House hacking is the real estate investment strategy where you buy a property at a low percentage, live in one part of the property and rent out the other part so that the rent of your tenants (or roommates) exceeds your expenses. By doing this, you have likely significantly reduced or eliminated your cost of living completely.
We often talk about the benefits of house hacking, such as living for free, building equity in a property, tax breaks. What we rarely talk about are some of the downsides. Here is a list of reasons why you shouldn’t be doing a house hack, along with ways to overcome them.
There is more work behind it
House hacking is essentially a small business. While it is mostly passive, there are times when you have to work. For example, you have to fill a vacancy, process a maintenance request or keep an eye on rent and deposits.
Not only is it more work every day, but your taxes become a lot more complicated too. In addition to the W-2 that you will receive in January, you will also need to fill out a Form E and remember to include all expenses for maximum tax savings.
Chopping houses is more work than renting, but most of this work is done ahead of time or in the first few months after buying the property. Once your tenants have moved in, you may work an additional three to five hours a month. Would you spend three to five hours a month saving hundreds or thousands of dollars? The work you do on the house hack is hundreds of dollars an hour.
It doesn’t scale
To get started with real estate or to get your first starter home, house hacking is fine. It just won’t scale from an investment perspective. Some lenders also prefer lending on non-owner properties. Do not forget that.
If you do a house hack then move on quickly and make real investments. Even if you invest in a rundown property, you can fix it for a profit, but you need to deal with capital gains tax.
You have to live with others
A big reason you shouldn’t be doing a house hack depends on how you feel about other people. Of course, you lose some privacy. Even if you don’t live in the same apartment with your tenants, you probably can’t throw big parties without inviting (or asking) your neighbors first.
Living with others can be especially problematic when you have a family. Would you like a stranger to live in your home with your children? Unfortunately, it only takes one person to turn a situation into a huge problem. That may not be a risk you want to take.
If you are used to living alone, living together with others can be difficult. But living alone can be lonely. If you are house chopping as a long term rental strategy, make sure you screen your tenants carefully so you know they are paying their rent on time and making good roommates.
For a short-term rental strategy, like renting out your basement or bedroom through a service like Airbnb, you’ll have a revolving door from strangers entering and leaving your home every few days. That may not sound appealing, but you will meet interesting people from all over the world. Most people are really nice, especially travelers.
More about house hacking from BiggerPockets
You need to keep relationships professional
Another reason why you shouldn’t hack a house is if you think you are getting too close to your tenants. This is more of a problem with hacking a single family home and renting it room by room. When you do this, there is a lot of confusion about whether the people you live with are “tenants” or “roommates”. In many cases they feel like “roommates” but be careful.
You don’t want to get too close to your tenants as they may be taking advantage of you. It can be a real emotional drain on you when you can’t break your mind.
Remember, your tenants are renters, not roommates. You can make them feel like flatmates by getting along and being warm, but avoid getting too close. To combat this, be courteous to your tenants as you go by, but don’t hang out with them too often – unless, of course, they were your friends before you started chopping the house.
Owning your own house is not always all it is supposed to be
This is especially true if you’re a bit of a minimalist, just starting out, want to avoid bills, work towards financial freedom, or enjoy being mobile and traveling.
If that sounds like you, owning your own unit can become a dead weight. It is your responsibility, and it can prevent you from anything else you want to do. You can be better served by investing in a small apartment building for income and renting elsewhere. House chopping is not a problem if you have the right mindset.
It can include life in a not-so-great investment property
When you do house hoes, you do it primarily for the overall financial impact. Because of this, you may want to consider buying a relatively cheap area for which you can then ask for the highest possible rents. It’s likely an inexpensive property as it is either a little run down or in a less desirable area. In any case, you will reduce your lifestyle, e.g. B. when you move out of the high-rise downtown.
To maximize your home hacking cash flow, the best thing to do is to buy a place that will require some work. It will likely be in that less desirable location or require a significant amount of work. Buying a property that requires work but is in a decent location is a great opportunity to add value. We call this “forced appreciation”. It is enforced because you are adding value to the property yourself rather than just relying on market valuation.
Plus, no rule says you need to buy a dingy property. Your cash flow will likely be less if you buy this type of investment without first repairing it, but it will be significantly less than if you rent it. It is up to you to decide how aggressive you want to be when purchasing the house to be hacked.
You could be affected if the market fuels
Typically, a house hack is your first real estate investment. It is not easy to part with almost all savings and invest in real estate. What if we see another Great Recession and the market tanks?
It’s important to remember that the market does what it wants. You cannot control it and it is absolutely a risk. If the market collapses the day after your property closes, you will be unfortunate.
The market can fill up at any time. You need to make sure that you are fine when the market rises, when it falls, and when it stays the same. How you do that? Well, you do the numbers.
You need to make sure that you can afford your space whether you are at 0% or 100% vacancy. If not, you need to make sure that your rent (including a vacancy factor) significantly outperforms your mortgage so that if rents drop by 10 or 20%, you can stay afloat.
You need to save some money first
If you compare buying a house hack to renting it, you will find that you are spending a lot more money on house hacking upfront. When renting an apartment, you are usually responsible for the first month’s rent, the last month’s rent and a deposit. If you live in an area where the rent is $ 1,000, consider spending $ 3,000 upfront costs.
When you do a house hack, you have to cut 3% to 5% off, pay a few thousand dollars in closing costs, and then spend even more money to fix it. You want that “forced appreciation” right?
For a $ 300,000 home, you could pay $ 15,000 to $ 20,000 upfront. Then, depending on how big a rehab you need, this can get closer to $ 30,000. Even if it is much cheaper than 25% to do without a conventional investment property, it is associated with higher up-front costs than renting.
You need a pretty large amount of money compared to renting – $ 20,000 isn’t pocket money. This is when you pinch your pennies to get that amount. But there really isn’t a better return on investment – without creating a full-time job for yourself – than house hacking.
If you buy a property for $ 20,000, there is a good chance that you will get it back in full in the first year through cash flow, loan repayment, and rental savings alone. That’s a 100 percent return, and we don’t even take into account the appreciation or tax benefits associated with owning real estate.
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You are concerned – what if the tenants don’t pay?
This is absolutely a risk. You rely on someone else to give you money all the time to make your investment work.
Unfortunately, there will certainly be times when tenants won’t pay. By properly screening your tenants, you can drastically reduce these payment defaults. It’s a small price to pay considering the total return on house hacking.
To avoid tracking down late or missed payments once a month, set up a service that automatically deducts the rent from your account. There are free services that allow you to enter your rental terms on a website, tenants connect their bank accounts, and the rent is paid automatically every month.
You have to learn to run the numbers to run
Some people think that simply hacking into a property is a great way to go without looking at the specific numbers. You should run the numbers on a house hack exactly as you would use them on a regular rental apartment. This would give you perspective on cash flow and potential profits.
With these equations in hand, do them twice for a house hack. Do it once as if you are renting out the entire property and once with the income from the units other than the one you will be living in. This will give you an idea of your cash flow returns.