House-Hacking, “Free Shelter,” and Accelerating Your Path to Homeownership

Katie:

Welcome back to The Money with Katie Show, Rich People. I'm your host, Katie Gatti Tassin, and today we are talking about all things house-hacking. I'm joined today by David Greene, real estate investor and host of BiggerPockets, the largest and longest-running real estate investing podcast in the game. So David has purchased, rehabbed and managed more than 50 single family rental properties, and he owns shares and three large multifamily apartment complexes. I wanted to talk with David because I recently saw him in an interview on CNN talking about how difficult it is for first-time home buyers. Take a listen to this.

David:

Our advice for what people should do that are in that position, because my heart really goes out to them, is that they should look at what we call house-hacking. Now, house-hacking is this concept where you buy a property even if the mortgage is higher than you're comfortable with, with the intention of renting out part of that home to someone else.

Katie:

House-hacking. You've probably heard of the concept before. Hell, we've even talked about it on this show before, when I decided to give it a try in Colorado and found that the numbers didn't quite square with the expectations I had based on the real estate investing content I had been consuming. House-hacking is the way we referred to buying a property to live in that you also rent out portions of for rental income, think a single family home with a basement that has a separate entrance, or accessory dwelling unit, a duplex, a triplex, or a fourplex. And like I said, my search was not very successful. This was what I found when I looked into house-hacking in Colorado a few years ago, that the duplexes that would readily rent for between $2,500 and $3,000 per side cost a million dollars or more to buy, which meant that our out-of-pocket housing costs each month would've actually stayed about the same as our current rent once all of our costs were factored in.

Now, if my husband and I had planned to stay in the area for a while, it may have eventually worked out in our favor, but the potential rental revenue for both duplex units, as in, after we had moved away for our next Air Force assignment, wouldn't have been enough to cover the entire monthly cost of ownership for quite a while. So suffice it to say we got spooked and we opted to continue renting. Still, the concept appeals to me, particularly as a sort of strategic stepping stone. While you might not be able to save enough money for a down payment on your dream home while also paying market rent in your area, only to then lock yourself into an even higher mortgage payment, you may find that you're able to save up for a down payment on a duplex or a triplex such that your net costs of housing each month after finding tenants drops to the point that you're now able to put more aside, while also theoretically paying down a mortgage using rental income.

But as you'll hear in my conversation with David, it is a lot more...we'll say complicated, nuanced. There's more to consider than meets the eye. So we'll get right into that after a quick break.

In a potentially realistic scenario for today's market, house-hacking might play out something like this, though your mileage may vary. You'd purchase a duplex for $500,000 by putting down about 10%, so $50k. For an owner-occupied multifamily investment property, a conventional loan allows you to put down as little as 15%, though you'd probably have to pay PMI. An FHA loan allows you to put down as little as 3.5%, and the VA loan allows you to put down 0%. And don't worry: If you're wondering whether or not that's even a good idea, I asked David that very question. I was like, "What type of loan should someone be getting for this?" So we'll unpack that a little bit more in the conversation.

Now, assuming an interest rate of 7.3%, which is what Google's mortgage calculator auto-populated for me for a 30-year fixed-rate FHA loan, your monthly payment would be $3,085 and you'd pay an estimated average of $873 in taxes and fees, for a total monthly payment of $3,958.

Keeping things simple here, let's assume that you live in an area where the price to rent ratio is 18. Now the price to rent ratio tells us the relative affordability of the buyer's market and rental market in a given area. So a price to rent ratio of 18, that colloquially means that the median home value in the area is roughly equivalent to 18 years of the current median rent. Generally speaking, price to rent ratios under 20 indicate that the area may be preferable for buying based on a few other factors. While price to rent ratios above 20 typically suggest that renting would be net cheaper, again, based on a couple of other factors.

Now, if we are assuming the price to rent ratio is 18, this means for one half of your duplex, or a unit that's worth $250k since both together are $500k, your expected rental income would be around $1,157 per month.

Now, I am being a little bit overly simplistic in these price to rent ratios and extrapolating what rental incomes would be, but for the sake of the example, we're going to forge ahead. This would make your net cost of housing every month around $2,801. That is, if you live in one side and rent out the other, your net costs are about $2,800. So you're on the hook for maintenance and repairs, which is obviously a big unknown, but if your current costs of housing, if you're renting a nice place for $2,500 a month, you may be comfortable with this arrangement knowing that in theory, the rent for the other half of your duplex will continue rising over time and your payment will stay fixed.

Now, if you extend this forward and you assume that rents continue to rise by, let's call it a hypothetical average of 2% per year, your rent, had you continued renting, would surpass your net costs as a house-hacker by year five, when your formerly $2,500 per month rent would reach around $2,706 per month, while your net monthly costs as the house-hacker would be $2,705.

So this is again in year five, and like I said, this is not considering repairs and maintenance and things that are definitely going to come up right, but by year 10, your rent elsewhere would be approaching $3,000 per month if we're assuming these 2% annual increases, while your house-hacking net costs would be down to $2,575. So you're seeing that the gap is getting better over time. It's not a slam dunk, it's not a home run, but as time goes on, theoretically it's looking more and more favorable.

Now, this is potentially realistic but not exactly ideal, which is a question that you'll hear me pose to David, because these are quite slim margins, right? One medium-sized repair could wipe out your monthly cashflow gains for years. That said, you are benefiting from the expected appreciation of your duplex and the mortgage paydown. If it's appreciating by 3% per year, by year 10, it's an asset worth $652,000 instead of $500,000, and you've paid down approximately $64,000 in principal, partially with rental income.

