Real Estate Investing: House Hacking

Happy Labor Day, America. Today we cover my favorite form of investing: real estate, but with a twist! Over the span of 5 years, this investment vehicle alone managed to bring my net worth from -$16k to (at it’s peak) over +$500k. We’ll discuss my anecdotal success story, the power behind house hacking, and how you can replicate these results with less money than you think. Let’s begin.

What is House Hacking?

House hacking traditionally involves purchasing a multi-unit property (such as a duplex, triplex, or quadplex) and living in one of the units while renting out the other spaces. This can be done with single-family residences where an individual purchases a home and rents out the additional rooms. Even further, for those still unable to purchase a property, renters (depending on their lease agreements) can utilize this logic and rent out to others in order to help off-set the biggest expense in your budget: housing.

Ty’s House Hacking Journey

As a newly minted college graduate with $40,000 in student loan debt, I started off making ~$55,000 as an analyst at a mortgage bank in the Los Angeles metropolitan area. In 2018, the average rent for a studio apartment cost ~$1,300. For me to have my own apartment, that meant my rent-to-income ratio was near 30% (the most anyone should spend for housing). So instead, I rent-hacked for two years. I found roommates and contributed $500 (11% of my monthly income) for my share of the space, freeing up $800 a month in cash flow to save, pay off debts, and invest. This hack alone helped me save $20,000 in two years. Typically, the three biggest expenses in one’s budget are: housing, vehicles, and food (for the younger generation, add: education). Control these big expenses, and you can set yourself up for financial success down the line. In my case, I managed to exist entirely off of $1850 a month, maintaining a 60% savings rate.

Fast forward to 2020 — masks and politics and mayhem ensue. I landed a new position as an analyst at Experian, was allowed to work remotely, and essentially doubled my salary. It was here I ran into a dilemma: use my hard-earned savings and wipe out my remaining student loans or put my money to work and invest. I think it is paramount to run your own risk analysis, but given my circumstances (and armed with the knowledge that current rates were at historic lows), I decided to purchase a fixer-upper property for $292,000 in Idaho. Using a conventional loan with 10% down, I became a homeowner!

My payments were $1,600 a month PITI. Throw in utilities, and I was already surpassing my original $1,850 monthly budget in housing alone! So what gives? The answer: house hacking. The home I purchased was a 3 bed/2 bath. I claimed the master, but the others were up for grabs — I lived like I was still a fresh graduate and rented to people I knew. At $550 per room, I brought in $1,100 in monthly rent to help offset my housing budget, effectively paying $800 to own a piece of property and live in it. This allowed me to funnel more money into my home by renovating it and forcing equity. A great addition to house hacking is incorporating the BRRRR strategy.

There’s many benefits to house hacking:

1. Owner-occupancy financing: Since your property is also your primary residence, that means you qualify for better financing terms not available to other real estate investors. Conventional or FHA loans are available to you. Additionally, if you decide to convert your home into a long-term rental, you get to keep your owner-occupied loan even after you move out. Just note that when you obtain an owner-occupied loan, you will be required to live in the home for one year.

2. Lower down payment: With an owner-occupied home, you can put as little down as 3% on a property. Typically, investment properties require 20-25% as a down payment. In my example, that’s the difference between putting down $8,760 (3%) or $58,400 (20%).

3. Training Wheels for Real Estate Investing: By house hacking, you learn the ropes of what it takes to become a real estate investor. The best part about being an on-site landlord? Your tenants are there to immediately address their concerns. The worst part? Your tenants are there to immediately address their concerns. You will quickly learn about your property, the types of tenants it attracts, and how to navigate difficult decisions while going about your daily routine. This period makes transitioning to an off-site landlord eons easier; and, once you move out, you get to enjoy the additional cash flow.

4. Leverage: House hacking allows you to invest with leverage, but safer. Like the majority of real estate investors, you place a smaller down payment to control a larger position. If you place $10,000 on a $100,000 property, your cash is working with the strength of $100,000. Typically, the housing market sees ~3% appreciation year over year. If you did nothing but sit on this, your home valued at $100,000 last year is now worth $103,000. Your $10,000 just made $3,000 — a 30% return within a year. With house hacking, you are able to turn a liability (payments on a place you live in) into a breakeven or even marginal profit by using other people’s money to pay for your expenses, all while enjoying the power of leverage.

5. Forced Savings, but Better: When you purchase a home, part of your mortgage payment goes to the principal, or the amount owed on a loan. Imagine you have a $300,000 loan on which you pay 4% interest over 30 years. Initially, your principal payments start low until the tail end of your amortization schedule. Each month, you are forcefully saving whatever amount that is being applied to the principal — this increases your overall net worth. In the example below, $432.25 - $448.36 is the range of money each month that is being added to your net worth. Say you rent 2 rooms out for $500 each — you are effectively nullifying the interest you are paying on your loan. That means your out of pocket money is paying the principal, in effect, paying yourself. The final icing on the cake? You get to save money deducting a portion of your housing expenses come tax season via depreciation.

House Hacking Takeaway

By far the greatest wealth generator today is the mild-mannered house hack. By using it in tandem with the BRRRR strategy (which will be discussed in a future publication), you can supercharge your financial independence journey. With favorable financing, a beginner-friendly introduction toward real estate, and a way to free up cash flow, why not consider how you can implement house hacking to ignite your wealth potential?