Today I am going to discuss the absolute best and easiest way to get started in Real Estate investing AND at the same time also work toward Financial Independence. It is through a concept known as House-Hacking.

What is it?

House Hacking is simply a term used to describe a situation where you own a property, it can be a single family home or a multi-family, and you live in it as your primary residence but also rent out other rooms or units. It has existed for years, but in the past we called them roommates, but only when you have a single family house. But is can also be used on small multi-families such as a duplex, triplex, or fourplex.

Why is it so Awesome?

For most people Housing is the #1 largest expense. There isn’t really a lot you can do about that, you have to live somewhere. Of course you can always live in your parents basement until they kick you out, but that doesn’t really do much to help you build wealth. But by doing a house hack, you can virtually eliminate that largest expense so that you can basically live for free, but at the same time have other people paying down your mortgage which builds up your equity.

Let’s go over two scenarios, a Single Family house and a multi-family fourplex.

The house we’ll say is a 3 bed, 2 bath house in an average area that you can buy for $120k. Maybe it needs some minor updates and things as well. But it is totally livable as-is. This specific situation will be most suited when you are single since most spouses would probably not want this and definitely not when you have kids. So, since this is your primary residence you can probably purchase it with very little money as a down payment. Maybe 3.5%, you may even qualify for a first-time home buyer and get almost 0% down and also you’ll get a very low interest rate. The interest can change over time, currently the lowest you can get is around 4%. For this example we’ll say you do the 3.5% down on a 30 year amortization and you get the seller to pay your closing costs so you need to bring about $4,200 to close on this house. Maybe a little more or less depending on certain other factors such as property taxes, insurance, bank fees, etc. But to keep it simple we’ll stick with $4,200. This means you have a mortgage balance of $115,800 and assuming a 4% interest this gives you a mortgage of about $552. That does not include taxes & insurance, so we’ll estimate an additional $150/mo for those plus with little down you will have to pay PMI (Private Mortgage Insurance) until the mortgage is paid down to 80% of the initial purchase. We’ll estimate that at $50/mo, it varies depending on the lender. So your total monthly housing expense is about $752. You of course still have to pay utilities as well for water, sewer, garbage, electricity, gas, internet, etc. But we won’t include those here.

With 3 bedrooms and 2 baths, one of those beds & baths are for the Master Suite. You know that rents in this area go for about $900 for a home of similar size and condition. Not ideal for a great investment. But you want to eliminate your expenses as much as possible. You work full-time and hang out with friends often so you are really not at home very much other than to sleep. You find some friends who are looking to pay less rent as well and would be happy to move in with you. You, being a savvy investor, make them sign a lease agreement, just in case. You are find with taking one of the smaller rooms and sharing the extra bathroom with one of your friends. You rent out the Master Suite to your friend for $500/mo. About the going rate for a 1 bed, 1 bath in that area but he gets the benefit of living with friends. You rent out the other room to another friend for $350/mo. He’s happy because he would have to pay at least $500/mo for anywhere else. You all split the utilities evenly as well. Your share of the utilities is about $80/mo. So you are now receiving $850/mo in rental income which more than covers your full mortgage bill and since it is over that amount by $100, it covers your utility bill as well and even nets you $20/mo.

You may be thinking $20/mo isn’t great. But you need to consider that you have eliminated a monthly expense to you of about $850-900 for the mortgage and utilities that you would be paying. Saving you this expense means that you now are “earning” that much more each month. But you also are getting your mortgage paid down by your roommates. This adds up over time and as the mortgage goes down you build up equity which adds to your net worth. Over time you also start making updates to the kitchen, baths, flooring, windows. You get your roommates to help you paint as well. After 2 years your house is fully updated and can now appraise for $160,000. Your friends moved out and you brought in new ones to replace them but since the property is much nicer, you rent out the Master suite for $650 and the other room for $450. You are now cash-flowing a few hundred a month. At this point you see the great benefit this has brought you and you have been able to save up a lot of money by eliminating your housing expense. At this point you are ready to do it again. But with a new complication, you are now engaged to be married. (side note: This scenario could have been done with a spouse on board and you would have taken the Master Suite and rented the other two rooms for $350 each. This doesn’t completely eliminate your living expense but does greatly reduce it.)