According to a home equity calculator that I found online, this shakes out to about $263,000 in equity after 10 years, when you're taking all payments and your down payment and depreciation into account, all while keeping your monthly payments relatively similar, stable to what they would've been had you continued renting.

So I wanted to flesh out this scenario fully. I wanted to see where we'd really be in year 10 given our conservative estimates, and I believe if you sold in year 10 with a duplex worth $652k, you would get roughly $619k at sale after 5% commissions, and then you'd pay back the loan of about $386k, which would leave you with $233,000 that you can then extract to go buy something else.

However, your total net payments up until this point, as in, after you are taking your rental income into account, are still $372k. So you are technically at a net loss of about $139,000. Now this doesn't sound good, right? This is important, but it's not the whole story, because your net loss from renting that entire time would've been around $328k over the same period. So I suppose this demonstrates the reality of what house-hacking even in this interest rate environment is really trying to achieve. You're really just attempting to shrink a net loss as opposed to creating a net gain. And don't worry, at the end of our conversation, I ask David, is the juice even worth the squeeze? Who is the juice worth the squeeze for? This is not going to make sense for everyone.

Now at this point, you would've several options. You could sell the property outright, you could pay back the loan and roll that $230k into a house you actually want to live in, or you can continue as is and you can watch your net housing costs continue to lower over time. You could eventually theoretically live for free. So if you're enjoying the arrangement, you may not be in any rush to go move, or you might decide, I'm going to keep the property, I'm going to rent out both sides and I'm going to go live elsewhere. Maybe I'm going to rent, maybe I'm going to refinance, and I'm going to access some of the equity I already have and put it towards something else. But you get the picture. You have a lot of options at this point, and I asked David, how should someone be thinking about those options?

So now that you've got the lay of the land and we're all caught up to speed on maybe what I would consider to be a more realistic interpretation of the concept, onto my conversation with David Greene. David, welcome to The Money with Katie Show. Thanks for joining us to talk about house-hacking.

David:

Thank you, Katie. Nice to be here.

Katie:

So first things first. When did you begin investing in real estate? What was your entry point? Can you speak a little bit to how the market may or may not have been different when you started?

David:

Oh, it was very different. The very end of '09 is when I bought my first house, and then I bought the next one in 2010, another in '11, another in 2012.

Katie:

Oh, wow.

David:

We talk about it like this was the heyday of investing, the golden age. "If only I could have been back then I would've bought all the houses." But the thing is, back then you were being told by everyone how stupid it was to buy real estate. It wasn't looked at like you were buying an asset. It was looked at like you were attaching yourself to a 30-year mortgage for very little reason. It was just stupid, is what most people thought. They thought prices would keep coming down. The constant worry was, what are you going to do when you can't pay that mortgage? What about when you lose your job? The economic environment was very uncertain and nobody wanted to spend money or commit to anything.

It was like, okay, keep all the money and savings that you can. Keep preparing for the worst. And the first house I bought, I had no intention of being a real estate investor. I had a friend that was moving away and he had an earnest money deposit on a house and he was going to lose it. He couldn't close, and I was like, well, I'm going to need a house at some point, I'm probably going to want a family. Maybe I should just buy this house that you're going to buy and you can keep your deposit.

So I talked to his agent and I went and looked at it and thought, man, this is not a bad deal at all. It was like 2,500 square feet, 2,600 square feet, in Lathrop, California. The house had been built about three years earlier, so it was brand new construction and the person that bought it from the builder lost it, just like a lot of people did back then, when their mortgages reset. And it was under contract at $215,000, and I said to the agent, "Hey, what do you think we could do about that price?"

Mind you, it had sold for $565,000 in '06 when it was built, right? So I asked the agent and they said, yeah, let me go talk to the broker, see what we can do, and they were listing a house that the bank had given to that brokerage to sell as REO. So she came back and said, would $195 work? And I was like, well, I'm glad I asked. Yeah, that'll work.

Katie:

Sure will.

David:

And I was in escrow to buy my first house.

Katie:

Oh my gosh. Okay. Before we get into the details of house-hacking, I want to ask this question explicitly: Do you feel like this is the best way for a beginner to invest in real estate? I hear about people who start with house-hacking quite a bit, but I also hear about single family live-in flips. I mean, how beginner-friendly is the house-hack, really?

David:

If I could go back in time, I probably would've just done way more real estate deals, put way less money down and just house-hacked more often. It is far and away the best option beginner investors have, and quite frankly experienced investors have. We could talk about why, but I'm a proponent of the BRRRR method. I wrote that book. I'm a big proponent of long-distance real estate investing. I own property all across the country. That being said, I still think house-hacking is as close to a no-brainer as you can get in the financial independence, financial freedom, just wealth-building world that there is.

Katie:

Walk me through, then, the ideal house-hack, because when I looked into this, I found one of two things to be true often. A duplex that was move-in ready was so exorbitantly expensive to own that the market rent for the other half didn't even begin to cover one half of the monthly payments on the property, and I think that would be something that has now exacerbated because of higher rates. But those that had numbers that did seem workable required quite a bit of investment in order to bring them up to modernity, say $50k to a hundred thousand dollars probably in work. And this was in northern Colorado. So is this something that you would say, yeah, I mean that's just kind of how it is. You just have to expect that you're going to have to put work in it, or how rare are move-in ready duplexes or triplexes where right away the numbers would make sense?

