House Hacking w/ Negative Cash Flow?

Question

Hi All,

TL;DR -- How do I evaluate properties that I will house hack? Should I look at the property holistically, or with only one unit of income?

I'm interested in house hacking, and subsequently purchasing multifamily rental properties. When evaluating multifamily properties for house hacking, how does one go about underwriting the property?

Estimating the property with two rental units versus one rental unit gives very different numbers on the property. Should I be underwriting the property with one rental unit or two? As a newbie investor, I see arguments for doing both.

Evaluating with one unit of income (since I'd be living in the other) gives me a realistic idea of expenses, but the property doesn't seem ideal. Assuming FHA financing at 3.5% with zero points, 10% repairs and maintenance, 6% vacancy, 10% capex, 10% management fees, taxes, HOA fees, and not including PMI:

• $6000 NOI, Cap rate of 4.0%, -25% CoC return, and the 50% rule generates a measly $2 in cash flow. The property underwritten at 1 unit also fails the 1% test miserably

Evaluating at two units of income seems to tell a whole different story. Assuming everything above is constant, except rent is calculated for both units, i.e. not living there:

• $18,000 NOI, Cap rate of 11.9%, 100% CoC return, and the 50% rule generates $756 cash flow. The property underwritten at 2 units also gives 1.6%, passing the 1% test.

It seems like this data is objectively telling me house hacking makes this property miserable, and that it's a grand slam rental property, but I feel like I'm missing something here. After all, one side of me is saying that a $400 or $500 mortgage with equity still seems better than renting. And the other side of me is sticking to the numbers, saying that I'm essentially renting cheap, but carrying the burden of being a landlord, and assuming costs that will sink my investment.

Thoughts?

•

Taylor L. · Answer

Cap rates don't apply here. They are for commercial real estate valuation.

Most of the time you're not going to be in the black on cash flow when you're occupying a unit of a duplex. That's 50% of your gross income not coming in! 50% vacancy!

I would look at it as "What happens when I move out and rent out my unit?" If at that point it's putting money in your pocket, that means you're building your portfolio and your cash flow!

Rebecca M. · Answer

@Joey Gorombey. I recommend simplifying it a bit.  If you use a loan that requires you live in the property, then first evaluate your costs of living in the property vs your current living costs.  Your rent will likely be much lower with the house-hacking option.  If you own the home you're living in now, then you can probably rent it out and make even more.

If you want to evaluate whether the house is a good buy, go back to the basics a little bit.  Instead of calculating cap rates and CoC returns, set up a spreadsheet (or Bigger Pockets Calculator) and put together a 5 or 10 year cash-flow analysis.  Enter everything you think you might pay for the property each month, and the income you expect from renting the other unit.  The first 1 or 2 years would show rent on just one unit, and the following years will show the rent from both units. Spend some time on your assumptions and include how much you expect both rent and costs to grow.

Factor in Rent, P&I, Taxes, Insurance, Vacancy, Garbage pick-up, Landscaping, Repairs, Tenant turnover costs, Cap ex, etc.

I recommend doing the same thing for any other properties you're comparing it to, using the same move-out dates, so that you are comparing apples to apples.

I did this for our first duplex and it showed negative cash-flow for the first year (but we saved on living expenses overall). The second year we started to break even on our monthly cash-flow once we moved out, and in the third year we hit positive cashflow.  It is now 5 years later that place is a cash-cow.  Our low interest rate combined with local rent increases have really worked in our favor.

As far as seeking advice or a number look-over, reach out to get quotes for any unknows costs, and look at what other comparable units are renting for in your area. I like using rentometer.com as a starting place. If you have a local investors group or people you trust who aren't profiting on the deal, you could always ask if you could run the number by them as well!

If you really want it and the numbers make sense, don't sit too long.  I have many properties I evaluated some time ago that I look back at now, and wish I had purchased ;-).

Good luck!

Rebecca M. · Answer

I feel ya! I tend to overanalyze too, and sometimes I have to step back and look at the big picture. If I have too many properties to compare I never seem to make any progress.  I've gotten better, but then, there are less properties on the market these days. :-)

Theresa Harris · Answer

Look at it as if all the units are vacant.  Then look at your living costs in your current home and see if it makes sense for you to live in the new home.  If it costs you $1500 a month currently, but only $700 in the new place, even if you aren't cash flowing (because you are living there), you can still come out ahead as your living costs are low.

Also remember if you get $2K in rent (if both units were rented) vs $1K because you are living in one unit, it also saves a bit on income taxes.

If one unit is in worse condition, that is the one you want to live in.  You can fix it up and when the other unit becomes vacant, you move into that unit and rent out the fixed up one for more money.

Theresa Harris · Answer

Look at ads for places for rent in your area.  Rentometer will also give a general idea based on location, beds and baths, but there are other variables (condition, finishes, etc).

Joey Gorombey · Answer

@Rebecca Miller Thanks for the detailed and thorough answer! It was comprehensive! I'll be sure to implement your feedback: you've given me a good starting point for metrics to really look at, and reminded me that, in the long run, house hacks might turn out well, even if I have negative cash flow for a couple years (and living expenses might decrease my first year anyway). I think, for me, action is the key. As you can probably tell, I overanalyze :). A five year report with Rent, P&I, Taxes, Insurance, Vacancy, Garbage pick-up, Landscaping, Repairs, Tenant turnover costs, Cap ex, etc should keep me steady, and help me move toward a close!

Joey Gorombey · Answer

@Drew Sygit Thanks for the honest advice! I did not factor in outside rent when calculating the cash flow of the existing property, because I wanted to see how the property performed in a vaccuum, i.e. only factoring in income and expenses related to the property itself. However, your suggestion about comparing living expenses in my duplex versus other areas is useful, too! It seems like it would be wise for me to get to know the market myself, rather than relying on other people.

What are some of the typical ways that you do that when assessing an area? Calling/emailing other landlords? Pulling historical data?

Richard Sam · Answer

Hello @Joey Gorombey!My advice would be to look at the numbers for both when you will live in the house hack and after you move out. Although the focus would be on if the numbers makes sense after you move out, I believe both scenarios have to make sense. As other replies mentioned, your living expenses in the house hack will most likely be less than what you're paying now. But it will not necessarily always be the case, especially if you try to house hack in a neighborhood where the cost of living is much higher than where you are moving from.

So, after determining if the numbers make sense after you move out, I would suggest you look at your living expenses in the house hack and see what you're comfortable with. Maybe you want your living expenses in the house hack to be less or equal to how much you're paying now for rent. You set the benchmark you're comfortable with. Personally, I would want my living expenses in the house hack to be less than what I am paying now for rent. So there are some neighborhoods, I would not house hack in.

I would not factor the tax benefits and appreciation from acquiring the property because I would look at them just as a bonus.

Bradley Dosch · Answer

I would focus more on the performance on the place once you move out. With such a low down payment, it's not the end of the world to have negative cash flow while you live there. I would plan to move onto the next house hack asap and get the unit you're occupied filled. This is the game you gotta play. Make sure you have a good lender that understands this strategy and keep in contact with them. The transition can be a bit tricky and you'll want a lender who is on the same page as you and can guide you through the process. Good luck Joey!

Christopher Gathe · Answer

@Joey Gorombey  Don't overcomplicate it always run the numbers As if you're not living in it what will the duplex bring in income wise when you move out?  While you are occupying the property your mortgage is being supplemented by the income income from the other units even though you are not cash flowing you are making money as a form of savings .

House Hacking w/ Negative Cash Flow?

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