The wonderful world of house hacking

For those that don’t know, the term house hacking refers to purchasing a property and then renting out a portion of it. If done well, this can cover your entire mortgage and other related expenses with extra money left over each month. House hacking can be done on a multifamily property such as a duplex, triplex, or larger property. But it can also be done by renting out by the room or renting out a mother-in-law suite.

This is of course much more involved than simply renting an apartment, or owning your own home. You’ll need to deal with landlord responsibilities. But by living for free, you can start to rapidly increase your savings rate. Additionally, you get to participate in the four wealth generators of property ownership.

1.  Cash flow- reducing your out of pocket expenses each month increases your cash flow. If you make more money than your expenses, you are truly seeing some cash flow from your property (this is the more standard definition of cash flow).
2. Appreciation- property tends to increase in value over time. Since most people buy with a loan/leverage, this can be a very powerful wealth generator.
3. Tax benefits (mainly depreciation)- because property wears out over time, the IRS will let people deduct the value of this wear and tear on their taxes. This only applies to property that is rented out, and not the part of the property that you live in as the owner. But this can still add up to thousands per year in tax savings. There are other massive tax benefits that investors can take advantage of too.
4. Loan pay-down- each month, your tenants pay off your mortgage. A portion of that goes towards principal, thereby increasing your net worth.

The disadvantages of rent by the room house hacking

I am a huge proponent of house hacking. I truly believe that it is one of the most powerful ways for the average person to get ahead financially at a young age. As stated earlier, the main potential disadvantage of house hacking is that there is more responsibility. There is the obvious financial responsibility of owning property over renting. But that is not exclusive to house hacking.

And there is the landlord responsibility. Since we are focused on using real estate to retire at a young age, this is actually an advantage. You get to learn the ropes in a controlled and relatively safe way. You’re there every day to manage the place and your tenants.

In addition to those disadvantages, house hacking a single family residence has some added issues.

1. They are your roommates, and also tenants

It is really important that you take the time to learn the landlord/tenant laws, and that you have systems in place to run things more like a business. That means that there should be a lease in place, due dates and late fees should be enforced. You have to be careful not to discriminate against protected classes when screening tenants. This can create a bit of tension should things go wrong, and even when they go right, can create a bit of a strange dynamic within the house. It can be hard to be strict with renting to friends, and with strangers, you want to build friendly trust.

These individuals are also your roommates though. You want your home to be inviting and enjoyable for yourself and your tenants. So a delicate balance needs to be managed. Don’t let this scare you, however. While it does require a bit of emotional maturity to handle, most of the problems can be avoided by really vetting the people before you let them move in, and by having a good lease. Take your time to find the right roommates, and make sure everything is in writing. My friends all said that it looked so amazingly easy, as I never had any real issues while house hacking.

2. The individual timelines reduce your personal flexibility

Each tenant has their own personal life agenda. Couple that with the general transient nature of renters, and you may find that having your rooms filled is a bit unpredictable. I started house hacking in the Denver market, which is very competitive for housing. I was able to find a fantastic roommate 1 week after I moved into my home who ended up staying with me for 14 months. Once I had another room available in my property, I found a great second tenant in several days once again.

If you’re planning to stay in the same location for many years, this is not likely to be an issue. But as our goal is to build a large portfolio of properties quickly, it is advantageous to move after about one year in order to acquire the next property. However, because you may have individuals on various lease lengths, it is hard to rent out the entire property to a family or group of individuals on one lease. You could continue to rent by the room, which generally allows you to charge more money overall, but the hassle of trying to play matchmaker is not worth the hassle.

This is the biggest issue with rent by the room house hacking. If you get a job in another city, it can be tough to get out of your situation. You can reduce this issue by having people on leases that all expire at the same time, and by having set term leases (1-year lease for instance). This has some risk too, however.

3. You never know what kind of roommates you’ll get

It is paramount that you conduct background checks, criminal background checks, and really try to understand what kind of people, and more importantly, personalities that you’re making your roommates. But even if someone seems really great on paper, you never know if they’re going to be very messy. Or perhaps they’ll suddenly get really into thrash metal accordion practice.

To avoid this, be sure that you’re really comfortable with someone before letting them move in. Don’t rush to find someone just because you want to make a few extra dollars. It isn’t worth it, and if the money is that tight, you’ve overleveraged yourself which is dangerous. Be willing to say no to people, and hold out for the right fit. Also, put some of the expectations into your leases such as noise requirements, house guests, and others. And if desired, draft a roommate agreement to have expectations in writing. Setting clear expectations from the beginning will greatly reduce any problems here.

4. Harder to do with a family

While many of my younger readers aren’t likely to have a family, it is still worth mentioning. This strategy can be difficult or impossible with a family. Most people looking to rent a room in someone’s house aren’t looking to have to curb their lifestyle to accommodate children. And most parents that I know would be very uncomfortable having someone else in the house with young children around. It can be done of course by renting to close friends or family members. And as the children get a bit older, this becomes less of an issue. My recommendation here is to wait to have children until you are able to accommodate them better financially. If you live in a cheaper housing market, it will make more sense to buy a multi-family building to house hack. Then you can get the best of both worlds!

Why you should still house hack

So we’ve covered the main issues that are exclusive to house hacking a single family home by renting out the rooms. Some of these things are scary, but the main way to solve this is to be patient in finding the right roommates, getting everything in writing, setting clear expectations up front, and setting an exit strategy to get yourself out from the property. This is how I got started in real estate investing. Given that I was in the expensive Denver market, there was no way that I could afford a multi-family building. I was actually stretching a bit to afford the single-family house. But in one year this strategy increased my cash flow $600/month, added an additional 40k to my net worth, gave me access to 25k of home equity credit, increased my confidence in real estate investing, and gave me experience being a landlord. I know of no better way to get ahead financially at a young age! Go in with eyes wide open, and take advantage of this amazing wealth building strategy.