David:

I don't know that that's a problem with house-hacking. That is a problem with real estate in today's market. There is such a discrepancy between the existing supply and the buyer demand. It's ridiculous. It's an incredible seller's market. Sellers don't have to upgrade their homes, they don't have to keep it in good shape. They can have tons of deferred maintenance. I mean, they could do pretty much anything that they want and there's a buyer that will buy that house because we don't have enough supply. When you're looking at house-hacking like other forms of investing, it's all about expectations. Do you expect the house to pay all of your mortgage and give you some cashflow, in which case you're going to be disappointed, or do you want it to be cheaper than if you didn't house-hack it?

Okay, so if you're like where I live, your normal mortgage might be around $3,000 to $4,000 a month. It's a little bit higher in California. If you can get away with renting out rooms and bringing in $2,500 out of that $3,000 a month or even $2,000 out of that $3,000 a month, that's a massive amount of savings. You're talking about saving, if it's just two grand a month, $24,000 a year. Over four years, that's almost a hundred thousand dollars. And let's remember that rents tend to go up every single year keeping pace with inflation, while mortgages don't. A lot of people get hung up on, well, it's not ideal, and so they don't take action and then five years later, the house is twice as expensive, rents are way higher. It's still not ideal, but if you look at what the rents are five years later, they look pretty dang ideal compared to what they were five years ago when you didn't want to buy the property.

A lot of people don't take action at all because they say, well, I can't get to the perfect scenario, and honestly, us real estate educators have not done a lot of favors here because we have taught these concepts and portrayed them in the most ideal light possible because that's what gets clicks, that's what gets views, that's what gets subscribers. I do my best to try to keep it as authentic as I can, but most of the people in my space, they don't want to say, Hey, do you want to learn how to save money every month very slowly over a long period of time and be financially responsible? Do you want to live for free in the best place you possibly could? You want to buy a house that pays you to own it? Well, sign up for my course. And the people that aren't aware that what you're consuming on social media, it feels free, but it's really not. You gotta kind of get out of that before you'll start to make good decisions.

Katie:

That makes a lot of sense. In reflecting on my own experience, and the guy that I was working with in Fort Collins, he had actually been on the BiggerPockets podcast before because he was an agent and an investor, and I explained to him what we were trying to do, and so he really got it. He wasn't just trying to sell us a single family home, but I just found that for us, our rent at the time was about $3,000 a month in this home that was probably pretty substantially overvalued. Zestimated at a million dollars, and we're paying $3,000 a month to live in it, and these duplexes were $1m to $1.1 million. So I was like, man, we're still probably going to be paying out of pocket about the same amount every month, and so I just got scared because I was like, well, I don't want to commit to that because that feels like a lot of risk. But I think to your point, our $3,000 a month rent was not fixed. We likely would've had to pay more than that. At some point the landlord would've raised the rent, and eventually I think that that realistic expectation of, well, it might not actually be all that cheaper this year and next year. But we're not really in the game for this year and next year, we're looking at it how it's going to set us up five or 10 years from now, and I think that that's a really good kind of reframe.

Let's talk a little bit more about numbers, numbers that make sense. What types of rules of thumb should I be looking for if I am an aspiring house-hacker? Is there a certain price-to-rent ratio or percentage of purchase price that I should be trying to get in annual rents each year to make it make sense? And someone might have an intuitive sense of market rents in a given area depending on how long they've rented there, but are there any tools that you like for accessing more robust data around, okay, I think I could feasibly expect to generate this in rent, and I think I could feasibly expect rents to change in this way over time, and so because of the price of this property, this does or does not really make sense for my first deal.

David:

I'm a little hesitant to say hard and fast rules, because I think that's what gets a lot of new investors in trouble.

Katie:

Oh, okay.

David:

When people come to real estate investing, there's obviously what you said, a lot of fear, hesitation, anxiety, as there should be. It is a big investment that you're making. What I found that ends up happening is people focus on the parts of real estate that they feel are most predictable, even though those are not the most beneficial. So there's this loop that new investors fall into where they're told know the numbers, know the numbers, know the numbers. And so they get a calculator or a spreadsheet that they use to determine, is this investment property—this isn't house-hacking, let's just say an investment property. How much money is it going to make in a year? Divide that by how much money I have to put into it: What's my ROI? I want the best ROI can get.

You fall into buying the houses in the worst areas where the rents are going to go up the least, because those tend to look the best in year one. It's kind of like the tortoise and the hare example here. Okay, so you go to Gary, Indiana, where the house is $45,000 and the rent is $900 a month and you're like, oh, it's going to crush it. The spreadsheet shows a 26% return on my investment, and so you buy it and then 10 years later the rent has never gone up. You never actually collect that $900 because the tenants aren't paying. You constantly have vacancies and repairs that need to be done. Even if you somehow squeak out some cashflow, the air conditioner goes out and that is the equivalent of 25% of the value of the entire house.

You end up losing so much money because the numbers in the beginning made it look like it was a safer investment, and because the people are scared when they first come, this is how the gurus target them. The spreadsheet is going to keep you safe. There's fundamentals you gotta look at, and it's hard to nail them down and get that feeling of safety, and this is why a lot of people don't invest in real estate, because you kind of have to make peace with the fact you don't have as much control as you think. So what I recommend people do is look at fundamentals, like you mentioned. What are things people can look at? What were the rents five years ago in this area? Are they roughly the same or have they been going up?

