House hacking is when a homeowner generates passive income from their primary residence.
This general term covers the many ways to create cash flow from your property. You could rent out a room in your home, for example. Or you could build an ADU (accessory dwelling unit) on your property as a rental unit, if zoning is permitted. You could even purchase a multi-family building, like a duplex or triplex, and live in one of the units while renting out the other unit(s).
In each case, you’re generating passive income rather than earned income. This means you’re not having to trade your time for dollars; instead, your property can be making money for you ‘round the clock!
In this article, we’ll explore each of these house hacking strategies, as well as
- Show you how to become a house hacker in five steps,
- Take a look at the financials behind a few house hacking examples, and
- Help you steer clear of some common house hacking mistakes.
But first, let’s discuss the benefits of house hacking to explain why so many homeowners are using this real estate investment strategy.
Why House Hack? 6 Benefits of House Hacking
House hacking is growing in popularity, primarily because it provides these six advantages.
1. Easy to Start
If you already own a home, you can start house hacking immediately by renting out a room, storage space, or parking space on your property. If you dream of being a real estate investor, but don’t have a lot of cash available to get started, house hacking is an easy, accessible way to start creating passive income from real estate.
2. Favorable Financing
Financing a property as a primary residence typically comes with lower interest rates, lower fees, and a smaller down payment than financing an investment property.
For an investment property, you would be limited to a conventional loan, which requires a strong credit score. But borrowers who are financing a primary residence can take advantage of other loan types, like an FHA loan, which offers a down payment as low as 3.5% for buyers with good credit, and has options for buyers with credit issues.
3. Reduces Personal Housing Costs
The income received from house hacking can be used to help cover your monthly mortgage payment, which reduces your personal housing expenses. It isn’t uncommon for the rental income from one unit of a duplex to cover the full mortgage, effectively allowing the homeowner to live on the property for free.
4. Provides Invaluable Learning Experience
If you are interested in being a real estate investor with a portfolio of rental properties, house hacking can teach you how to be an effective landlord! You’ll learn how to maintain a rental unit, find qualified renters, and negotiate lease renewals.
5. Convenient Property Management
Since the space you’re renting out is on the same property as your primary residence, it’s easy for you to keep an eye on the rental unit. Furthermore, if there is a maintenance issue to be addressed, you can quickly and easily assess the situation and get it resolved.
6. Can Grow Wealth Through Passive Income
It is entirely possible to house hack so effectively that you earn enough to cover all property expenses and still have leftover income to pocket! You can invest this passive income to grow your net worth faster.
Top House Hacking Strategies
As we’ve mentioned, there are different ways to use house hacking as a real estate investing strategy. Your preferences, goals, and current property setup are all factors in choosing which specific house hacking strategy is right for you.
To help you decide which path to take, here are the top five house hacking strategies.
1. Single-Family Rentals
A single-family rental hack is when you rent out a living space within your current home. In most cases, this means renting out a room, but it can also mean renting out an existing “in-law suite” (a space that includes a living/sleeping area plus a bathroom and a kitchenette) in your attic, basement, or garage.
This is one of the most popular house hacking options because anyone with a spare room can do it! All you need to do is make sure the space is clean and in good repair. You may also need to furnish the space (if it isn’t already furnished) as most renters interested in this type of space will expect a furnished rental.
College students and retirees are more likely than other demographics to rent rooms in this arrangement.
2. Multi-Family Property
Multi-family properties are simply properties with more than one unit. Duplexes, triplexes, 4-plexes, etc. all qualify as multi-family.
Multi-family house hacking requires a little more planning; most homebuyers don’t search for properties with multiple units unless they are deliberately looking to generate income from the other units. Multi-family properties also typically cost more than single-family homes and may have stricter financing requirements. But with the ability to generate multiple income streams, the investment may be well worth it.
Military service members and veterans have an additional advantage when using the multi-family house hacking strategy; these groups can use their VA loan benefits to potentially buy a multi-family property with 0% down (as long as one of the units is the borrower’s primary residence). This makes it extra easy for military members and vets to become real estate investors.
Learn more about how to invest in multi-family real estate.
