Help with deal analysis on first house hack

[Steven DeMarco]

I'm looking at a SFH + ADU in Salt Lake City, UT as a potential house hack. Before I put in an offer, I want to run the numbers by some professionals.

The property is 4BD/2BA in total, with 2BD/1BA upstairs and 2BD/1BA downstairs with separate entrance. Current list price is $564K, my offer would be $515K using a 3.5% FHA loan. My estimated mortgage would be $3380/mo. Currently the upstairs unit is rented at $1395, which is below market rents (Rentometer average is $1650). I would owner occupy the downstairs unit in Year 1, per FHA guidelines.

Currently I pay $2150/mo. in rent. So in Year 1 for house hacking and keeping the existing lease in place, I'd be saving about $165/mo. in rent ($1980 in total rent avoidance for Year 1).

In Year 2, if I decide to move out, I have to take the following measures to break even.

- Raise rents for each 2BD/1BA unit to $2050 (a 47% increase of current lease). This puts rents at 75th percentile according to Rentometer and brings total rental income to: $4100/mo.

- Reserve only 9% for maintenance, capex and vacancy: -$369/mo. ($4428 for the year)

- Spend only 8% for property maintenance: $-328/mo. ($3936 for the year)

- Pay the monthly mortgage obligation: -$3380/mo.

So for Year 2, that leaves me with a net cash flow of $23/mo.

In order for the deal to work, I'd have to be slim on my reserves (only reserving $369/mo.) and have to find a nimble PM company (for 8% or less of monthly rent). I've done some research and it's possible to find solid PM company for 7% - 8% of rents in the SLC area.

What are your thoughts? Can I make this deal work with slim reserves and by raising the rents to 75th percentile? This would be my first house hack and second real estate investment. I have a strong W2 with good savings and could potentially float additional capital expenses if/when they come up.

[Ryan Thomson]

And here is a longer read on why house hacking is still a great ROI even if you are not casfhlowing:

It has become increasingly difficult to cash flow with house hacking. Despite this fact, the return on your investment (ROI) is incredible enough that it still warrants exploring buying real estate with the house hacking strategy. Home prices have increased substantially in the last couple years and interest rates have doubled. It is difficult to cashflow in year one of your house hack for a couple additional reasons: 1. You are living in one of the rentable units 2. You are only putting 5% down so your loan amount is much larger and therefore your mortgage payment is higher.

In this article we will dive deep into the 4 big ways that house hacking makes you money, even if it doesn't cashflow. You need to consider how much the down payment returns to our net worth. To calculate your Net Worth ROI for house hacking, you'll need to consider four factors: appreciation, loan paydown, tax benefits, and rent avoidance.

Appreciation:

Appreciation is the increase in value of your property over time. On average, real estate appreciates at a rate of around 3-4% per year, although this can vary greatly depending on location and other factors. For example, if you buy a house for $500,000 and it appreciates at a rate of 4% per year for five years, it will be worth $608,280. This increase in value would add $108,280 to your net worth.

Loan paydown:

Loan paydown is the reduction of your mortgage balance over time. Every time you make a mortgage payment, a portion of it goes towards paying off the principal balance of your loan, which increases your equity in the property. Over time, your mortgage payments will consist of less interest and more principal, which means more of your payment is going towards building equity. This reduces the amount of debt you owe and increases your net worth. For example, if you have a 30-year mortgage for $500,000 with a 6.4% interest rate, after five years you will have paid off around $31,807 of the principal balance. This reduction in debt would add $31,807 to your net worth.

Tax benefits:

Tax benefits are the deductions you can take on your income for expenses related to owning and operating a rental property. This includes things like property taxes, mortgage interest, repairs, and depreciation. These deductions can significantly reduce your taxable income and increase your net worth. For example, if you own a rental property that generates $20,000 in rental income per year and you have $15,000 in deductible expenses, your taxable income would be reduced to $5,000. In the 40% tax bracket this reduction in taxable income could save you around $2,000 in taxes per year, which would add $2,000 to your net worth. You have to actually be cash flowing for this benefit to take effect. Or be a real estate professional and be able to deduct against your professional source of income (another topic for another day).

Rent Avoidance:

Rent avoidance is the amount of money you save by living in one of the units you own instead of paying rent elsewhere. One of the most significant advantages of house hacking is rent avoidance. When you own a house hack, you are not only generating rental income, but you are also avoiding paying rent. When running numbers on a house hack include how much you are currently paying for rent (or how much you would pay to rent a comparable property) vs how much of the PITI and budgeting expenses are left for you to cover. For example, let's say your alternative to buying a house hack is renting a one-bedroom apartment for $2,000 per month. Let's say that once your tenants pay you rent you still have about $971 in PITI. You need to budget and an additional $929 to set aside for future budgeting items (vacancy, maintenance, and capital expenditures). Your total expenses to live in this house are $1900/month. Renting would cost you $2,000/month. Your rent avoidance is $100/month, $1,200/year, and $6,000 over 5 years.

Taking these four factors into account let's calculate your net worth ROI for house hacking.

Your net worth ROI calculation over 5 years would look something like this:

Appreciation: $108,280

Loan Paydown: $31,807

Tax Benefits: $0 (b/c you aren't cash flowing)

Rent Avoidance: $6,000

Total Net Worth Increase: $146,087

To calculate your net worth ROI over 5 years, you would divide your total net worth increase by your initial investment (your down payment of 5% or $25,000). $146,087/$25,000=584% This is an incredible return on investment. You will be hard pressed to find a better return elsewhere in the world. Simple Interest Rate of Return = 48.67%/year.

Let's change things up a little bit and say your situation isn't so rosy. Let's say you can only rent the other side for $1500 and that your current rent is only $1,000. The payment you still need to pay (after rental income) for PITI and budgeting items is no longer $1900 but $2,400/month. Your alternative to buying is renting for $1,000/month. If you decide to buy this house, you are negative $1400/month for five years. Does it still make sense to house hack? $1,400 x 12 months x 5 years = -$84,000.

Net Worth ROI Calculation (new situation):

Appreciation: $108,280

Loan Paydown: $31,807

Tax Benefits: $0 (b/c you aren't cash flowing)

Rent Avoidance: -$84,000

Total Net Worth Increase: $56,087

ROI = 56,087/25,000=224.35%

Simple interest rate of return = 18.7%/year

House hacking can be a great way to build wealth and get into the real estate game. While it may not always provide immediate positive cash flow, the long-term benefits of owning a property that is generating rental income while also providing a place to live can be significant.

When considering the ROI of house hacking, it's important to look beyond just the monthly cash flow. By factoring in appreciation, loan paydown, tax benefits, and rent avoidance, you can see a substantial return on your investment in the long run. Additionally, when compared to the alternative of paying rent every month and not building any equity or wealth, house hacking is a clear winner.