House Hacking Case study: 1 bed 1 bath in Oklahoma City
I could not have asked for a better case study of the power of House Hacking than the one that just came to me from a phone call.
“Hello” I answered
“Hi, I’m looking to rent a home in the city and I was wondering if you could help us out.” Lucy asked.
“Well I sure can! Tell me a little bit about what you’re looking for.”
“We’d like to stay between $700-950/month on our housing costs and we really only need a 1 bed home. We’d prefer a house over an apartment and area is important to us. We work in X part of town and would like to be fairly close to that,” Lucy explained.
“Alrighty, let’s meet at my office tomorrow morning to process through some options, hone in on what you guys prefer, and map out our path forward,” I replied.
Click, Open laptop. Off to work I went
The Search
Given the location of their office and the 45 minute drive they currently have, I knew it would be a blessing to their lives to cut that down significantly, so I searched within a 15-minute radius of the office.
Most of the 1 bedroom houses . . . don’t exist. Ha, that was a silly way to express that, but in reality most people don’t build a 1 bedroom house.
I pulled together an impressively diverse list of rental possibilities ranging from $450 super-value apartments to Tha Luxe (top-shelf) townhouse rentals with a pool and the works for $950. Alright, we’re going to be able to learn quickly what they value and get them in an amazing situation.
We will. That’s probably the route they’ll go, but . . .
1 bed 1 bath + 1 bed 1 bath
That monthly range and bed/bath combination provoked my thought. A duplex that I showed an investor last week came to my mind, so I checked to see if it was still available.
It was! So . . . let’s check out the math.
Here you have a duplex consisting of two 1-bed 1-bath units selling for $110,000.
Now you may have a moderate credit score (let’s say 650) and you qualify for an FHA backed 3.5% down loan on this house. Here’s what that would look like approximately:
3.5% down = $3,850
Monthly PITI payment = $891.73
PITI = Principal, Interest, Taxes, and Insurance
Due at closing = $8,621.76
For $892 a month Lucy is able to get what she was wanting – a 1 bed 1 bath home. What’s light-you-on-fire awesome about it, though, is that within her desired spend range she ALSO gets another 1 bed 1 bath unit, right beside hers, that is currently leased for another year at $650/month.
Did you get that? She pays $892 per month and then her neighbor pays her $650 per month to live there.
Let’s say Lucy saves that amount for a year and puts it into a “Oops, stuff happens and vacancies happen” fund and then starts paying it towards her mortgage. This is what we would be looking at:
“Oops” fund = $7,800 if nothing requires pay-outs in the year
Then $650/month pays extra towards THE PRINCIPAL each month.
Loan balance at 12 months = 104,328
Balance paid off in 9 more years.
Total length of payments = 10 years.
Now you own 2 units outright that generate, say, $550/month = $1100/mo
Otherwise let’s say you hit your “oops” fund then start accumulating “down payment money” to get you into a similar deal as soon as possible. How quickly would that extra payment accumulate to the point where you could replicate this deal?
After 12 months “oops fund” = $7,800
After 26 months you have $9,100 saved for another deal
Cash to close @ $8,621 means you can close on the next one
after 26 months.
So, you could replicate this ever 2 years and 1 month. If you did that you could have 8-10 units by the end of a decade. These units could return $4,400 to $6,500 per month, which would more than cover the PITI payments. You would also build up an Operations Fund for each property before you start stashing for the next one.
Granted, this is simplified to a degree, but it shows you the power of thinking differently about renting and homeownership.
But Will, what if Lucy couldn’t come up with $8,621 to close on the first one? That’s a lot of money for someone who is looking for a rental thinking that the $200 security deposit is a reasonable “cost of entry.”
A strategy that I use a lot with cash-strapped home-buyers is this: let’s offer a higher price for the duplex in exchange for the seller contributing towards the buyer’s closing costs. The seller CANNOT in any way contribute towards the loan amount, but the costs of closing (capped at 3% of the loan value for a conventional loan, for example) can significantly offset the cash involved in the transaction.
So, let’s look at a purchase price of $114,000 asking the seller to kick in $3,420 to the closing costs. That will raise the PITI to $924.16 (because your loan will be bigger) and lower the cash-to-close amount to $5,450.
If Lucy had a high credit score she might be able to explore options like a 0% down loan through a credit union (like Weokie locally) or a down-payment assistance loan (available through many institutions) and lower the cash-to-close considerably more.
Let’s say Lucy’s cousin, Braden, hears about this idea and is moving to the city in a few months to start his freshman year of college. He catches some passion for this concept and decides to roll with it. Because he stashed away some earnings in high school and got a graduate gift from his parents he qualifies for a loan no problemo.
Between 18-28 Braden is going to move every 24 months or so. He’ll exit this decade with (for simplicity’s sake I’m going to make these numbers easy) 10 units (5 duplexes) generating an average of $550/month not including utilities (renters pay those). That would be $5,500 coming in each month. Due to vacancies and maintenance costs he really doesn’t accelerate payments at all and finds that he pays off the note in 27.5 years (important for tax reasons). When he is 55 1/2 years old Braden will have 10 units, free and clear, and pulling in $5,500/month — assuming that the rent didn’t raise at all over nearly 3 decades. So, keep them and pull in $66,000 in a year at 55 and a half?
Or you could sell them. Let’s look at that.
You owned 5 duplexes at a total investment value of $550,000. Lets say that these valued at an average of 0.5% per year for the time that you owned them (this would be way behind the market norm, which averages around 2%, but we want to get a low-ball estimate. Also, this is assuming that none of the units valued until Braden owned all 5 of them – only 17 years of valuing, instead of the actual more complicated valuing that would actually happen).
Braden would own, free and clear, 5 units totaling $599,000. Paying full scale real estate commissions on the sale and he takes home $562,747. Then he has two options we’ll explore:
- Reinvest this cash into a more valuable asset (differing capital gains taxes).
- Take the money and run.
Reinvesting into a more valuable asset
Let’s say Braden then, at age 45, uses the $562,747 he netted from the sale of the 5 duplexes and bought the max that 25% down would get him. Let’s assume that he continues to follow the 1% rule of investment real estate (1% of the total asset value per month in rent is a target return).
$562,747/0.25 = $2,250,998
$2,250,998 in assets following the 1% rule = $22,509.98 in rents . . . per month.
-Estimated debt service of $15,036.58 monthly
= $7,473.40 every month from age 45 to 72.5, then rinse and repeat
–> that’s about $90,000 annually with an extremely low tax rate.
Or take the money and run
Option 2 is to simply keep the money. This would trigger a capital gains tax on the net proceeds from the sale, which would reduce Braden’s net gains, but also would leave him with a sizable cash pile to go along with what he has generated from his other income sources by the age of 45.
Simple and stunning
It’s not a choice that everyone will make. Time will tell if my friend Lucy will make it, but the shocking reality is that you, yes you, could make this very same choice today. You may not be 18, able to afford the cash to close a deal, have bad credit, or couldn’t possibly swing a 1 bed 1 bath duplex . . . but this can work for you. House hacking can be done in numerous different ways and the speed and style of it can be tailored to fit you where you are, but the way to start is with a plan.
So, there’s the opportunity. What will you do with it?
Will Fraser
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