The more that rents have gone up every year, which is usually a function of what wages have done in the area versus the amount of supply. If supply is constricted, there's not a ton of rental units, and wages are going up, rents are going to be going up in that area as well. That creates a higher amount of urgency that you need to buy something and house-hack because every year your rents are going to go up and if you buy the house, every year the rents that your tenants pay is going to go up, it's a double win, and it quickly becomes something that makes financial sense very fast. The value of the homes usually go up in those areas as well as the rents. Now you're gaining equity all the time. It's sort of a forced savings account, especially if you're not good at saving money.

It's tough for me to say, here's the formula that you should use, but what I tend to do is say, where are the areas where rents are going up and values are going up the fastest? These tend to be the most economically thriving areas with the best weather, the best infrastructure, the most amenities where everyone wants to live. Then I would say, what would I need to do to live there? I definitely don't want to pay five grand a month and be house poor. Well, if I bought a house with a mortgage that was five grand a month, how could I reduce that? Well, I could buy the duplex, but the duplex doesn't work. What about a triplex? Could I find three units instead of two, so I have two units to rent out instead of one? Or what about a fourplex? Oh, there are no fourplexes, or the ones there are, there in the worst part of town. I don't want to own there.

Okay. What if I rented out the rooms? Well, this three bedroom, two bathroom house feels safe because it's cheap, but there's not enough rooms to rent out. You've only got two rooms to rent out if you live in one. What if you spent more money but you bought a house that had five bedrooms and a dining room that could be turned into two more? Now you've got a total of seven. That means you're living in one and you're renting out six. If every one of those rooms rents for $800, that's $4,800 of rent, and you are spending five grand on your mortgage, now you're going to have some vacancy and some other expenses. But that creativity is the way that investors need to be thinking today. What we say is you need to make a deal, not just find a deal, because so many other people are looking for these same deals. They're not just going to jump out at you.

Katie:

Yeah, that's an interesting kind of distinction. I definitely feel like in the content that I've consumed about real estate investing, there is often this emphasis on these places where houses are less than a hundred grand, and it doesn't seem as though the supply and demand kind of basics would work in an area like that where it's like, well, there's probably a reason that house is so cheap. Are there even people that want to live in that area? So it is interesting to hear you say by trying to save a lot of money up front or to make it look really good on paper in year one, you might be in the long term disadvantaging yourself.

We'll get right back to it after a quick break.

So maybe I'm interested, maybe I have a hunch that I'm in a market where this might make sense. How do I go about looking for multifamily properties that are for sale? Maybe I'm thinking, okay, I don't really want to live in a single family home where I'm renting out rooms to strangers. Maybe I'm not super comfortable with that. I'd rather start with the duplex, triplex, fourplex situation. Is there a Zillow specifically for multifamily or do I use Zillow? I've heard people talk about getting off-market deals and how that's the best, but those seem by design harder to come by. Am I driving around the area knocking on doors? If someone doesn't yet have real estate connections because they are a beginner, how do you think they would realistically begin a search like this? It strikes me that there probably is some luck involved because sophisticated real estate investors can sniff these deals out right away, pounce on them long before a beginner would have a chance to discover one of them. But realistically, how would you advise someone to start that search?

David:

Yeah, the off-market deal, it's example of the fisherman that goes fishing every weekend for a year and the only Facebook post you see is the biggest fish they ever caught. It's a full-time job to find those, and it's just a sales technique. It's what people in the real estate world do to get you interested in following them or taking their course. "Look at this great deal. Don't go on market, go off-market." Well, yeah, of course, the casual person, the person who has a job, by the way, I think a lot of people at their jobs make more money than the full-time investors that spend all their time looking for these off-market deals and occasionally find one, but it's not as good of a deal as if they just worked. Yes, you have to start if you're a normal human looking at things on a site like Zillow, so they do have a filter where you could go and look for all of the small multifamily. That's the terminology we use for two to four units.

Now the thing with Zillow is you're just looking at what's in the MLS. You're looking at the same thing that the realtors see, that the brokers manage, so you can also find a real estate agent and say, I want to buy small multifamily. Can you put me on a list and send me everything that hits the market that's between two to four units? I'm actually a broker and I have agents on my team. So find one that at least knows how to use the software of their MLS that can send you these opportunities. But if not, you go on Zillow, you go on realtor.com, whatever website people prefer. You set up your filter for small multifamily. You look to see what's out there.

Now, what I've found in my years of buying is that you have two different types of multifamily locations. So some cities, which I typically find happen when they are developed slowly, this happened in the south a lot of the time, people buy a plot of land, they build a property, they build it themselves, they own it, they live in it, they pass it on to their family, maybe they sell it to someone else, but it's mostly homes that are built one at a time. That's what you're looking for with small multifamily. What you want to find is that triplex built in the same neighborhood as a bunch of single family homes with pride of ownership, with low crime, with decent school scores. You're going to get a much better tenant base.

What other cities do, and this is what I found, is in California where we build tract housing, they will build a whole bunch of single family homes in one little area and they'll say, we're going to zone this for multifamily, and so they build all of the multifamily houses in the same little spot at the outskirts of town or it's not near any of the commerce, and that's when you're looking at the duplexes or the triplexes, the picture looks pretty, but the area itself is not as good.