Scenario 2 – a small multi-family

We will continue the case from the first scenario for fun here, but this scenario 2 could also be used in a similar fashion to scenario 1. You decide you want to continue building wealth with rental properties and continue doing it with low down payments and low risk. You find another great opportunity with a fourplex that is located close to your work and is in a desirable area. It is also in good condition, could use some minor updates to give it a facelift, but nothing major needed. Each unit is a 2 bed 1.5 bath. The asking price is $250,000. Two years ago you may not have qualified for this amount, but because of your smart first house-hack, you saved up money and can now also include the additional rent income from that property ($650+450+450-since you will move out = $1550/mo*12 mo = $18,600) with your w-2 income which helps get you to a higher income level and since you were smart with your money you don’t have any debts other than a car payment on an older car that costs you $80/mo. And since you are using a lender who understands rental properties, she also includes the expected rental income from the fourplex. Each unit will rent for $750. Since you will live in one she counts the other three units as an additional $2250/mo or $27k/yr. Wow! With this purchase your total gross income from rentals will be $45,600. That is great because every lender and credit card bureaus will count that gross income along with your salaried income to give you a new total income. Maybe your work salary is $45k/yr gross, so now you essentially doubled your income.

So here are the details, you get approved for the loan. You again go with the 3.5% down on a 30 year fixed at 4.25% interest, since it has gone up in the last 2 years but your credit is great and you are buying it together with your soon-to-be spouse. You will get married before the closing date on this property. You again get the seller to pay closing costs and your down payment will be $8,750 which you were easily able to save up since you had no housing expenses the last two years. Your new mortgage principal will be $241,250 with a monthly mortgage of $1,187 plus interest and taxes and PMI which brings you to a total of $1,587. Since these are separate units you will pay your own utilities which will run about $100/mo. So your total housing expenses are $1,687. Remember, the other three units rent for $750 each totalling $2,250. Which means you have a net gain of $563/mo. Amazing! And don’t forget you are also now receiving extra rent on that first property since you rented out the room you were living in for $450 which means you now net on that property about $800/mo. This gives you a total net rental income of $1363/mo. You self-manage both properties and have very minimal maintenance expenses. So now, not only did you completely eliminate your housing expenses, you are now earning an additional $1300/mo which should definitely cover your other living expenses such as food, utilities, entertainment. But of course you are smart and not going to go spend this additional income. You keep your expenses low still and continue to save. Since you are in a 2 bed apartment, you could even entertain the idea of renting the extra room to your sister-in-law for $200 to help her out.

Why this is so powerful

Let’s review this again. When you started 2 years ago you had virtually nothing. You had a job and you paid rent and very little savings. You bought a house with very little down, as most people do. Many of your co-workers bought a house at this same time. But what you did differently was optimize that house to be a true asset for you and not a liability. For most of us we consider a house as our biggest investment. That is not the correct way to think of it, it is actually a horrible investment. But we’ll save that for another time. It is a liability because it is something you have to pay for or the bank will take it away. But if you can convert it into an asset, something that makes money for you, then you are in a much better financial position. You essentially give yourself a raise, and really a tax-free raise, by eliminating your biggest expense. You then are able to save more money faster and paying down your mortgage with other people’s money. You create wealth and it put you in a position to buy your next property the same way. And you continue to grow from there building wealth, increasing your income, and gaining experience as a landlord. A househack is like training wheels for a landlord. Keep in mind there will be some additional tax items to deal with because of depreciation since you have to split it with the portion you live in, so please consult with a Real Estate tax professional to help you with that. But don’t let that alone scare you away from this best way to get started.

What’s next?

