In this article, I did some math on retiring on $60,000 a year. To retire, you needed to save up about 2.7 Million. Now let’s look at things differently. I will go through how you can achieve a similar income with closely held real estate holdings while having to save vastly less money.
What is House Hacking
House hacking is a term coined by Brandon Turner, and it is simply buying a home and renting out parts of it to cover some or all of the mortgage payments. My first property was a house hack in a college town where I stayed in one room and rented out the other four rooms. House hacking works extremely well with small multifamily properties.
The Model
Let’s say you focus on purchasing a fourplex apartment every two years. This four-family apartment building cashflows $200 a door, including professional management. Let’s say you self-manage it and after costs associated with that earn an extra $50 a door.
With each of these four families, you make $1,000 a month cash flow while self-managing it. Ignoring principal pay down and appreciation will only make this technique sweeter. You would only need 6 of these buildings to achieve financial independence.
How much does it cost per building?
For this example, I will pull data straight off the MLS in the market I am in of Cincinnati. On this building, I have not done any due diligence on the condition of the building. Besides that, the building looks rent-ready in the photos, and the price is about what I would expect in that neighborhood for a rent-ready building.
This building costs: $175,000
Down payment: $6,125
Closing cost estimate: $4,000
Total investment: $10,125
Rent: 750 x 2 + 650 x 2 = $2,800
Mortgage payment: $900
Insurance: $70
Utilities: $250
Maintenance: $150
Management: $280
Property tax: $300
Vacancy: $140
Total expenses: $2,040
Net income with management: $760
Net income self managed: $1040
Those numbers may be a bit optimistic for that specific building, but again these were just the first four families I saw on the MLS, and it assumes the sale price is exactly what it is listed for. So if you are spending one year before purchasing your first property, chances are you will be able to find one that has better economics than the one I found in 30 seconds.
If you cannot find a building with as good of cash flow economics like this, do not despair. Making this strategy work with less cash flow per building is possible, and you will have to purchase a few more buildings. Perhaps in your market, the total price is higher, which will, in turn, mean that principle paydown will have a greater effect on your total investment returns.
This is on an FHA low-down mortgage with a higher interest rate than a traditional mortgage. If rates are still low, it would be possible to refinance after several years when your equity is higher and get a lower monthly payment.
So how much do I need to save up?
In this example, you would need $10,000 to make your first purchase. You will probably want to have another $10,000 that is somewhat liquid in case of an emergency with the property.
How long will it take?
I believe this is a discipline that benefits from momentum. When you decide to start, it may take a year to acquire your first building. Then it may take two years to get the hang of the ropes, save up enough money, and feel confident buying your second one. Then you could conceivably buy one more per year for five years.
In this model, it will take eight years to achieve financial independence. This model caps out in speed because banks will only let you do owner-occupied low-down payment loans every 12 months or so. If you mix this method with the BRRRR method, you may be able to grow your portfolio even faster.
What is the down side?
The low down payment FHA owner-occupied loans come with a lot of fees. They also come with many terms and conditions that restrict lending.
In this model, you will be highly leveraged. However, with the 3.5% down payment option, you are effectively underwater on the day you purchase the building for two reasons.
- If you purchase on the open market, your purchase price is higher than what anyone else offered.
- To sell the property there are transaction costs that will amount to more than 3.5%.
If you are dedicated to this method, the risk of being upside down will be outweighed by the benefits of achieving financial security in such a short period of time.
But am I Really Financially Independent if I Self Manage?
Sort of. While there is no such thing as truly passive income, self-managed real estate is not the most passive. For example, if you acquire six buildings at four units each, you will have 24 units total. Therefore, self-managing a unit may take 10 hours per unit per year, or 240 hours per year. This is about 20 hours a month or 4.5 hours per week.
Sure, this probably makes it hard to take extended travel or spend periods of time focused 100% on something else. But if you continue to grow your portfolio, you could switch it over to being professionally managed at any point. Also, by the time you have 24 units, you will likely have a pretty solid team in place where you will handle most issues without physically stepping foot into the building if need be.
Should I go for a Single Family House?
This model works really well not because it is focused on the cost reduction of your living expense but on acquiring quality assets using mortgage products that benefit owner-occupants. While true, it certainly will reduce your housing cost by offsetting it with income, and it is a real portfolio builder.
There are tons of 4 family properties in my market that meet Fannie Mae guidelines. In your market, this may not be the case. If it is hard finding traditional four-family buildings in your market, or the pricing does not work for Fannie Mae guidelines, then a single-family may work. You will want to look for a single-family home that you can rent out parts of while living there. But more importantly, you will want to find one that you will be able to earn a solid cash flow when you rent out the whole thing.
But I don’t want to move all the time
This is a highly valid complaint about building a portfolio this way through house hacking. One argument is to toughen up. You are trying to achieve financial independence, which requires sacrifice. But, on the other hand, uprooting your life every year or two has genuine costs to your time and mindset.
This is a much easier method to deploy as a single person or a young family. A family has more requirements for the size of the unit, neighborhood, amenities than you would if you are single. Getting everyone on the same page is more difficult. However, it is still a possible strategy to use as a family and a single person.
If you use this strategy, you should note that you will want to optimize your life for moving every year or so for a few years. To do that, you can embrace minimalism, select furniture that is easy to move and durable, and focus on storage that moves with you rather than living from cardboard boxes.
The End Goal
So the end goal of all this work is to build a portfolio that will support the lifestyle you are looking for. If used properly, house hacking can be a great tool to achieve financial independence earlier in life. It can give you a boost toward building cash flow. It can also boost your balance sheet while building equity, which you can tap into later in life.
