A few days ago, I was on realtor.com looking for a possible investment property. The benefit of owning a property is that it can be used to generate cash flow. Turning the property into a revenue generating asset may require a bit of creativity and ingenuity. One of the ways that a property owner can turn their property into a cash flow asset is through the concept called house hacking.
House hacking is a term that was coined by Bigger Pockets podcast owner Brandon Turner. The principle is that other people will pay for housing expenses while you grow your real estate portfolio. Simply put, while you live in one part of the property, you rent out either another room or another unit.
Multi-Family Homes
The first way that one can engage in house hacking is through multi-family homes. Multi-family homes are duplexes, triplexes, or fourplexes that are considered residential real estate. If one is looking at a property with five units or more, then that is considered commercial real estate. To house hack, an investor purchases a multi-family home and lives in one of the units, while renting out the other units.
The advantage of doing this is that there are loan products that allow an investor to purchase residential multifamily units for little or no money down. Some of these loan products include the VA loan or an FHA loan. The VA loan requires no money down, while the FHA loan requires 3.5% of the purchase price. For example, if you purchase a multi-family unit for $250,000, then you would pay down $8,750 plus the closing costs on the loan. The first caveat to the VA loan and FHA loans is that an owner must live in the property for at least one year. The second caveat to these loans is that there are limits to the amount that can be borrowed against the property. It is best to check with your mortgage broker or lender to determine what those limits are.
When examining multi-family homes, it is best to analyze the zoning restrictions in the area. There are some areas that are exclusively for multi-family homes. The disadvantage of this is that there are multiple units that are concentrated with tenants that are renting homes. It is better to find a multi-family unit that is mixed in with single family units because there is less of a concentration of investors flooding the area with tenants and it usually improves the pride of ownership as well as the property values.
Finished Basements
The second way that one can house hack is by investing in a property with a finished basement. When I was living in Baltimore, I found that there are many townhomes that come with a finished basement. Many of these finished basements already have a separate space for a kitchen, bathroom, living area, and bedrooms. While a family lives in the main unit, the finished basement can be rented out to tenant(s).
The advantage of renting out the finished basement is that the tenant pays rent to the owner and that can be applied to the mortgage and housing expenses. In addition, the owner does not have to share their living space with their tenants.
It should be noted that if the investor wants to increase their rents, the owner can choose to live in the basement and rent out the main unit to a family. If the investor does not have a loan with living restrictions such as the VA loan or the FHA loan, then both units can be rented out.
Guest House
A third way that one can house hack is by investing in a property that has a guest house. A guest house usually has its own separate plumbing, electrical, and structural setup that allows for habitation to occur. Usually, one must check out local ordinances to determine whether a guest house can be rented out.
If one is house hacking, the owner can choose to live in either the main unit or the guest house. If they choose to live in the guest house, they can charge more rent for a tenant living in the main unit.
Renting Out A Room
A fourth way to house hack is to rent out a room to a tenant. When I was living in Tucson, AZ, I had friends that had just purchased a three-bedroom home. They were a married couple and willing to share their living space with me. When my lease at my apartment was up, they approached me about renting out one of their rooms. It was a win-win situation as I was able to save on my rent, while they were able to apply it to their mortgage. Because they had a third bedroom, they were able to rent out the other room to their nephew. The additional rent was applied to their monthly mortgage payment and they were able to save on their housing expenses.
If one is looking at renting rooms, then it is highly recommended to have as many rooms as possible. A four-bedroom house is more expensive than a three-bedroom house but renting out three rooms as opposed to two rooms will lower an investor’s housing cost.
Converting a Room
Another way to house hack is to convert one of the rooms into a bedroom and rent out the converted room. When I was searching for my house in Albuquerque, I came across a home that converted the garage into a bedroom. Originally, it was a three-bedroom house with a garage, but with the conversion it became a four-bedroom home. While it cost the owners thousands of dollars to do the conversion, it also added property value to the home.
Advantages
There are a few advantages to house hacking. These include cash flow, financing, landlording, experience gained, and a good starting point for real estate experience.
Cash Flow
Cash flow is one of the best advantages of house hacking. With the rents that a property owner receives, the owner can pay down their mortgage or save the additional money for future investments.
Financing
Financing a property that can be used for house hacking is another advantage. As was stated earlier, an investor can use loan products such as the VA loan or an FHA loan to put little money down on the property.
Landlording Skills
A third advantage is that an investor can gain landlording skills. It has very little risk and allows the investor experience in marketing their property, screening tenants, managing tenants, understanding real estate agreements and contracts, bookkeeping, and managing repairs and maintenance on the property.
Management Experience
The next advantage is that real estate lenders like to see that an investor has experience managing rental properties. If you are looking at future real estate investments and need conventional financing, the lenders usually like to see that you have had some experience. Every time that I apply for financing, the banks want to see if I have had at least two-years’ experience with rental properties.
Great Starting Point for Novices
Finally, house hacking is a way that one can start out with real estate investing. It allows one to gently enter into the market as an investor and provides a novice investor with experience in real estate.
If you are interested in getting started on house hacking, Realtor.com is the perfect starting point to conduct your research. Happy Hunting!