Because of the housing shortage in many high-demand areas (like California), more state and local governments are creating allowances for ADUs. ADUs are additional living units built on existing single-family properties. In some cases, ADUs are built into the property (by converting an unfinished basement into an apartment, for example). In other cases, ADUs are stand-alone structures next to the main house.
As long as your property is zoned to allow an ADU and you have the space available for the structure, you should be free to build your ADU, find renters, and start collecting your rental income!
4. Short-Term Rentals
While long-term rentals are more common for the house hacking structures covered so far, it’s also possible to create short-term rentals out of those spaces if you’re located in a market with short-term rental demand.
Short-term rentals, also called vacation rentals, are rentals of less than a month. Homeowners who live in popular tourist destinations can earn higher nightly rates on their rental spaces by offering them to vacationers. And, since you live on-site, you’ll be able to check your renters in and out and easily handle the “turn” process between guests.
5. Storage Rentals
If you’re not comfortable sharing your property with other residents, you can still benefit from house hacking; simply rent out storage space on your property!
Many people have more stuff than they have space to hold it all. They might just have personal household items to store, or they might have a vehicle or equipment to store. If you have room in your attic, garage, basement, or barn, you can generate passive rental income from those spaces. And if you just have land, you might allow someone to store a boat, RV, or extra vehicle on the property.
This is the lowest-maintenance option for house hackers.
How to House Hack in 5 Steps
Here is a simple five-step plan to help you start house hacking.
1. Clarify Your Goals to Decide on a House Hacking Strategy
What are you hoping to accomplish with your house hack?
If you want to optimize passive income, and you’re willing to relocate from your current place, a multi-family property is probably your best bet because it will give you multiple cash flow streams.
If you want to maximize your returns on your current property, an ADU may be the right path for you. No room for an ADU? Then go the single-family route by renting a room.
Do you live in a tourist town? Capitalize on visitors with a short-term rental.
As you consider your options, pay close attention to local laws that govern how you can use your property.
Now, if you’re able to use an existing space as-is, you can skip ahead to Step 5. For everyone else, it’s time to consider your finances.
2. Get Your Finances in Order
If you’re buying a new property or building an ADU, you need to establish a budget and understand your financing options.
For building an ADU, you simply need to research costs. Building the ADU on your own can save you money on labor, but could take longer to complete. You might be able to get a home equity loan or HELOC (home equity line of credit) to finance the build if you don’t have cash on hand.
For those who plan to buy a property to hack: you’ll need to determine how much you can afford and make sure you qualify for any funding needed. Those of you who read our first-time home buyer tips, know that you need to get pre-approved for a mortgage loan before you start looking at properties. This is even more important for house hackers because the financing options and terms may be different, depending on the property type you’re looking to buy.
3. Analyze Potential Properties and Secure the Right One
If your chosen house hacking strategy requires buying a property, you’ll want to invest some time in analyzing multiple options to select the right one.
There are many things to consider when buying a rental property, particularly when you also plan to live there yourself. Not only do you need to make sure that the income potential makes sense, but you also want to find a place you’ll be happy to live in.
Spotting a good real estate investment is mostly about location and budget. The old adage about buying the worst home in the best neighborhood generally holds true. Those properties typically offer the best value and the greatest return potential.
As part of your property analysis, make sure you understand how to calculate ROI on real estate investments so that you can compare potential properties against each other to make the best choice.
4. Complete Any Construction or Renovations
House hacking renovations can be as simple as a fresh coat of paint and updated decor. Or you might construct an ADU from the ground up. Maybe you’re renovating a four-unit multi-family property. Each of these is an example of adding value to real estate. The greater the value, the higher rents you can command.
Whatever your construction/renovation phase looks like, ensure you get the appropriate permits for your work. And that the quality of the work is strong.
5. Find Qualified Renters
Whatever your house hacking strategy, you’ll need to find qualified renters. Long-term rentals can be advertised locally or on sites like Zillow. Short-term rentals can be posted on platforms like Airbnb or VRBO. And storage space ads can be published locally or on sites like Rentle.
The qualifying process looks different for each of these situations. But the important thing is to make sure that you’re comfortable with your renters and that they are likely to pay their rent and behave responsibly on the property.
