The Complete Guide to House Hacking

What Is House Hacking? 

House hacking is the act of generating income from your home or real estate property while living in it. This can be done by renting out a part of the home you live in, or renting out multiple units of a multi-family unit while living in one of them. House hacking can also be done through short term rentals such as Airbnb or Vrbo. House hacking helps pay for part or all of the mortgage or housing expenses, thereby making real estate investment more attractive.

Read our blog post: How Much Home Can I Afford?

How Does House Hacking Work?

House hacking works as follows: You buy a single family or multi-family unit and rent out some or all of the property. The tenant pays rent and also sometimes shares the utilities bills, thereby reducing living expenses for the property owner. This generates cash flow and passive income that makes the real estate investment more affordable, enables you to generate cash flows and improves the return on the investment. 

Real-World House Hacking Scenario: Crunching the Numbers

Let us assume the following scenario:

• You buy a house worth $500,000 with a 30-year mortgage at 6% interest and 20% down payment. Your monthly mortgage is $2398 and annual property tax is $6250 or $521 per month (at 1.25% property tax rate).
• Assume an annual appreciation of 6% and a 10-year holding period. At the end of 10 years, the home will be worth $895,400. After subtracting the mortgage balance, the home equity is $560,681.
• Scenario 1 - No House Hacking: You pay all the mortgage and expenses on the property. Your Internal Rate of Return (IRR) is 3% and Total Profit is $156K.
• Scenario 2 - With House Hacking: You get a roommate who pays roughly half the mortgage + property tax, ie $1500, with annual rent appreciation of 2%. In this scenario, the Internal Rate of Return (IRR) is 10% and Total Profit is $354K.

As you can see, house hacking makes the investment significantly more attractive through generating rental income. 

Different types of house hacking

Live in a home and rent out part of it

You can increase your home affordability and ROI by getting a roommate whose rent pays part of the mortgage and utilities.

Pros

• Increase home affordability
• Cash Flow benefits
• Higher ROI

Cons

• Living with a roommate reduces space and privacy. May not work for everyone, especially people with families.

Multi-family property

Buying a rental, multi-family property is a good way to generate passive rental income while not having to share living spaces with strangers. You can live in one of the rental units and rent out other units. 

Pros

• Passive rental income
• You do not have to share living spaces with strangers. You can live in your own unit and rent out the other units.

Cons

• Rental property may require significant long-term investment.
• You need to factor in rent related laws in the area you plan to purchase in.
• Maintenance and property management fees may eat into your cash flow and profits.

Airbnb/ Vrbo or short-term rentals

Increasingly, these days, people are renting out their homes as short term rentals on Airbnb or Vrbo. This helps them pay part of the mortgage while not having to deal with long term roommates. This may be especially useful to people who travel often and want to monetize their property when they are not using it.

Pros

• You can monetize your property and derive cash flows without the hassle of long-term rentals.

Cons

• You need to make sure to factor in local or state laws pertaining to short term rentals. Many locations or states have imposed constraints or laws for renting out on Airbnb / Vrbo and similar platforms.
• Renters are constantly changing and you may not be able to vet everyone – so there is always some risk.  

Flip while living in the house

You may have heard of house flips, in which you buy a property that is not in great condition, and then upgrade/ remodel it and sell for a profit. There is another take on this concept. While you are remodeling the house, you can live in it, thereby not having to pay a mortgage or rent anywhere else. Then after a few months, you sell this property for a profit and move on to a new one and repeat the process.

Pros

• You get a double benefit – (1) increased property value due to remodeling (2) save on housing costs while doing the remodeling.

Cons

• The home may not be in a condition worth living in while remodeling.
• Flipping may be risky – it assumes that property values increase beyond cost of purchase and remodel.

What Are The Benefits of House Hacking?

1. Home affordability

House hacking can enable you to afford a home that you may not have been able to otherwise afford. The rent from house hacking may help pay for part of the mortgage or even the entire mortgage.   

2. Generate cash flow

House hacking helps generate cash flow through rental income. Additionally the renter may also share in the utility bills, further helping you save money.

3. Increased IRR

House hacking can improve the return on investment on the real estate investment. This is through additional cash flows which offsets the mortgage and other expenses of home ownership.

4. Build home equity

While renting out part of the home or the entire home, you will simultaneously build home equity over time. House hacking enables you to afford a home, and you can build equity. With adequate price appreciation, you can make a profit on the home as well at the time of selling.

5. Learn RE investing at low risk

House hacking is a lower risk way to start on the path to real estate investing. The additional cash flows reduce the barrier to home ownership and by making a profit on the sale of the first home, you can use this as capital to invest in subsequent real estate properties. Moreover, you also learn the basics of managing tenants and renters. 

Key Factors for House Hacking Success

To succeed with house hacking, it's essential to thoroughly understand and plan for all costs, responsibilities, and regulations that come with managing a rental property.

1. Make sure to factor in all expenses including property tax, maintenance, HOA and property management fees. These expenses are typically paid by the property owner and not the tenant and can add up to a non-trivial proportion of overall housing related expenses. 
2. Rental income is taxable. You need to calculate your net rental income after deducting the income tax.   
3. Keep an eye on regulations. Different locations and states may have different types of rent control or other laws that you need to be well aware of before purchasing the rental property. 
4. Make sure you are cut out to be a landlord. Being a landlord is not for everyone. Not everyone wants to worry about dealing with tenants’ plumbing issues, rent collection or other maintenance related hassles. You could hire a property management firm to take care of these operational tasks, but it may cost you ~10% of rental income. 
5. Finally crunch the numbers comprehensively, taking into account all the variables, including maintenance, insurance, property management fees and occupancy rates. Planwell’s upcoming personal finance product will help you figure out the ROI on house hacking and multiple home buying scenarios. 

Conclusion

House Hacking helps you generate income and cash flow from your house while living in it. It helps generate a higher rate of return on the real estate investment. However, you may have to deal with the inconvenience of having a stranger live in the house and managing real estate property, so it may not be for everyone. 

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Photo by Hugo Sousa on Unsplash