So that's what you gotta be careful of when you're going after these, is how the city has set up their zoning. But these are dynamics you have to be aware of when you're choosing location, because it's not just going to jump out at you. I teach about this a lot, when it comes to making deals, not finding deals, is you can make the duplex. Instead of looking for the property, like I said earlier, that has the highest cash on cash return right now, I say, where's the best area? The best schools, the best location, rents are going up the most. The people that live here are constantly getting raises. They're working in tech, in biotech, in medicine. They have these jobs that they invested a lot of money to get a degree, they're not going to leave them. This is a thing that it feels very sustainable, and I say, how do I make this work?

And I look for homes that have basements that are unfinished. The bigger, the better. I look for homes that have unpermitted square foot, work was done to the house the owner never got the permit for, so it's listed as 1,300 square feet in the MLS, but it's actually 2,200 square feet. All the other buyers are missing that because the agent just looked at the tax records and said, Hey, it wasn't permitted. I don't want to get in trouble for claiming that it's more than it is. So the house is comparing to other 1,300 square foot houses, but it's bigger, and that addition that was added...now again, this doesn't mean buy unsafe housing. You still get a home inspection to make sure that the work was done well.

But those houses with additions tend to be converted into having, we call them ADUs in California, accessory dwelling units, right? Some people call them ohana units, in-law units, granny flats, you have it turned into a separate unit. Maybe you have to add plumbing, hopefully it already has some, but you put a kitchenette, make sure there's at least a bathroom. You see how many bedrooms can be included. You frame those in, boom, you've got a separate unit.

Now it functions like a duplex. You've got the main house that you live in. You don't have to share your space with strangers. You could be comfortable and you've got this unit that you can rent out to others that happens to be in an area where you have a high demand, you get to pick the best tenant, the rents are going to go up every single year, and then maybe you find a property that has two spaces that you can do this with. These are things that if you want to think outside the box because you want a house-hack, rather than looking at all the reasons you can't do it, start thinking this way and look for ways that you can make it work.

Katie:

I see. Okay, that's really interesting. So let's say we've located our ideal property and now it's time for us to figure out how we're going to pay for it. We need to get some financing. How do you to approach financing a property like this, and I imagine now at the phase that you're at, you're probably treating it a lot differently than a beginner would, but do you tell people go for the lowest down payment possible? Are you shooting for 20% to avoid PMI? I think there are some nuances here with if you're going to house-hack and it's going to be owner occupied in some capacity, the down payment requirement of being 25% for a rental property type rule goes away, and now you could potentially house-hack with a 5% down payment, but in this interest rate environment where money is no longer basically free to borrow, how do you think about this strategy?

David:

When I've run the numbers at putting more money down to save on the mortgage, I've rarely found that it actually makes financial sense to put money down. I realize how heretical that sounds in our space where logic would say the more you put down, the safer it is. I think that advice holds true in a static environment where prices are mostly the same. Okay. A house is worth, let's say $500,000. In 10 years, it'll be worth $505,000? This is just a set number that we can create a baseline to make decisions off of. Yes, putting more money down could make sense. We don't live in that world.

The Fed prints a lot of money. We've had several rounds of quantitative easing. We have really bad inflation. It turns the game of what should be checkers into chess. It's not as simple as make a bunch of money, save it, put money down on the house, and then have a good home for your family. A lot of times the extra 15% you'd have to save to get to the 20% instead of the 5% down conventional loan option, the house itself would appreciate by so much money during the time you had to save it that it doesn't save you very much, and even though rates are much higher than they were, it used to be, like you said, almost free, 3% interest rates. Now they're 7% to 8% or so. That's significantly more. It's two, two and a half times more expensive.

It's still not as terrible as if rates were at 15%, 18%. At those rates, putting more money down will have a significant improvement on the cost, but I could run the numbers for you right now if you wanted. It would not be as much a month difference as what you're thinking to put more money down. What I have noticed is if you use these strategies that we are talking about, buy a house that generates income, the income the house can generate for you is significantly more than whatever you can save putting the money down.

So in some cases, spending $50,000 more on the house or having a loan balance of $50,000 higher, if that home compared to the cheaper one can generate you another $1,200 a month, $800 a month, that's way more than what it costs to borrow the $50,000. You have to look at it holistically. You have to look at a house like, what is the income it brings in and what are the expenses, not just how do I get my expenses lower and miss out on the creative ways that you can get your income up.

To sum this up, you have more control over how you make a house make income than you do over how long it takes you to save $150,000 to put down on one house.

And frankly Katie, if you had an extra $150,000, I really think you'd be better off to buy the house, put $50,000 into turning the garage into a studio that you can rent out as an Airbnb or you can rent out as a rental, and then take the other $100,000 and use it to buy your next house next year and end up with 10 houses in 10 years that are all appreciating at huge rates because of how much money is being spent. That would dwarf the results you would get if you just put that $150,000 down and saved yourself the 7% interest rate.

Katie:

So that's actually interesting. I do kind of want to take you up on making that real with an example and kind of showing how those numbers would work.

David:

So Katie, let's say that you put $50,000 down on a house at 3.5% percent interest, so you save an extra $50k to try to get your mortgage balance less. That $50,000 is going to save you $225 a month at 3.5% percent. Not a huge deal, and for most people, they can cover that. Now, if we bump interest rates up to 7.5%, that $225 jumps up to $350, it's not a huge difference. You'd be thinking that extra $50 grand is going to make my house more affordable. It's not that big of a difference, right? $350 a month isn't nothing, but it's not a massive amount.

