an amount of expected monthly rental income based on rental comps, historical data, and predictive analytics (as shown below).
Of course, you will also need to check out real estate comps if you’re dealing with a distressed property. Once you figure out the repairs needed and the ARV (after repair value), real estate comps provided by this tool will help you determine how much you can charge for rent.
Net Operating Income
The Net Operating Income (NOI) lets you know how much money you’ll make with your rental property. This amount is before you pay your mortgage or income tax but after rental expenses are paid. So, this amount will tell you if you’ll be making enough to cover your mortgage or not. Again, you’ll need to be doing this math before making a move on a property. The NOI formula is:
NOI= Gross Rental Income – Rental Expenses
Rental Expenses= Vacancy Costs + Property Taxes + Property Insurance + Maintenance/Repair Costs + Utilities (if any) + Other Costs
We already have the rental income, so now we have to figure out the rest of our rental expenses. You can consult the previous owner to get a better idea, talk to a real estate agent, and use Mashvisor’s calculator to figure it all out.
Mortgage Payments
Once you have the NOI figured out, you need to see if it covers the mortgage payments. With the help of your mortgage lender, fill out a mortgage calculator like the one below to include:
- Type of mortgage
- Down payment
- Loan amount
- Interest rate
The calculator above will automatically show you the Cash Flow (NOI-mortgage expenses). If this number is positive, you’re actually making some extra cash. If it’s zero, your rental property is making enough to cover your housing expenses and that’s just what we want. If it’s negative, this isn’t the right rental property for house hacking.
Hack your house with this tool. Click here to get started.
Related: Learn How to Evaluate Multi Family Investment Properties
Not Ready for Buying an Investment Property? You Can Still Hack Your House
Own a Property Already?
Even if you don’t want to buy an investment property, you can still hack your house. For example, if you already bought a house with a mortgage, look for spaces to turn into a rental property. Maybe a larger garage space, a separate floor, a basement, or even a cottage/cabin-like unit on your property can work for this strategy. In this way, you will be able to charge enough rental income to cover some of your mortgage payments and set the rest aside for real estate investing.
What About Airbnb?
If you don’t have an entire space to rent out, consider renting out a room. This can be done either as a long term rental strategy or, for higher rental income, rent out a room on Airbnb. If your real estate market is a magnet for tourists, renting out a room on Airbnb should bring in enough money to cover a good portion of your monthly mortgage payments.
Even If You’re Renting…
If you don’t own a property, check with your landlord or the owner and review your lease. You’d be surprised that some landlords allow their tenants to rent out a room on Airbnb. For these landlords, they’re giving themselves a competitive edge over other rental property owners. For you, it gives you a feasible way to hack your house and save up a modest amount for a down payment for investment property.
Note: Before you go about house hacking in any of the ways mentioned in this section, be sure to check with local laws and regulations. This includes Airbnb regulations, zoning laws, and even landlord-tenant laws.
The Downsides of House Hacking and How to Overcome Them
Just because hacking your house can be a great way to get ahead of the game and start investing in real estate, that doesn’t mean it is a perfect strategy. But just like the successful real estate investors before you, all you have to do is identify obstacles and plan to overcome them.
Becoming a Landlord Can Be Difficult
With house hacking, you’ll likely have a 9-5 job and that makes the idea of becoming a landlord all the more overwhelming, I know. However, if you want to get serious about investing in real estate, learning the property management trade will be an invaluable skill once you master it. And there’s no better way to master it than with hacking your house.
The best way to overcome this fear? Prepare your landlord starter pack, so to speak. Take the time to learn how to set up a proper lease agreement. Review landlord-tenant laws, landlord rights, and even the eviction process. Ask around for references of maintenance professionals and handymen (you should already have contacts if you went through a full-on rehab).
Related: 8 Steps to Becoming a Landlord
Think of it this way. When landlords make mistakes with rental properties, they could end up with negative cash flow properties that bleed money. However, when you’re living in your investment property, even if the other unit(s) are empty, it’s equivalent to just spending on your residence. Essentially, house hacking is the time to practice and make mistakes as a landlord. That should take the stress off of being a first-time landlord of a multi family home.
Living Next Door to Bad Tenants
This is something that unfortunately can come with the territory of being a landlord- but it doesn’t have to. It all comes down to proper tenant screening. Learning how to screen tenants and do so lawfully will be part of prepping that landlord starter pack we talked about. I can get you started with 2 helpful guides on this matter:
8 Things That Make a Good Tenant
Tenant Screening Process: Red Flags Landlords Should Not Ignore
Some people who take this approach to multi family real estate investing actually rent out to friends or family to make being a landlord and dealing with tenants easier. However, I think if you want the experience, try looking for rental tenants and learn to deal with the issues that come along with that. Succeeding in this means you won’t have to rely on professional property management until you end up with a few dozen investment properties.
If you do end up with a bad tenant, I happen to have another 2 guides to help you out!
What to Do With a Tenant Not Paying Rent
How to Deal with Bad Income Property Tenants
What’s Next?
After your property is up and running, you can go with the BRRR strategy:
Buy a property ✓
Renovate it ✓
Rent it out ✓
Refinance it
The last step is where you refinance the investment property. If you were dealing with a distressed property, after renovation, it’ll be worth more. It’s possible that with this step, you might even get back your full cash investment or more. This makes it easier to take the next step of buying an investment property.
Read more about this strategy here: The BRRR Model: Pros, Cons, and What Rental Investors Should Know.
Eventually, with enough wealth built up, you’ll be able to buy your dream home. What you’ll be left with are money-making rental properties. House hacking can get you there. Just be sure to follow all the steps in this guide and use the right tools to make sure you’re buying the right rental property.
Let Mashvisor help you with hacking your house. Try us out here with a 14-day free trial and a 20% discount after!