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 lets look at things in a different way. I am going to 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 stayed in one room and rented out the other 4 rooms. House hacking works extremely well with small multifamily properties.
Lets say you focus on purchasing a 4 family apartment every 2 years. This 4 family apartment building cashflows $200 a door, including paying for professional management. Lets say you self manage it and after costs associated with that earn an extra $50 a door.
With each of these 4 families while self managing it, you are making $1,000 a month cashflow. Ignoring principal pay down and appreciation, which 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 am going to 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
Property tax: $300
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 this was just the first 4 family I saw on the MLS and assumes sale price is exactly what it is listed for. If you are spending 1 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 as this, do not despair. It is possible to make this strategy work with less cash flow per building, you will just 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, which has 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. From when you decide to start, it may take a year to acquire your first building. Then it may take 2 years to get a 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 5 years.
In this model, it will take 8 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 mixed 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. With the 3.5% down payment option, you are effectively under water 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 being able to achieve 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. If you acquire 6 buildings at 4 units each, you will have 24 units total. 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 be able to 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, it is a real portfolio builder.
In my market, there are tons of 4 family properties that meet Fannie Mae guidelines. In your market, this may not be the case. If it is hard finding traditional 4 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 you are living there. But more importantly, you will want to find one that when you rent out the whole thing you will be able to earn a solid cashflow.
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, toughen up, you are trying to achieve financial independence and that requires sacrifice. On the other hand, uprooting your life every year or two has very real 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 as well as a single person.
If you are going to use this strategy, it should be noted that you will want to optimize your life for moving every year or so for a few years. In order 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 cashflow. It can also give your balance sheet a boost while building equity which you can tap into later in life.