Now, if interest rates, let's say that they go up to, the calculator I have, well, at 18% you hit about $754 a month. That's a pretty significant amount of money at that point. Putting more money down on a house can make a difference, but when we're talking about 7.5% interest rates, even though that's higher than where they were, $50 grand, how long does that take your average American to save? That's the equivalent of making $80,000 after taxes. Then saving 100% of your money, let's say you're super good, you can save half of your money, and now you got $160,000 to be able to save $80,000, and then you get taxed on that, you get left with...it's so hard to do. How long is that going to take before you get any progress?

Katie:

This is where I wanted to ask for your take on, I hear the reasoning and I think it's interesting to see how it impacts the numbers, and I think in a house-hack situation, in an investment situation where you're buying a house that is going to produce income for you in some capacity, you're not just buying a house that you're going to live in and pay for. So what I have always found concerning about the advice to put as little down as possible is that often I find that that translates to people for whom maybe they aren't making very much money, and so they're saving as little as they can. They've got this cash cushion and then they're deploying all of it for the 5% down payment, and then something doesn't go as planned, something breaks, and now it's like they're truly up a creek because they weren't putting 5% down strategically and then using the other $100,000 on something else. It was like, no, they literally just only had the 5% and now all of their money is tied up in this asset. Now, if something goes wrong, how do you think about that risk calculus? Is that valid to be a concern?

David:

I agree with you a thousand percent. One of my big pet peeves is the people in our industry teach people how to buy real estate with no money or low money down, and they're just preying on people that are bad with money. And there's always a person that will sell them a course. "Well, put five grand on your credit card and buy my course and I'll teach you how to buy real estate with no money." It drives me nuts. It's why I wrote the book I have coming out. I was tired of people that were bad with money that wanted to come invest in real estate. This is not an asset class. It's not like buying a bond. It can actually require you to put money into it. Things can go wrong. You've got to have some reserves if you want to play in this space.

If you had 20%, I would not want you to put it down on the house. I'd rather see you put 5% down and keep another 5% as reserves. Have another 5% go into improving the actual property, making it nicer, increasing the equity, adding units that could create more money, getting a return on that, and then the last 5%, save that for the next house that you're going to be buying. Give yourself a little bit of a headstart or put it into some other investment options, if you're good at understanding equities or whatever space that you play in. It doesn't make sense for me to, like you said, have people put all their money in the house.

I am much more inclined to say, real estate investing is going to cost money. Put as little down as what you can reasonably get away with, but then go back to making money. Go back to saving money. I don't think investing should be a alternative to working hard and being financially responsible, and unfortunately, that's what it's turned into. In a lot of ways, people, they don't like their life, they want to be rich. They want to get rich through real estate. It's a terrible way to try to create money. It's a very good place to stick money you've already made and let it grow.

Katie:

Amen. Okay, well, I love that. I appreciate the no bullshit approach that you seem to have, because in a weird way, hearing you discuss it and very practically of like, yeah, it's going to cost money. Yeah, there's risk. It makes it more attractive to me because I always found a lot of that language to be quite, okay, well, what's the catch? You're telling me that you can...okay, I don't buy it. I think any reasonable person would and should be skeptical of that, and so you've alluded a few times now to continuing to buy homes, and I got the sense from the real estate investor and realtor that I was working with, who was wonderful, just that when I was thinking about giving this a shot, I got the sense from him that, well, it's not that it's not worth it to only own one, but it's not worth it to only own one.

If you want to invest in real estate, you're not going to see much of a return until you're treating it like a portfolio of properties. But is that still the case, in your mind? If you're really just using house-hacking as a means of accelerating your timeline to maybe more traditional single family residence ownership, or to defray some of the costs of owning the house that you live in? If someone said to you, Hey, I just want to use this to lower my own shelter costs so that I can eventually live very cheaply, or I can eventually buy a house that I acknowledge is not an investment, but it's just the house I want to live in, but I don't want to build a rental property empire, would you be like, yeah, totally works, or if you're just going to do it once, probably not.

David:

No. On the contrary, I definitely think that they should buy it, even if it's going to be one. I don't think it's very likely that when they buy one, they'll keep it at one, if they're tracking their finances. What I found is people that aren't following how their money is growing, they may not see the benefit in what happened. They'll realize it later. So let me ask you a question here, Katie. Do you remember what your parents paid for their first home?

Katie:

Yes, I do. Although I don't know that this example is going to be what you want.

David:

No. Well, how long ago did they buy it?

Katie:

They bought their first house in 1994 for $225,000, and they sold it in 2019 for like $350,000.

David:

Okay, well, what if they had kept it? What do you think it's worth right now, the Zestimate?

Katie:

It's at $465,900 now. I just remember when they sold it, I was like, wow, that did not appreciate, really. I mean it did, but not in a way that would be...

David:

Well, it appreciated by about 33% or so, and what area was that? Was that in Colorado?

Katie:

It's in northern Kentucky. It's where the Cincinnati airport is. Yeah, it's home of Amazon warehouse. It's like a commuter town, really.

David:

It's not a highly appreciating area whatsoever.

Katie:

No.

David:

Kentucky isn't known for that, right? But even then it more than doubled, right?

