September is just looming around the corner and for the more than 250,000 college students and young professionals in Boston, this means one of two things: agree to the extortionist increase in rent OR start looking for greener pasture (aka new housing).
Of course with median rent cracking over $2000/mo, greener pasture isn’t always better. This is certainly a problem many of us can commiserate with in Boston. In 2011, just after one of the worst recessions in recent history, I ran into a friend living next to the Green line who introduced me to house hacking or the art of creative real estate investing. In other words, he was living for free in the 4th most expensive city in America with enough leftover rental income for grocery!
The reality is that if you’re even moderately responsible with a plan to stay in Boston for at least 5 years (like most working professionals and PhD students), house hacking can actually help alleviate the stress of moving and economic uncertainty. This was the financial squeeze I felt 3 years ago right after college. With much help from family and friends, I’ve dived into the world of house hacking and have learned a tremendous amount (mostly through hard lessons) from seasoned investors and mentors. To hopefully spare you the hard lessons, here are 5 steps to get you started on your house hacking journey!
Step 1: FINDING
There is a popular investment adage: find a good deal and the money will find you. This is true even for new house hackers. You have to first find yourself. Ask yourself where are you in your life? Do you have a stable job? Do you pay your bills on time? Do you mind living with roommates? Where is work for you and what living situation can you tolerate? If the only places you’re willing to live are in Coolidge Corner or Back Bay, then your house-hacking options may be extremely limited. In short, this is because it’s cheaper to rent than it is to buy in these areas. That being said, there might still be good deals if you can FIND it. Once you’ve found yourself. You need to find your team. Your team should be comprised of (at a minimum) an investment-minded real estate agent and a good loan officer. Here are some quick tricks to test drive your agents. Speak to at least 3 investment-minded real estate agents. Ask them if they are investing in real estate and have personal house hacking experiences. This is an important question because there are nuances to ownership that most seller/buyer agents won’t be receptive to. Next, use the same criteria to qualify your loan officer/lender. Ask for an updated pre-approval letter on a sunny Sunday Afternoon and see how fast they’ll turn around. This is a good test because in a competitive market (such as Boston), your ability to submit a quick offer is critical and since most showings take place on Sundays, you need your house hacking team to be ready at a moment’s notice!
Step 2: ANALYZING
Once you’ve found your team and your properties, you’ve got to put in the due diligence and run the numbers. Now, there are several good deal analysis calculators available online (check out this one from Biggerpockets) but there are regional and even local exceptions that can affect your bottom line and operating expenses. As an example, if you’re in a class C or D neighborhood, the norm might require the landlord to pay for utilities which will ultimately affect your cash flow. This is also why we recommend that you invest in your backyard where you have an unfair advantage. Even with that being said, here are two simple formulas that can help you avert some beginner mistakes:
Rent-To-Value Ratio (RTV): This is defined as the value of the property divided by the monthly rental income. This value is best utilized as a rule-of-thumb as you’re scanning through hundreds of deals that will be sent your way. Generally, the higher the RTV, the better a deal MAY be. In Boston (and greater Boston area), RTVs can fluctuate between 0.3% and 1.5% on face value. And there is a general correlation between RTV and the classes of neighborhoods across Boston and surrounding cities. In Brookline, the typical RTV may be hovering under 0.5% while in Roxbury, you’ll find deals above the 1% mark!
Monthly Cash Flow (CF): Cash is king and once you’ve identified a target deal via RTV, it’s time to calculate just how much margin you’re working with. In short, your cash flow is your Total Rental Income subtracted by ALL your monthly expenses related to the property. Rentals are fairly easy to calculate. You can ask neighboring landlords and tenants. You can use craigslist to do a rental analysis. You can even ask your broker. The devil is in the expenses. Here’s a short list of potential expenses: Mortgage Payment, Insurance, Real Estate Taxes, Utilities, condominium fees (if applicable), reserves for repairs, snow removal, etc. Ultimately, if you’re house hacking, your cash flow needs to be positive. Don’t cut corners and try to make the numbers work as most beginner investors end up doing. Conversely, if your numbers work out, make sure you take the leap and don’t get paralyzed by indecision and overanalysis!
Step 3: BUYING
One of the biggest misconceptions about house hacking is financing. Young professionals are typically discouraged by the astronomical price tags purported by sites like zillow and trulia. But there are creative options available if you’re willing to do more digging and asking. Unlike buying a meal at a restaurant, you can (and should) finance your purchase. This means for a $600k house, you can put down 20% or $120k as initial down-payment and carry a monthly mortgage payment (principal/interest) of ~$2,024 per month at a 3% interest rate for 30 years.
If you’re unfamiliar with these terms and numbers, your loan officer is a great source of expertise! In the scenario above, you basically asked a bank to lend you $480k to buy this house and you agree to consistently reimburse the bank over the course of 30 years. The bank benefits from this transaction because they are able to make a 3% interest. Lastly, let’s factor in homeowner Insurance and real estate tax which yields approximately a monthly payment of $2,474.
