How does one get started in the business? There are different ways, but I took a rather unconventional way of getting started in real estate. I bought a rental property out of state in a place that I wasn’t familiar with, with zero experience and no team in place. It was a big headache in the beginning, but eventually the property turned profit and performed fine. Even though I was able to make the disaster work out, if I were to start over, I’d do things a lot differently. After reading and hearing about how others got started in the business, I’m convinced that house-hacking is a great way to get started, which I did for my second property.
House-hacking is where one buys a house and rents out a portion of it. Someone might buy a duplex, triplex, or quadplex, live in one unit, and rent out the other units. The rents will reduce the owner’s mortgage, and in some cases, even offset the mortgage all together. This can also be done in a single-family house if the owner gets roommates to help reduce the mortgage. When I bought my triplex in Chicago, that’s exactly what I did. I live in one unit, rented the other two, and had 2 roommates in my 3 bedroom unit.
House hacking is easier in a sense that it takes less capital to get started. If one were to have a house to live in and another property as an investment property, he/she has to buy 2 houses. With house-hacking, one can buy a duplex that is typically cheaper than 2 separate houses. As mentioned above, one can get started with house hacking even in a single-family residence.
The owner can also qualify for primary residence financing terms. These terms are more favorable than investment property loans; they have lower interest rates and higher LTV (lower down payment requirement). If the investor is a first time home buyer, he/she may even qualify for FHA loan and only put 3.5% as a down payment.
Aside from less capital and attractive loan terms, House hacking is great in a sense that the investor is right where the action is. The new investor could get blind-sided with a remote investment property. If he/she lives there, the investor will know right away if something is a bit awry and will have a chance to address it early. Aside from being able to keep an eye on the property, living there offers great first-hand learning experiences. The investor will get a taste of being a landlord; leasing the unit, tenant screening, addressing repairs and tenant issues, rent collecting and enforcing the lease, etc. Even when the investor hires a property manager down the road, having first hand experience will enable the investor to better oversee the property manager.
House-hacking is also more forgiving than a remote investment property. My first property was initially negative cash-flow and was a source of grief. Had I house-hacked my first deal, a lot of this could have been allayed. With house-hacking, the investor is paying mortgage to his/her own home every month, and any rent that can reduce that is a bonus.
House hacking can be very lucrative. If the investor can make it work where he/she pays no mortgage, then the would’ve been living expenses can be saved up for more investments down the road. And while the savings are piling up, the property is also accruing equity due to the principle being paid down each month.
A variation of house-hacking is where the investor buys a house that needs a little bit of work, fixes it while living in it, and then sells for a profit. The investor can take his/her time to fix the house as opposed to a flip where money is burning each day that the property is not finished. The investor can choose to do their own work or hire people and supervise the work directly. This offers more oversight and first-hand learning experience. Again, the margin of error is larger on this strategy because it is the residence of the investor. Any profit made is pure bonus. Perhaps the biggest advantage to this strategy is the tax mitigation. For primary residence, a single person can be clear of up to $250K in capital gains and a married couple $500K as long as the person lives there for at least 2 years and the property was used as a primary residence for at least 2 of the past 5 years. If the investor buys a house for $300K and makes $250K profit, he/she doesn’t owe any taxes on the gains! This can be a huge advantage for the investor who flips a house every two years.
My triplex in Chicago worked out nicely. I lived in one, rented out the other two, and had two roommates. My mortgage was covered by the rent, and I got some first hand experience in being a landlord, dealing with section 8, and more. I had to do some cosmetic improvements in the unit that I lived in, and ended up selling it for a nice profit years later.
Although it worked out nicely, I could’ve maximized if I had bought it for 3.5% down with FHA loan. Because Utah beauty was my first house, I didn’t qualify for the FHA loan for Chicago.
It’s easy to see how house hacking can be less intimidating, more forgiving, and still very profitable. If I were to start over, I would certainly go this route, and I would say that this can be a good strategy for many beginning real estate investors.
By: Ki Lee