Katie:

Yeah.

David:

Okay. This is a good example. What most real estate isn't doing, it went up less than everywhere else. So $225k to $460k, let's just say that. That about doubled. If they put 5% down on that $225k, that would have been about a little over $10 grand, less closing costs, let's say $15,000 to buy that property, and it would've paid itself off and it would've appreciated up to $465. So what's the rate of return on $15,000 turning into $465,000? If you could do that math, that'd be awesome, but I know it's really, really good. That's a pretty good return on money that you forgot you even invested.

Katie:

But that wasn't the only money they put into it, right? They had to make all the payments. They had to pay taxes, they had to pay insurance. How are you looking at that $15,000 to...

David:

Let's assume that if the person who bought it, the house was generating revenue the whole time, that's the difference between the real estate investment and just buying the house to live in, right? If they had bought a property that was generating revenue, that was paying for itself at a certain point, now all those expenses are covered by your tenant, and even if you just don't track what your house is worth, you don't track anything, you would look back and be like, oh my gosh, what do you know? It's like putting $20 in your coat pocket that turns into $465,000 of equity at the end of your life that you now have, right?

Katie:

Oh, I see what you're saying that because, yeah, not in their case, but that in a house-hacking scenario, many of those...you are putting in, but okay.

David:

And I wish I'd bought more houses. Once that thing is gone from California, my parents paid $62,000 for their first house in the late '80s, and it's now worth about $500,000. I've never heard a human that said, I wish I would've bought less real estate. They're, I should have bought more of it. I should have bought more of it. Now, when you're tracking it, you want to buy more of it. Not everyone does, though. Some people just aren't good with money. They don't pay attention to it, they don't look at the performance of it. So what my point was, is it worth buying a house if you're not going to buy a lot of them? If you're tracking it, you will buy a lot of them.

Katie:

What if you just don't want to be a landlord? What if you're not into managing properties?

David:

Then house-hacking is the perfect thing for you, because not only will the asset be going up in value and the loan is slowly being paid down, but you also are saving on the biggest expense that the average person will ever have, which is their housing, right? At a certain point, especially if you bought in an area where rents are going to be appreciating, that house becomes living in for free while all of your neighbors are watching their rents go up. At the same time my parents bought it, rents in that area were $150 a month, okay? Now they're like $2,800 a month. That's how much they've gone up over my life. So you're putting a buoy in the water that's going to be going up as the tide rises with inflation, but the house-hacking is powerful, not just because of the real estate component; it's the savings component. 30 years of not having a mortgage is a buttload of money.

Katie:

Yeah. And I mean, as we alluded to earlier in the conversation, you might still be paying for a sizable portion of that monthly payment depending on the numbers in the beginning. I guess, actually, let me put a finer point on that. If we're saying 5% down, what type of loan am I getting if I'm putting 5% down?

David:

You still get a conventional loan. So You have FHA loans that are 3.5% down. Those are going to have the equivalent of mortgage insurance. It never goes away. At a 5% conventional loan, you will be paying mortgage insurance, usually a couple of hundred bucks a month, depending on the loan balance, until the property reaches a certain amount of equity, and then it can be dropped off. So again, you're not going to pay it for 30 years. You're going to pay it until...

Katie:

So it's the conventional loan is the one that you want to go for?

David:

Yeah. It's still a conventional loan. Exactly. They have 20% down options. They have 10% down options if you want to get a secondary home, or they can go down to 5% if it's a primary residence. I have a mortgage company called The One Brokerage, and this is why we started it so that we can help our clients figure out what's the best way to use your money. Would it be better used putting more money down on the house, or would it be better used putting less money down and putting that money into the stock market, a mutual fund, something like that.

Katie:

That does clear that up for me. So now it's time to move in. We've got our house, we've paid for it, we're ready. I presume at this point we now need to find a tenant, assuming we have done the work we need to do to get it, move in ready. Do you have a preferred method of finding tenants? I feel like I wouldn't know where to start with this.

David:

I've always used property managers for that exact reason.

Katie:

Oh, really?

David:

Yes. I tried it. The first house I ever bought, the one I told you about, I did it myself, found him on Craigslist, terrible experience. Absolutely got ripped off. Had the guy end up cashing the refund check from my escrow that was sent to that house erroneously, and then paid me with three months of rent of my own money before I figured out what was going on. It was horrible. Had to do an eviction, and then I hired a property manager that was not even that good, very mediocre, but so much better than me. I just realized this is one of those things where if you get a person that has experience, they'll save you a lot more money.

Katie:

Would you say that that's true even for a house-hack where I'm just going to have one half of my house that I'm renting out, or two units, would you still say, yeah, pay the 10% or whatever the fee is to have someone else find your tenants for you?

David:

If you're a human being who it doesn't feel heavy, it feels light, it wouldn't crush you, you wouldn't be really irritated to do it. And if you're somebody who does not have a hard time holding boundaries, that's one of the problems is it's very easy to start being nice to tenants, thinking they'll be nice to you. Most of the laws in the majority of the states in the country will favor the tenant, so that only becomes an issue if you picked a bad tenant, right? Very rarely does this happen with people that have something to lose. I've found that the majority of the people that make decent money, they don't want their credit score going down. If they can't pay the rent, they'll just leave. So if you struggle with boundaries or if it just seems intimidating, hire a property manager, pay him 8%. It's not that much money.

