House hacking is a simple but effective strategy. You buy a property, move in, rent out the associated units and start living for free. Or at least it seems that simple on the surface. Unfortunately there are four seemingly impossible criteria. First of all, the property must be:
- Inexpensive with conventional financing.
- Be in a place that you want to live.
- Can generate positive cash flow generate.
- May provide a fair chance for recognition.
For first-time investors, it seems like the hard part of hacking the house is getting funding or finding property that has enough cash flow. But the real challenge is deciding where to make that commitment. Buying a rental property that you want to live in and actively manage is more than just a financial commitment. You will likely live, work, and invest in this field for at least the next few years.
Because of this, before you start hacking houses, you need to ask yourself some serious questions. All four of the above criteria are so important to a first time investor, and some basic things will help you meet each of them as long as you are patient and methodical.
Here are four questions to ask yourself before hacking home when you are just starting out.
1. Can I afford the property with conventional financing?
There are two follow-up questions to this question:
- How much money do i have?
- How much money does the property cost in the area I want to buy?
If you do house hoes and still want to live in a decent location in an urban area, you will need some money. Even with good owner-occupier financing terms, you will need a substantial amount for the down payment if you want to live in a somewhat desirable location near a thriving city.
Working hard and living frugally can save you an amount that would cover a down payment for real estate in the area you want to live in. If you don’t like this strategy of raising funds for your first down payment, you should seriously be wondering whether you even want to invest in real estate.
Also, keep in mind that no matter how big they are, you will need money on repairs. You can spend thousands on plumbing and electrical work, appliances, home improvement tools and supplies, among other things.
When moving from renting to owning a property, chances are you don’t have sturdy tools and are unfamiliar with the materials needed to work on relatively simple projects like paint and drywall repairs. If you save extra money as a buffer, you can more easily cover any small repairs and contractor costs that may arise. And it can get you a pretty solid little toolset.
More about house hacking from Advance Guide
2. Will I be happy to live there?
Both new and experienced investors need to recognize that we are investing to improve our finances and our lives. House hacking doesn’t work when you have to live in an area you don’t want to be. For example, some people love to live in the city and don’t want to live in areas where things like grocery stores, for example, are not within walking distance.
Unfortunately, cities may not be the best place to go for first-time investors. Properties can be too expensive to even consider the possibility of cash flow. But that usually means that there are cheaper spots on the outskirts of the city if you’re just starting out to invest.
3. Will the property have cash flow?
As a first-time investor, there are ways to gain an advantage over others. For example, buying an apartment building is a good idea considering many other newbies aren’t considering it. You can also take advantage of a government program called Fannie Mae’s First Look Program.
Fortunately, as an owner-occupier looking to buy an apartment building, you have some serious advantages over the competition. First and foremost, you’ll be looking at properties that most other would-be homeowners weren’t interested in. First time buyers typically don’t look for a duplex, triplex, or fourplex purchase.
Second, through a special government program – Fannie Mae’s First Look Program – you have the option to bid on real estate in front of investors who did not intend to live in the property. According to its website, this program offers investors a “first look” at newly foreclosed properties. This can give you the edge you are looking for when looking for great multi-family deals in your desired location.
Because other investors outside the program will not be able to make real estate offers for several weeks. Since the demand for duplex, triplex and fourplex apartments among first-time owners is low, there is usually little competition. This window can help you gain the confidence you need to make such a huge financial commitment.
Ready to invest?
Our weekly webinars will educate and encourage you – and teach you to take action towards your dream of financial freedom. Ready to dive in? Find and register for upcoming webinars, find and review old webinars, and get real estate investing education.
4. Is there a reasonable chance of recognition?
Investors refer to appreciation as “the icing on the cake”. But unfortunately it is usually not taken into account when buying investment property. While it is still a good idea to look at cash flow first as an owner-occupier, the extra time to look for investment properties that also offer a good chance of appreciation can be well rewarding in the long run.
As a house hacker, having a special tax law that benefits owner-occupiers can have greater financial implications for you than for a traditional investor. Assuming you have lived in the property for more than two years, much of the capital gains on the sale of the property are tax-free. This tax break is effective for those looking to hack home with small apartment buildings as it gives you the opportunity to take advantage of the appreciation in terms of both income property and smaller residential properties.
In the case of multi-family houses, an increase in the income of the property can result in an increase in value. As hybrid properties, duplex, triplex and fourplex can also benefit from appreciation caused by an improving local market. When choosing properties, choose the ones that you think will give you the opportunity to receive both types of appreciation.
Forced income increase
This happens when you, as an investor in a property, control how it is valued. This can include cosmetic work such as a good paint job or the use of high-quality lights. This also includes internal work and maintenance work such as replacing bad pipelines.
If you have forced appreciation in mind when choosing a property, consider a property that requires a lot of work and has several areas for improvement. In apartment buildings, it also means you can increase the rent for the tenants and make more money and value from the investment.
For example, you can overhaul the entire plumbing system, add equipment like washers / dryers and refrigerators, and do significant cosmetic work. If you build it yourself, it can also save you a lot of money since you don’t have to pay contractors. (Just make sure you know what you’re doing.) These improvements should lower the property’s running costs over the long term and give you an advantage in attracting and retaining tenants, which will hopefully improve the property’s long-term income potential.
Also called capital appreciation, this is when the value of something increases in value over time. One of the perks of buying property in an area you want to live in is that other people tend to want to live there too. This provides an opportunity for appreciation when you have personal reasons to live in areas that belong to a large population group. But also look for properties in these neighborhoods that are part of government-sponsored infrastructure projects.
Hopefully, you can use both types of appreciation to add significant value to your property in the years to come. Then you can pay off this increase in equity tax-free and invest in another project that can bring in even more income.
These questions to ask yourself prior to home hacking may seem like a lot, and they can be overwhelming to people just getting into this type of investment. But these are the same questions that set you up for success.
However, don’t be too strict with yourself. As a first-time investor, you will make mistakes. This list of questions should help you avoid many of them, but waiting for the “right time” to invest just means you never will. There’s never really a right time to try something new like this, but as you read this you arm yourself with the knowledge to make the best decisions you can.