Hey Money Talkers! Today is part three of the four part series on four different ways to invest in real estate. This blog post is all about House Hacking. A lot of people have no clue what house hacking is. So let me break it down for you. Basically, house hacking is where you buy a personal residence to live in and rent out the space you don’t use. This method of investing in real estate usually means that you are living in your home for free, and oftentimes it also means that you are generating positive cash flow as well. Then when you move out of the property it could also be a great long term investment generating you passive income. But house hacking is more complicated than it seems, so let’s dive right into the complexities of this method of real estate investing.
The first step you need to take when getting into house hacking is to secure financing (unless you're paying all cash, of course). Since this will be your personal residence you will be able to qualify for a Conventional loan or an FHA loan.
FHA Loan: With an FHA loan you will need at least 3.5% down.
Conventional Loan: With a conventional loan you could need as little as 3% down and as much as 20% down.
Your loan terms will all be dependent on your credit and personal debt to income ratio. With that being said, make sure you are keeping an eye on your credit score and spending to ensure that you have the highest credit score possible when you are ready to buy your house hack home. Also, make sure that you speak to a lender in advance to make sure you are preparing adequately. When you feel you are prepared and ready your lender can write your pre approval letter for you to secure your financing and move forward with the process.
The next step after securing financing is to figure out what kind of home you are hunting for. You have two options of property type when you are house hacking: single family or multi family.
Single Family Residence: This is your typical single family residence home. In this scenario you would live in the home and rent out the rooms you do not use. If the property has a basement, garage, or attic you could convert it into a room or an apartment and rent it out for more income as well.
Multi Family Residence: Multi family units that classify as residential are duplexes, triplexes, and quadruplexes. Basically, as long as the property has four units or less it is considered residential and as long as you live in it you can qualify for a personal residence loan, such as an FHA loan or Conventional loan where you can put less money down. In this scenario you would live in one unit and rent out the other units.
Once you have decided which property type works better for you, single family or multi family residences, then you have to consider the condition of the property you want to purchase.
Turn Key: A turnkey property is one that is ready to go. This is a property that is a move-in ready home that doesn't require any major repairs or improvements before it is livable. So once you close on it you can immediately occupy it and begin renting out your unused space.
Needs TLC: This is pretty self explanatory. This is a property that will need a little work done. Maybe this property needs a little lipstick: landscaping, new floors, paint, appliances, etc. Maybe it needs a full renovation. Either way, if you can afford to do some improvements to the property it may mean more profit for you.
For example: if you buy a turnkey duplex home for $300,000 and your mortgage is $1500 a month, and hypothetically the most you can rent it the unused unit for is $1200. So you only have to pay the $300 difference to cover your mortgage. Now consider that you bought a duplex that needs a little lipstick for $250,000 with a $1200 mortgage payment. You put $10,000 worth of renovation into it which automatically boosts the equity of the home. Now you can rent out the renovated vacant unit for $1200 a month. So you are living completely for free. You locked in the lower price, with the lower mortgage payment, and boosted the equity yourself to be able to still charge the highest amount of rent that is reasonable for your area and final condition of your home.
Now that you have secured financing, and narrowed down the type of property and condition you are looking for it is time to get into specific property evaluations. When buying a house hack property it is important to do the necessary property evaluations to ensure that the particular property you are buying will have a positive cash flow. Just because something looks like a good deal does not necessarily mean that it is. So you always have to run the numbers.
The first number you must calculate is the Net Operating Income. The Net Operating Income, also known as NOI, tells you the amount of money your rental property will produce before paying your mortgage and before income taxes. Why is this number important for house hacks? Because it tells you how much of your mortgage payment will be covered by rent each month. Here is the formula for NOI:
And here is an example of calculating NOI with real numbers:
I would recommend that you calculate the NOI when you first find a property and again with the help of your agent or other investors during the due diligence phase before purchasing the property. Calculating the NOI early is helpful because then you can then run a second calculation – your mortgage payment. This is a step you don’t have to do on your own, your lender can easily help you. Or you could go to this online mortgage calculator and calculate an estimate on your own.
The mortgage calculator will tell you the monthly payment amount. If you want to practice, use the numbers below and enter them in the calculator to figure out your payment. Don’t skip ahead yet. I’ll show you the answer right after.
Loan principal = $175,000
Interest rate = 3.1%
Term = 30 years (360 months)
Now compare this number to the NOI calculation above. Are we living for free or not?
