House hacking: A process where you buy a rental property using tactics typically used for primary residence purchases. You then live in one of the units and rent out the others. The goal is to pay down the mortgage, allowing you to refinance or buy a single-family home, and potentially flip it while living in it.
So why do new investors often become house hackers instead of buying with financing options available to investors?
1. House hacking allows you to put a smaller percentage of the purchase price down when buying a property. This means a real estate investor can buy a $300k 2-unit building with only a $9,000 down payment instead of the standard 20 to 25 percent down, which would be $60,000 to $75,000 down.
2. A young couple may decide to buy their multi-unit property with an FHA loan. Suppose the property is less than four units. In that case, it is eligible for an FHA loan, which means not only is your down payment lower, but the house hacker can get a loan with a lower credit score than if they were to buy their investment properties with a conventional loan.
3. Lower property taxes equal higher passive income: living in a home means that you qualify for the homestead tax exemption, which can cut the tax bill for a Chicagoland area investor by $600 to $1000 a year. Your homeowners' insurance is often slightly lower as well when you live on-site.
4. Exemption on capital gains tax when you sell the home for a profit. When you sell a home that you have lived in for three out of the last five years, you are exempt from capital gains tax for the first $250,000 if single and $500,000 if married, which is a considerable boost in net profit.
5. The possibility to have your mortgage paid fully by your tenants and not have a housing payment.
So, house hacking sounds amazing. Why would someone not want to house hack in the Chicago area?
1. The obvious one is you need to live on site, so unless you are doing a flip, odds are you won't really be able to live in single-family homes while you build your investment portfolio with house hacking.
2. Building a real estate portfolio with house hacking is slower since you can only buy one property at a time. If you have the money to put down and build your investment portfolio faster, then you can hit your goals much quicker than buying a new property once every few years.
3. A higher monthly mortgage payment means less cash flow from your rental units. Because you are putting less down, you are paying more a month and more interest than if you put more down, which drives up monthly housing costs, making your rental income lower.
4. Even with property management, it is much harder to hide from your tenants the fact that you own the building. This means that if something goes wrong or if they want to beg for an extension on paying their rent late, they just have to walk up a flight of stairs to find you and ruin your quiet enjoyment of your home.
5. You cannot use house hacking techniques to buy large multifamily properties; the advantages only work up to 4-unit homes. As you become more seasoned investors, you're likely to transition to buying larger multifamily homes for a better return on your equity.
Even with the negatives listed above in terms of starting investments and getting your first deal under your belt, it's hard to beat the advantages of house hacking. So let's run through the steps of buying your first two investment properties as a house hacker.
Step one: Get preapproved. There are several types of loans you may want to use for a house hack, including FHA, Homestyle renovation loans, or even conventional loans. Make sure to ask your lender about any grants available, as Illinois usually has down payment assistance for your first home to bring your down payment amount down even further, allowing you to buy a more profitable building. Once you are pre-approved, you know how much you can spend to buy a home. Remember to have an idea of how many units you want to buy, because the rental income can be used as income to get approved for a higher amount on your loan. If you are going to buy a home that needs a lot of home improvements, it may be worth looking into the homestyle renovation loans, which give you the money to buy and fix up the home. This approach works for both long-term hold house hacks and single-family house flips. Just understand that if you are flipping the home, you will want to live in the home for at least a year.
Once you have your pre-approval letter, it’s time to start looking on sites like zillow.com, redfin.com or homes.com for a property that may suit you. If you have one or can afford a good real estate investing real estate agent, they can often be worth their weight in gold, finding you great deals both on and off market.
Once you locate something that looks like a great investment property, run it through our rental analysis and make sure the numbers work the way you think they will.
If everything looks right, the next step would be to talk to our Chicago property management experts to help you run your projections. This ensures that you are not buying a property that loses you money with hidden expenses.
After you have determined that your rental property meets the criteria that you are looking for, put in your offer. If it gets accepted, make sure to get a professional inspection done within the five-day attorney review period. If you need an attorney, check out our recommendations here .
After the purchase is complete, move in, rent the other units, and pay your mortgage to get 25% equity as fast as you can using the rent income. Between appreciation and rent income, you can accomplish this within a year or two, many times.
Now that you have 25% equity, it's time to refinance to a non-owner-occupied loan. This will allow you to move and buy your second property with another FHA loan and again be able to buy the residential property with only three to five percent down. continue using this and our monopoly strategy until you can stop house hacking and buy commercial properties (meaning multi-unit properties) with more than five units.
Some bonus ideas for house hacking:
Accessory dwelling unit: This allows you to buy a single-family house and rent out a part of your property which is set to be its own apartment. This may be a unit in the basement or above the garage. Chicago area zoning laws don't always allow this, so make sure that you check all zoning laws before buying an investment property that you think can have an accessory dwelling unit that can make you some additional income.
Living the bachelor life: Buy a single-family house and turn it into a bachelor pad. Get your friends to rent out bedrooms to help pay down the mortgage.
House hack your way through college: instead of renting a dorm room or off-campus property, if you are a college student or parent of one, buy the condo or house near the campus and rent out the rooms to your friends to help pay it off. Once you graduate, sell it and make your profit tax free since it's your primary residence.
A house hack is a great way for a new investor to start their journey to long-term wealth, and we at Chicago Style Management are here to help even if you're not ready to hire a property manager. We are here to help give you feedback on your deals. Give us a call today and let's chat and build your wealth: 224-601-5415
