If you are new to real estate, you may be wondering if you should buy an investment property or a house hack. In a world of podcasting and blogging where snap-shot answers are all the rage, you may be thinking – it’s not so simple..
Congratulations. It’s not! Furthermore, I am not sure that I can give you a definitive answers much better than ‘depends’.
So, let us walk through some of the rationale together and see if we can’t put things in perspective.
3 Considerations for Investment Property or a House Hack
When it comes to business of making money, the way I see it what we are really doing is synthesizing several elements, namely 3:
- Profit Potential
- Risk Assumed
Ideally, then, we want to see the most profit, for the least amount of time commitment, and the least amount of risk. In every potential monetary enterprise there exists a golden mean, a sweet-spot whereby for the least amount of risk and time commitment we can drive the highest monetary gains.
That said, the question Should I Buy an Investment Proeprty of a House Hack, can be translated as:
Will buying an investment property or a House Hack generate the highest returns on my time and money, with the lowest risk exposure?
If phrased this way, the original question becomes much less conceptual in nature, and more pragmatic and calculable. In order to answer we simply have to analyze the reward, risk, and time commitment of both/either. So, let’s try.
My House Hack
At the time I released my book House Hacking, I only had a few months worth of data and had to make certain projections. My projections, and in the book I walk you though the entire underwriting process, called for me to finish the year with $15,000 – $16,000 of cash flow.
Seven months into my house hack, and I’m already at $9,200 of cash flow. Thus, it seems likely that we will hit our projections. Especially considering that the top-line revenue is on the rise for the rest of the year.
So, here’s the question:
Would you be able to generate $15,000 of Cash Flow easier, faster, and with less risk by buying a dedicated real estate investment or a house hack?
Doing the Numbers on Real Estate Investments
Follow me on this:
In order to produce $15,000 of leveraged annual Cash Flow you would need at least $45,000 of Net Operating Income (NOI). Out of that NOI you would pay the debt service of about $30,000 per annum and be left with $15,000 of Cash Flow.
In order to buy $45,000 of NOI at a market capitalization rate of 8%, which you would be lucky as all get-up to find in current market conditions, you would need to spend $562,500:
Value = NOI / Cap Rate
Value = $45,000 / 8% = $562,500
In order to buy a $562,500 asset you would have to make a down-payment of 25% – a cool $142,000.
If you didn’t want to finance, you could simply buy an asset capable of producing $15,000 of NOI, which in this case would also be your Cash Flow. At an 8% market Cap Rate you would then need to stroke a check for $187,500. This is what it would take to buy $15,000 of annual cash in pocket in un-leveraged form.
Thus, in order to buy $15,000 of cash flow in a pure investment vehicle you would need $142k for a leveraged acquisition, or $187k un-leveraged. In addition, you’d need more capital in order to fix things that need fixed.
Question – is this easier, do you think, than making a 5% down-payment on an owner occupied SFR with a house hack component? I don’t think that it is for most people. And this is what makes a properly executed House Hack a much more efficient proposition relative to finances. There is a ton of financial gain for a very subdued investment of capital!
What About Risk?
Let me paint you a picture:
I own a really nice 10-unit building. At the time I bought it, I paid a bit under $400,000. I did not put any money down, because while I did have a 25% down-payment requirement I managed to finance it. For more on how to do that please reference the CFFU.
Now, I’ve had this building for about 4 years now, and most years it throws off $12,000-$13,000.
A Few Points on That:
First of all, understand – my Luxury House Hack, which enables me to live almost for free in a really upscale home, throws off same or more income than a 10-unit building.
Secondly, in order to maintain this income, in case of my house hack all I have to do is maintain 1 solitary Casita. On the other hand, to keep the money coming from the 10-unit I have to maintain – 10 units! I have to service 10 tenant’s needs. I have to replace flooring, HVAC, etc. in a 10-unit building.
Finally, to own that 10-unit I have to expose myself to additional debt, property taxes, and other costs. But, in the case of my Casita House Hack all of those costs are absorbed into the house. In other words, the income doesn’t cost me hardly anything.
So, do you think one is less risk than the other?
What About Time?
Do we really have to talk about this…? lol
The difficult thing about advising is that we obviously must take into account our individual personal circumstances. All we’ve considered here are the numbers. And yet, your desired way of life has to be figured into this equation. House Hacking may not be appropriate for you no matter how much sense it makes in terms of dollar signs if your life cannot accomodate. However, I am loving it, and I’d say that as a statement of generality, a proper Luxury House Hack as I describe in the House Hacking book is the most efficient and appropriate way to invest in real estate for most of you guys reading this article.