If you've ever binge-watched HGTV, you have likely seen the show, "Income Property." The host helps house-poor homeowners make income from their home by building a rental apartment into the house. He converts a walkout basement or in-law suite into a rental unit.
Well, many people—including my husband and me—do this intentionally and live mortgage free. It is a concept called house hacking, and it helps us not only live nearly mortgage free but also to profit over $100,000.
What is house hacking?
House hacking occurs when an investor buys a multi-family, lives in one unit, and rents the others. The rental income pays for most, if not all, the mortgage.
My husband and I became house hackers without knowing what we were doing. We bought what we could afford. It was an old three-flat that needed some work. The work wasn't an immediate need, so over the next six years, we slowly fixed it up.
My husband and I lived in one unit while fixing the other. We rented out the nice unit and then traded off. This decision, unknowingly, saved us $21,000 in capital gains tax. But, I'll explain that later.
What are the benefits of house hacking?
House hacking is the easiest way to get involved in real estate investing. There are numerous benefits to renting out an owner-occupied property.
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Financing—You get better financing options with owner-occupied properties. If you were to buy a multi-family as an investment property, you would need to put down 25 percent. If the house cost $400,000, you would need $100,000 down. That's not cheap. But, an owner-occupied multi-family property could be purchased with as little as 3.5 percent down. On that same home, you could put down as little as $14,000. Additionally, owner-occupied homes get a better interest rate. An investment property could have an interest rate of .5 percent-.75 percent higher than an owner-occupied home.
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Tax benefits—As a landlord, you can deduct many rental property expenses on your taxes, such as the property taxes, interest rate, maintenance, advertising, and insurance. When you live in the same building as your rental unit, you can take the percentage of the home that is a rental unit and deduct that percentage on all those items. Essentially, if you live in a home, you pay for maintenance, no matter what. When you rent part of your home, you can deduct a percentage of those maintenance costs from your taxes.
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Real estate investing (training wheel addition)—When you house hack, you're learning real estate investing with training wheels. You learn how to be a landlord, advertise, manage tenants, and so on—but with less risk. You're doing all this with a property you would already be paying for.
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Reduced spending—Each month, you pay a mortgage, insurance, and utilities. When you rent out a unit in your own home, you greatly reduce that spending. Our mortgage was $2,600 in our house hack experience. One unit rented for $1,750. Another room rented for $300. We paid out $550 a month for our three bedroom house in Evanston, IL. The average rent in Evanston is $1,800 for a 774-square-foot apartment. We got 1,400 square feet of space and a yard for $550.
What are the cons of house hacking?
Living under the same roof as tenants isn't always ideal. You may have read my article, "Avoid a lawsuit: top 4 reasons people sue." This article was inspired by a tenant my husband and I had while house hacking who sued us.
That's a con if I ever heard one.
Living in close proximity to tenants can be taxing. Noise complaints, broken rules, and other small things feel much bigger when it's your home, too. On the other side of the coin, tenants may feel crowded and think rules are unfair because the other tenant is their landlord.
Living in the same building as a tenant can be difficult, so weigh the pros and cons of house hacking. Do the financial pros outweigh the personal boundary cons?
How did I flip to make six figures?
By the time our second baby came along, we decided it was time to give up house hacking and focus on us. In 2016, after five years of renting units in our multi-family, we decided to sell it.
We originally bought it for $275,000 in 2011 and slowly improved it. We painted the exterior and improved the curb appeal first. Next, we converted it from a three-flat to a two-flat. One unit was a four-bedroom, two-bath, and the other was a three-bedroom, one-bath. We refinished the floors, painted, and upgraded the kitchens over time.
In 2016, we sold it for $415,000, making $140,000 profit. We paid approximately 8 percent in real estate fees, taxes, and other miscellaneous costs, netting approximately $107,000.
Pure dumb luck helped us avoid capital gains tax. We lived in each unit long enough to avoid capital gains taxes.
To avoid capital gains, you need to live in the unit for two of five years. When we sold the property, it was a two-flat. So the third unit wasn't a consideration. From 2011 to 2013, we lived in unit one while we fixed it up. From 2013 to 2016, we lived in unit two while we renovated it. In the end, we avoided 15 percent in capital gains tax and saved $21,000.
Conclusion
House hacking is a way to wade into real estate investing. The risk is lower because you would be paying for your home whether you rented it or not. But you get the added benefit of paying down your mortgage faster while learning about what it takes to be a landlord. When you're ready to get started, list your unit with Apartments.com. Your rental will be shown on all twelve of our network sites, with millions of monthly visitors. For those interested in joining the FIRE (financial independence retire early through real estate) movement, house hacking is the way to go.