Now, $2474 is a heavy monthly burden but this debt can be easily buffered by your potential rental income. Let’s assume that the house contains a total of 5 bedrooms and 2 bathrooms. If you rent out each room at $750/month, that’s a gross rental income of $3,000. If we use the cash flow equation above, you’ve gained $526 a month while you live for free.
Another value that we want to pay attention to here is the down-payment. Afterall, $120,000 is no chump change! So how do we navigate around this? This is where having a great loan officer can save your day. The US government actually wants to promote 1st time homeownership and consequently have put in place amazing programs for new buyers. Programs such as FHA, BRA, Mass Housing, USDA, VA Loans are just a few that you can leverage to house hack the down-payment. If you have a good friend/loved one that will be sharing housing with you, you can also co-borrow with $60k down each. This may mean that an extra room will be utilized but you’re still pulling in $2,250/mo with the example above. Not a bad deal. If all else fails, you can also take a personal loan from your family. Owner-occupied borrower are allow to accept a gift from family as a down-payment. Here’s a great way to frame the request to you mom and pop, “I need a co-investor and here’s your opportunity to invest in an asset that will yield over 12% each year!” Great financing helps to set the stage for continual growth with your house-hacking journey!
Step 4: MANAGING
At this point, you’ve secured a killer financing deal and you’re ready to enter the management phase of your house hacking journey. This can be generally broken down into 2 main domains: tenant acquisition and property management
Depending on the location of your property, you may be targeting different tenants/housemates. For instance, a house in Allston will likely attract college students and graduate students. If you’re in the Longwood and Mission Hill area, you’ll likely attract healthcare professionals given the proximity to all the major medical centers. Understanding your target demographic is important because this will help craft the message in your rental ad as well as the platform that you use. Craigslist is a default in the Boston area but if you’re targeting Northeastern University students then some low-budget flyers by the student center might be more effective. Your tenant acquisition should also include robust (also non-discriminatory) screening tools. Effective tenant screening such as references and credit reporting can help avert some costly management issues down the road.
Property management probably imbues the most fear into new house hackers. And yes, it’s unavoidable. Most of us are brought up in sheltered household where all of our needs and services are outsourced. The reality is that if you want to house hack you NEED to know how to manage your property/tenant.
The short answer to a great property manager is professionalism. But this doesn’t mean you can’t be friendly and helpful. Once the tenants (in this case your customers) are moved in, your job is fairly simple: make sure that THINGS WORK and collect rent ON TIME. I’ve met landlords with varying degrees of management style. Some had elected to outsourced to a property management company at a cost to their margin. Others are hands-on and want to be involved with every repair. You need to discover your comfort level, strengths and weaknesses. If you’re in your twenties, chances are you haven’t had to deal with a broken furnace or changing out a PVC pipe. But the world is a lot safer than it seems! You’ll be amazed at the contents you’ll find online and this is really how your sweat equity and willingness to learn will literally pay your off. In short, be courteous, be professional and ask for help when you need it.
Step 5: EXITING
Like any big projects in life, you want to start with the end in mind. This does not have to be precisely figured out but it helps to examine some exiting strategies available to house hackers.
One option is long term holding. Assuming that you’ve secured a solid deal with positive cash flow, you can simply sit on the investment through maturity. Let’s assume that you’ve made this investment when you’re 28 and if we use the example above, you’ll be netting more than $2,600/month as passive income by the time you’re 58.
As most young professionals would lament, it’s hard enough figuring out my situation in the next 5 years, let alone the next 30 years! Wouldn’t investing in a property lock me down to an eternity of monotony?!
Dramatic flares aside, there are a number of creative ways to grow and exit with house hacking. The simplest of which is to sell it. Houses in Boston have appreciated 9% since last year (REF: TRULIA) and we expect at least modest gain in home values for years to come. Even with zero appreciation, you would have gained equity through your rental income which you can also cash out on. Finally, if you have plans to purchase another property in your new location, you can also tap into the 1031 Exchange Program to avoid taxation on any appreciation. Additionally, if you have a gem and you want to hold it from afar, there are also qualified contractors that can manage your property with you being out of state. The lesson here is that life is constantly in flux and there are creative strategies to manage your real estate in lieu of those changes.
In summary, I want to note that the intent of this post is not to promote a get-rich-quick scheme. As I’ve prefaced earlier, finding yourself and defining a fairly stable situation is a critical prerequisite for house hacking. It’s also important to recognize that house hacking is merely a set of creative tools to help you grow financially. It should NOT take you away from your passion, your career and your loved ones. With that being said, it’s a brave new world bustling with opportunities out there. I hope this has been a helpful introduction and good luck with your house hacking journey!