To find out, you use the mortgage payment you calculated above (the answer is $950 per month). So, your house hacking monthly cash flow looks like this:
Living free! You’re welcome to do a happy dance now! I don’t know about you, but it’s a wonderful reality when your tenants are paying for your housing expenses.
Now that you have secured financing, narrowed down the type of property and condition you are looking for, and chosen a specific property that has been evaluated and has a positive cash flow it is time to buy that property. You can do so solo or with the assistance of a realtor, the choice is yours. I highly suggest that you work with an experienced Realtor who specializes in investment properties; and house hacks in particular. A good Realtor will be able to negotiate for you and advocate on your behalf. They will also be able to review your property evaluations to make sure they are correct. If you have a good Realtor in your back pocket they may also be able to find house hack deals for you as soon as they hit the market, or even before, so you have first dibs and can possibly get them at a better price this way. But if you do choose to go in solo make sure that you run all the numbers, multiple times, so that you make sure you are paying the correct price. Also, keep in mind that you will need to pay for an attorney to do all of the closing paperwork if you are running solo. Finally, whether or not you choose to be represented by a realtor, remember that you will need to pay closing costs at closing which can run you 2%-5% of the purchase price of the property.
Finding the Right Tenants
You did it! You bought your first house hack property! But your job ain’t over yet. Now you have to secure tenants for the cash flow to start rolling in. You can use a realtor to secure your tenants by paying them a fee or you can go in solo. For this task, I actually suggest that you do it on your own as long as you do it right. You cannot just let any Joe Shmo live in your home; you have to screen your tenants correctly. You cannot take what they say at face value, you need to see actual documentation and proof of their claims. This is my list of typical requirements all tenants need to be able meet:
Proof of income of all applicants who will be on the lease at least 2.5 times the monthly rent amount. You can do either three months bank statements or pay stubs. Pay stubs are preferable as they come directly from the employer.
All applicants who will be on the lease need to complete a rental application
All applicants need to have a credit score of 600 minimum with no prior evictions, foreclosures, or bankruptcies and provide a full credit report.
All applicants must provide a clean criminal background check
First months rent and one months rent deposit are required to move in.
I typically use Rentspree to obtain the applicants application, credit report, eviction report, and background check. Rentspree is super easy, you just login and send them the applicant the link, they fill everything out and pay a $35 fee to obtain all of their reports and then Rentspree verifies their information. The program was created by the Credit Bureau, Transunion, to ensure renters information remains private throughout the rental process while also ensuring home owners that the information provided is correct. So it’s legit and accurate for you, and it makes your renters feel like their personal information is safe.
In addition to the regular screening process I outlined above, if you are looking for renters for your house hack property, especially in a single family residence, I highly suggest having an in person interview after they meet all of the requirements above. I know you cannot judge a book based on its cover (and its illegal to discriminate renters based on race, color, religion, sex, disability, familial status, or nation of origin), but this is a great way to get to know your potential tenants and feel them out; especially if they will be your roommate. So once you have screened and interviewed your potential tenants, made your choice, signed the lease agreement (you can create your own or google one, but make sure it is notarized to be legally binding), and collected all deposits and rent, you may think that you are done… wrong! There is one more step in the house hacking process.
The final step in the house hacking process is landlording. You may say to yourself “I don’t know how to be a landlord!” However, house hacking is the perfect way to learn to be a landlord. You’re bound to make mistakes. And yes, there will be occasional texts, calls, or knocks at your door with maintenance issues. But because you are living on-site, you can make up for your lack of knowledge with hustle, sincerity, and your own sweat.
Plus, you don’t have to do these things yourself if you don’t want to. If you want to contract out the work then simply have a good general contractor, plumber, electrician, etc. saved in your phone and ready to go. When issues arise, call them, they handle the problems, and you write them a check and keep your peace of mind.
Basically, house hacking a great way to invest in real estate without spending an arm and a leg up front. It is also a great way to lessen or even eliminate your housing costs (which is often the largest part of a person's budget), to free up that money for other investments. Plus, house hacking is a great way to learn to be a landlord for any future rental properties you acquire.
If you enjoy house hacking you continue to do so forever. Every two years you can buy another property (refinancing if necessary) and do it again, renting out all units in your previous residence to gain optimum passive income.
I hope this was helpful Money Talkers, and Happy house hacking!