House hacking has become a common term in the real estate investing world. You may not have heard of the specific term house hacking before, but you may be familiar with the practice. House hacking is when you buy a multifamily property, live in one unit and rent out the other units. House hacking can be a great way to start buying rental properties because you can buy with low-money down owner occupant loans and still collect rent right away.
Why is house hacking a great way to invest in rental properties?
There are many roadblocks to investing in real estate. When buying rental properties you must have 20 percent down in most cases. There are ways to invest with little money down, but you usually have to buy as an owner occupant. When you buy a single family home as an owner occupant you can’t rent the home for a year (because you are living in it), which can make it harder to buy multiple properties. When you buy a multifamily property as an owner occupant (which is perfectly legal as long as it is 2-4 units), you can live in one unit and collect rents on the other units right away.
When you house hack you can buy a rental property and start collecting rent right away. This helps you build a rental history sooner and be able to qualify for more rentals sooner than if you bought a single family home. Most banks will not let you use rents collected as income until they show up on your taxes. This makes it very difficult to qualify for new loans when you already own a rental property, but do not have a long rental history.
What are the disadvantages of house hacking?
House hacking is a great way to start buying rentals, but it takes some sacrifice. When you buy as an owner occupant you have to live in a house for at least one year in most cases. If you are buying a multifamily house you will have to live in one unit of the property for at least one year.
Depending on what stage of your life you are in, living in an apartment can be fine or not so fine. If you are a single college student you are probably used to living in apartments. If you have a family and kids you may be used to living in nice single family homes. It would be very difficult to move into an apartment in a multifamily property if you are used to nicer properties.
For some people it is worth it house hack and for others the sacrifice and family stress it would cause is not worth it.
What are your options after living in a multifamily house after one year?
When you buy a house as an owner occupant you do not have to live in the house the rest of your life. Different loan types have different requirements, but most loans require an owner occupant to live in a house for one year. After that year is up you can sell the house or rent the property out. If you lived in one unit of a multifamily house, you could rent out that unit after living there one year. You have to live in the property more than 50 percent of the time to be considered an owner occupant. You can’t leave one unit vacant and pretend to live there.
After renting out the unit you were living in you could then buy another rental as an owner occupant and repeat the process over and over. As I already discussed it is easier to qualify for more loans when you have a longer rent history. House hacking makes it easier to buy more rental properties quicker than single family homes if you have high debt to income ratios.
If you buy the right multifamily property you may be able to live there for free or even make money while you are living in one unit. For example:
- 3 unit property with 3 bedroom 1 bath units and rent is $800 per unit.
- The property cost $150,000 and with 3 percent down the payments would be $900 a month (including mortgage insurance).
- With taxes, insurance, maintenance and vacancy costs the total monthly expenses would be about $1,450 to $1,550 depending on what taxes are in your area.
- You would bring in $1,600 a month in rent, which is less than your monthly expenses and you get to live in the property for free (excluding utilities). When you move out your cash flow would increase even more.
This kind of deal is not available in all markets, but they are out there. For me personally I still prefer single family rentals, but house hacking is still a great option.
Is it better to own single family or multifamily properties?
I own 14 rental properties with number 15 under contract. All my rentals are single family properties, except for one duplex. I prefer single family rentals for many reasons, but the main reason is I make more money on single family rentals in my area. I make more money because:
- There are more single family homes to choose from, which means I have a better chance of getting a great deal on a rental.
- The tenants are usually more stable in single family homes, which means less vacancy costs, less management and less maintenance.
- Single family tenants pay all of the utilities and maintain the property.
- Single family homes tend to appreciation more and are easier to sell because of a larger pool of buyers.
- In Colorado the CAP rates on multifamily homes are 5 to 7 percent which make it really hard to make money with multifamily properties. Other states have much better CAP rates and you can make more money with multifamily than single family.
Although I like single family homes, that doesn’t mean buying single family rentals is the right choice for everyone. You may be able to get better returns on multifamily in your area. If you want to house hack multifamily may be a better choice even if the rents are better on single family homes.
If you want some help figuring what is the best option for you, my Complete Blueprint to Successful Real Estate Investing helps investors create their own strategy when buying rentals.
House hacking can be a great way to get started buying rental properties with little money down. It can also be a great way to buy more rental properties faster, because it makes it easier to qualify for new loans. House hacking is not for everyone, especially if you have a family that would disown you or the numbers don’t work for multifamily in your area.