4 Wealth Building Strategies for Lubbock Millennial Home Buyers (PT IV: The House Hack)
June 7, 2017
While I believe there are 100’s of ways to get creative and use real estate to generate wealth for millennials, this will be the last of the 4 part series, “Four Wealth Building strategies for Lubbock Millennial Home Buyers”. As nerdy as it sounds, this one is one of the most exciting because of it’s potential.
Before we continue, catch up on the 3 strategies outlined in the previous 3 strategies:
Part I: The Stepping Stone Home
The House Hack
Pros:
- Covers housing expenses with rental income.
- Additional property not needed to generate rental income.
- Can be purchased with low down payment since considered residential housing.
Cons:
- Being a landlord (repairs, tenant relations).
- Multifamily housing competitive and hard to find.
- Living close to your tenants.
House hacking doesn’t mean you’ll be paying for your house in stolen bitcoin. Or that you have to know anything about computers. Think of it as, “hacking the system”, without breaking any laws, morals, or ethics.
House hacking isn’t a term I invented, but it was something I was doing from my very first purchase, without even being that familiar with the concept. House hacking is simply renting out additional space in your property, to cover your mortgage payment, essentially allowing you to live for free (or close to it).
It can be used by young single people that don’t mind living with other people. It can be used by a young couple that wishes to rent out a single room, or the additional mother-in-law suite on AirBnB. But I think the best strategy is in duplexes, or multi family housing (with 4 or less units).
The first two examples are great for those who are okay with living in close quarters with other people. But what if that’s not you? What if you have a young family?
Multi-dwelling houses are a popular option to use for house hacking. Not many people know 1–4 family dwellings are still considered “residential” investments — meaning you can purchase a duplex, triplex, or quadplex all under a residential loan, instead of a commercial loan — meaning you can potentially buy a multifamily unit for as little as 3.5% down.
Let’s look at an example:
Ron is a young professional looking to use real estate to cover his living expenses. He heard from his real estate agent buddy that duplexes are eligible for residential housing financing, meaning he can purchase a duplex with a FHA loan, requiring only 3.5% down. Ron’s loan officer qualifies him for a $175,000 loan, making his projected total monthly payment $1250/month. And while his loan officer says he can afford that much, Ron isn’t comfortable paying that much monthly. So he decides on “house hacking”.
Ron and his realtor find a duplex close to the top of his budget, $170,000 in the Broadmoor subdivision in Lubbock. Research shows each side could potentially rent for $1,100 a month. Ron decides to pull the trigger and make a full price offer. However, he only has enough reserves for his down payment and not the closing costs of around $5000. Ron makes an offer for $175,000, with the seller to pay up to $5,000 of his closing costs.
Ron closes on the house with only $6125 down. He begins screening tenants, and signs a lease with a middle aged couple with great rental history for $1,100 per month. Ron’s total monthly payment for the duplex is $1250 dollars a month, making his monthly rent $150 a month. But, Ron is a smart guy, and anticipates an 8% vacancy rate between tenants and 5% per month for anticipated repairs, which equates to $143 a month. He takes $143 a month from the rent payments and puts it into a savings account. This puts Ron’s total monthly housing cost to be $293.
…
Imagine living in a $175,000 property for just $293 dollars a month. That’s what house hacking is.
If Ron decided to move in 4 years, he could rent out the other side, and make a gross income of $2200 a month. Banks will consider a portion of his gross rent as his income too.
Most millennials do not consider the remote possibility of being a investor/property owner/landlord. And yet, here Ron is, with a duplex under his belt, that grosses $2200/month. And all he needed was $6125 down.
And let’s be real. Not everyone wants to live in a duplex the rest of their life. So what’s a potential exit strategy?
If Ron was only paying ~$300 a month to live in his duplex, imagine how much extra he could put towards his monthly principle to reduce the loan more rapidly and save on interest. Let’s say Ron was comfortable paying $1000/month for housing. If he’s already paying ~$300/month himself to make up the difference of the mortgage and for vacancies and repairs (because the tenants are paying for most the mortgage), he could set up an auto-draft with his bank to pull an additional $700/month that would go straight to the principle loan. And if we know a property needs about 30% equity to refinance (20% to stay in the house, ~$5,000 to refinance, and the rest leftover for a down payment), how fast could Ron refinance and find another house? In this example 46 payments, or just under 4 years, not even including appreciation. Here’s the math:
(The above example doesn’t even account for market appreciation.)
Now when Ron decides to purchase his new house, he’ll have $2,200/mo in gross rents generating from his duplex once he rents out both sides!
This is a great example of the potential has to generate wealth for our generation. Sure, it requires us to be creative. but it doesn’t mean we’re left without hope. a little sacrifice and creativity will go a long way in a short amount of time.
Originally published at www.coreyzant.com.