The Numbers Behind House Hacking
Let’s consider a few examples of how much financial benefit house hacking can offer.
Example #1: Boat Parking
Aaron lives in a rural area near a lake town where people boat in the summer and store their boats during the winter. The lack of boat storage in town has created a market for storage spaces, and Aaron’s property happens to have an under-utilized barn that could fit a boat.
Aaron rents the space for $50/month from October through March each year, generating $300 in completely passive revenue with no additional expenses to consider.
Example #2: A Single-Family House with a Bedroom for Rent
Matt and Anna are first-time buyers. They are unsure about growing their family, but they want a house with an extra room just in case. They decide to rent this extra room to a local college student during the school year to reduce their mortgage expense.
Their mortgage payment is $3,200/month. Spare rooms in comparable houses generally rent for around $500/month. An added resident increases utilities by about $25/mo, leaving Matt and Anna an income of $475/mo from September through May, effectively reducing their mortgage to $2,725 during those months.
Example #3: A Strategic Multi-Family Purchase
After selling her starter home, Cara has enough for a 20% down payment on a four-plex in Las Vegas. She plans to live in one unit and rent out the other three. With a purchase price of $1.2M, the monthly payment comes to around $6,500. Based on comparable rental units, each unit can currently rent for around $2,000/month, creating a gross income of $6,000. With a maintenance/repair/vacancy loss factor of 6%, Cara expects to average $5,640/month in revenue for the first few years, effectively bringing her housing cost down to just $860/mo.
With rent increases over time, the units will eventually make enough to completely cover Cara’s housing expenses. Plus, she builds equity in the property over time.
Example #4: Adding an ADU for Retirement Income
John and Rosa own their Los Angeles home free and clear. As they near retirement, they want to remain in LA, but they are concerned about the cost of living. So they decide to construct an ADU on their property, which will serve as a rental unit. They take out a $100,000 home equity loan to cover the cost of construction.
Between the loan repayment, maintenance, insurance, utilities, and vacancy estimates, the monthly cost of the ADU is around $800/month. But in the high-value LA market, this unit rents for $2,400 per month, giving John and Rosa around $1,600 per month in passive income, which will continue to grow over time as rental rates increase.
House Hacking Mistakes to Avoid
If you’re buying a property to hack, make sure to review our mistakes to avoid when buying real estate. The following are mistakes that apply to all house hacking strategies.
- Failing to match local demand. Investing in rental property is all about offering spaces that appeal to your target market. If you have an attic space in Florida that isn’t climate controlled, for example, you’re going to have a hard time finding renters for that space most of the year.
- Improper renter screening. Unreliable renters can make your life difficult. Establish an application process, run credit checks, and get references.
- Ignoring local laws. Many local jurisdictions have regulations governing rentals, including house hacks. Make sure you understand those laws. This includes zoning and permitting requirements.
- Underestimating expenses. You’ll need to budget for repairs, maintenance, and vacancy. You’ll also need to budget for increased utility bills if you’ll be covering your tenants’ utilities.
- Overestimating rental income. Check your competition to establish market rental rates. And don’t forget to factor in vacancy losses between renters.
- Not setting living boundaries with renters. Sharing your property with renters requires clear boundaries. Where do the tenants park? Are there house rules? Are any parts of the property prohibited?
- Failing to have proper insurance coverage. Having additional residents on the property warrants a review of your insurance policy; you might need additional coverage.
Avoiding these mistakes will allow you to make the most of your house hack!
Invest in Real Estate with Gatsby Investment
Are you looking for more alternative real estate investment opportunities? Consider investing in real estate syndicationwith Gatsby Investment!
Like house hacking, syndication provides passive income to real estate investors. Unlike house hacking, syndication provides a professional team to manage every detail of your real estate investment.
Syndication pools money from multiple investors to fund a specific real estate project (which could be anything from a short-term home flip to a long-term rental). This keeps investment minimums far lower than investing as an individual. The sponsor searches for the properties with the best return potential, secures the right property, oversees the construction/renovation phase, and handles the rental or sale of the completed project.
Whether you decide house hacking is right for you, or not, you can diversify your real estate investment portfolio through syndication today!