You are now on your way to Financial Independence and Early Retirement. You have already about matched your work take-home pay with your cash flows. You of course want to continue house hacking since it is so powerful. But you know your time to do it is limited. You can maybe do it one or two more times since you want to start a family and have lots of children. Although you can still do it with a family, it just becomes more difficult with more kids since you need more space and most apartments like this have a max of 3 beds. So after one year you have been able to save up a substantial amount of money. Your expenses are practically nothing so you can save most of your work income plus you have been saving your rental cash flows and your spouse worked a part-time job so with all of that you saved $50k. You are ready to move up. You also made some minor updates in the fourplex and raised rents on the other units to $725. You are expecting your first child and want something a little nicer. You find another fourplex and repeat the process. This one you buy for $325,000. It is still a 2 bed 1.5 bath but is larger. Each unit is about 1200 square feet and in a nicer area of town. Each unit rents for $900. You do the same as before, 3.5% down interest still at 4.25% on a 30 year note. You need about $12,000 down including closing costs, your mortgage is $1542 plus property taxes, PMI, & insurance brings you to $2100/mo. The other three units at $900 each bring in $2700/mo. So again you are ahead by $600/mo.

Remember your very first property, that single family house? Prices have risen over the last 3 years and because of the updates you made it is now worth $180,000. You want to start buying more rental properties as a direct investment, not a house-hack. You try to decide between selling that house and taking the cash to use as a down payment, or taking out a HELOC. Since you lived in the property for 2 of the last 5 years, you can sell it and pay no capital gains taxes. Your balance is around $108k and if you sell, after paying commissions and fees you would net about $55k. But it is making you a great return as a rental. You can get a HELOC and take out 80% of the appraised value which would get you about $36k to use, or option 3, you could do a cash-out refinance and thereby take away that PMI expense as well. But by doing that you would increase your mortgage and decrease your cash flows since it would now be an investment property you have to pay higher interest. In the end you decide to sell since it will be your last opportunity to sell it without paying taxes.

You now have $55k from the proceeds plus your other $50k you saved up. That gives you $105k. By now you have had your first child and have a second on the way. At this point your spouse is insisting on having your own home to raise the kids. You first find a large 20 unit apartment building in great condition in need of very little to no repairs or updates. Each unit rents for $500 which is $10k/mo. It is in a good area and is selling for $750k. Typically you will need 25% down to acquire this which equates to $187,500. You don’t have that much in cash saved, but you can potentially borrow the difference from a private lender. However, you instead decide to attempt some creative financing. You ask the seller to provide seller financing with $100k down payment. You are surprised that the seller agrees. So you now put $100k down at a 7% interest rate with a 30 year amortization with a balloon payment in 5 years. That means you have to pay the seller the rest of the purchase price within 5 years. That doesn’t scare you because you know the rents are under market value and within 5 years chances are the property will be worth more and because of your other rentals you will be able to save up more and get a bank to refinance in that time. Your new mortgage expense including all expenses and accounting for maintenance, capex, and property management, since you don’t want to manage this one, come to $8,000. This nets you $2,000/mo in cash flows. But over the next year you make some small updates and increase rents to $600 each which is $12k/mo which also increases the cash flows now to $4k/mo.

As unbelievable as that sounds, it is totally possible. You now have a combined gross rental income of $15k/mo from your 3 properties consisting of 2 fourplexes and one 20 unit. That is a gross yearly income of $180k. But even more amazing is that your monthly cash flows, the amount that is left over for your actual cash income, is $1300 from the first fourplex, $1500 from the second fourplex and $4000 from the 20 unit. That is a net of $6,800 in monthly cash flows. Congratulations, you have surpassed your monthly take-home pay and if you decide to do so, can easily quit your job. But you decide to hang in there a little longer, mainly because you want to now buy your primary residence. You still do the same low-down payment option just because you want to preserve more cash to invest in more properties. You find a nice 5 bed 3 bath home and buy it an live in it with a monthly total housing expense around $1100/mo. But that is easily paid for from your full-time job you still have and can save the additional $6800/mo to continue to build to buy more rental properties since now going forward you will need more money for the down payments.

Looking Back

This scenario may sound far-fetched but it is completely 100% possible. Many have done something similar. It is hands-down the best way to get started in Real Estate investing. Unfortunately for many of us that get started in REI later in life, we are way past the possibility of being able to do a house-hack. I have 4 kids and there is no way we could do this, with the some exceptions such as if we bought a house that has a guest house or converted garage to rent out. But even then, that intrudes on privacy and could put your family at risk. So it is not for us. This is why I said it is best to do this when you are single or newlywed with maybe one or two small children that don’t need a lot of space.

To this day I WISH I had known about house hacking when we bought our first home. It would have made a HUGE difference in our current financial position. I highly suggest this method to ANY young person getting started or ANY single person or couples that have no other dependents. The compounding effect is immeasurable. Let’s just do a quick simple comparison to the case described in this post to another person that did not do this who has a same paying job and lives as most others do, with a larger car expense and no savings.

___________House Hacker_________Co-Worker; Non-House Hacker

W-2 Income	$2500/mo take home	$2500/mo take home
Expenses:
Housing exp Yr 1	$20	$900
Car expense	$80	$150
Eating out	$30	$120
Groceries	$120	$200
Cell Phone	$10	$115
All other	$60	$120
Total Expenses:	$320	$1,605
Monthly Earnings	$2,180	$895

(The $10/mo Call phone bill is possible, I use this myself. I’ll explain in a later post.)

As you can see there is a HUGE difference in what each of these people are able to save. And it is very likely that the “other” expenses would be a lot more for the non-frugal person as people tend to spend what they make and save less than 5% of their income. He would be spending on nice things for the house, to fill every room with new furniture and a big tv and probably buying those things on credit which will give him a monthly debt to pay. Not to mention he probably would not have bought a similar house to begin with but would have instead bought a nicer house because he can “afford” it. This difference has a huge impact for enjoyment of life and the pursuit of financial independence. The house hacker will save to buy another property and maybe take some nice vacations along the way. The non-house hacker won’t be able to afford a nice vacation and will probably be stuck at the job they hate because they have to afford their lifestyle.

As time goes on and the house hacker moves to the second property, let’s see the difference. In all cases we assume additional expenses took place such as vacations or gifts purchased, etc.

___________House Hacker_________Co-Worker; Non-House Hacker

W-2 Income	$2500/mo take home	$2500/mo take home
Rental Cash Flow	$1,363	$0
Expenses:
Housing exp Yr 3	$100	$900
Car expense	$80	$150
Eating out	$50	$150
Groceries	$120	$200
Cell Phone	$10	$115
All other	$60	$150
Total Expenses:	$420	$1,665
Monthly Earnings	$3,443	$835
Cash Saved	$40,000	$1,500

As you can see in both cases some expenses went up. But where the bigger difference shows is in the monthly income. The additional rent helps offset the increased expenses and therefore boosts the savings rate. As time goes on which of these situations would you rather be in? After the next two properties are bought if both of these people were to be in an accident which left them unable to work, who would be better off? Remember the house-hacker now is receiving almost $7k/mo in cash flows. That number will go up over time as rents increase and other expenses decrease. If this person can no longer work, the cash flows will be able to support the family. You simply cannot afford that peace of mind in any other way.

Recap

With some smart financial decisions you can set yourself up to live the life you want and be completely retired from a W-2 job by the time you are 30. Then have the rest of your life to enjoy, spending time with family, traveling the world, volunteering in your community, etc. This is what life is for. Life is not meant to be lived in a cubicle. We are here to be happy and enjoy life. It’s up to you to make that happen. You can follow the crowd and work until you reach traditional retirement age and hope your health and savings are good enough to actually enjoy it. Or you can put yourself in a strong financial position early on to get out of the job that is holding you back and get out to have the best life possible for you.

This is the #1 strategy I have been trying to instill in my kids so that when they get out to start their adult lives they start off on the very best way possible and put themselves in the best situation to not have to deal with the stress and headaches of housing expenses and provide them with additional income. If I could go back in time this would be the one things I would have changed in my own life.

I hope this has also been able to help you realize the power of house-hacking as the #1 very best way to get started in Real Estate investing AND serve as a powerful method to be saving to reach your FIRE number. Additionally, it was not mentioned, but with that savings that is being built up, it could be put into an Index Fund to be growing as well so that it is not just setting in a cash savings account earning very little interest.

Feel free to comment or send me your questions. I would love to help you make this happen in your life.