If the tenant's paying you a thousand dollars a month, that's 80 bucks of it, and then over time rent increases happen and it covers the costs of the property management. If you're someone who's excited, yeah, let's do it, this would be fun, yeah, give it a shot yourself. What most of the people do that manage it themselves is they advertise it on Facebook Marketplace, is a place that I'm seeing a lot of people are finding tenants. Obviously Craigslist is a big one, and then they run credit checks on the person and they call their previous landlords, and they have a rule of thumb where they want to see that the rent is going to be no more than a third of what the tenant makes at their job.

Katie:

I mean, I find the places that I've rented on Zillow, that's how I always find the properties that we live in.

David:

You just contact the for rent by owner directly?

Katie:

Yeah, I'll just go on Zillow and look at rentals, and then usually the property manager or the owner is listed. So both times that I've rented from Zillow or using Zillow, I'm working with the actual owner of the home, where they bought the home as their primary residence and are now moving and want to rent it out. So that has worked well for me. I just wasn't sure if there was some behind the scenes hack where it's like, let me save you the trouble, but that's surprising. Honestly, I feel like I hear mixed reviews on whether or not you should or should not work with a property manager. I think I'd probably be more in the camp of I want to do less work.

David:

Me too.

Katie:

I'd rather run it like a business and delegate that to someone else and pay someone else to do that. But I guess it depends on how the numbers look, too, if you're really scraping by.

David:

To me, Katie, it's such a small percentage of the numbers. We're talking about what the property managers get. It's not a big savings to save on property management. There's other ways you can save a lot more money. If someone is going to do it themselves, I will give this piece of advice. Managing the property when everything goes well is not that hard. The tenant's paying all the time, they need the light bulb changed, you'll hear a lot of people say, yeah, it's not big deal. I do it myself. Of course. You want them for when it goes badly. So if you manage it yourself and then you have a tenant not paying, a tenant making threats, whatever the case is, don't forget, you can still go to them and say, Hey, can you take over an eviction for me? You may have to pay a little bit more money because you didn't hire him in the first place, but it's still better than you trying to learn how to manage your own eviction.

I made that mistake. I went and bought Evictions for Dummies book and tried to figure out how to handle it. It was terrible. It took like six months instead of one or two. That ended up being a lot of money in rent, right? You're talking about twelve to fifteen thousand dollars of money I lost trying to save money doing it myself. So when you find yourself in a jam, rather than hiring a lawyer, you can go to a property management company that has done this many, many times to just hire them to run the eviction for you.

Katie:

I was thinking that people who are doing the single house-hack thing and are just renting out a portion of a home they're living in, kind of assumed they would be the property manager too. Sounds like that's not really what you would personally recommend. Are there other things that you get from, let's say things are going wrong, not just from the standpoint of maybe the tenant is paying and maybe they're great, they're on time, whatever, but things in the house are just going wrong. Does the property management company also deal with those problems, or is that on you as the owner?

David:

No, you can ask them to deal with it. What I find the benefit is, and the real reason I love it, like you said, running it like a business. Most people don't want to go have a really difficult conversation with their tenant, especially if its a tenant/roommate.

Katie:

A little awkward.

David:

You're literally living in the same space; it's very awkward. So it's nice to have a third party person that can have that conversation for you. Let's say that your tenant, they're leaving their junk out and there's flies that are going around their dirty dishes that were left out. In one hand, I get it, if in their own home that's how they live and this is their home, so they think they can do that. On another hand, this is your home and you have different rules. This is what makes relationships tricky. It's the expectations of the ways we think that things should be versus someone else. If you see it's a problem, you just have the property manager drop an addendum that says, "Hey, these are some of the rules of the house that everyone's going to need to agree to if you want to have your contract extended." And you cover dirty dishes in there; the property manager says, "Hey, we need to know that you've agreed to this."

And then if there's an issue, you take a picture, you send it to the property manager, they can go talk to the person: Here's a stack of flies from your dirty dishes, or here's where you left the window open when the air conditioner was running, whatever issues might start to pop up. A lot of people avoid those conversations that need to happen in business because they don't want to have them. There are some scenarios where people rent the triplex and they live in one unit, rent out the other two. They just don't tell the people that they're the owner. Yeah, I'm a tenant too. Yeah, the Acme Property Management's where I go when I have that problem and then they just tell the property manager, "They're parking on my side of the driveway," and then the property manager says, "Hey, just a reminder, this is your parking stall. It's going to be $100 fine if you park on the wrong side or whatever," and you as the landlord don't have to deal with the anxiety of that uncomfortable conversation.

Katie:

Oh, wow. Okay. This is wild. So let's say everything goes according to plan. You do this, years pass. Ideally the property is appreciating because you've done your research on the area; you have reason to believe it will. You gain some equity and now...blank. The most strategic move at this point? Am I thinking about potentially selling it and taking that money and maybe I'm not going to be a real estate person anymore? I'm going to take the accrued equity and savings and I'm going to go buy my dream house and live happily ever after? Am I going to say, I'm going to keep it, rent out both sides, I'm going to move out, move into something nicer? Once you've made that progress and you've made those good decisions and they've compounded over time, how are you then accessing that equity such that you could do something else with...I would love for you to walk us through the options and some of the considerations once we're now several years in, and in your mind, what a realistic timeline for those types of options and considerations are?

David:

I love that you posed the question this way, because what most people say is, give me the blueprint. Tell me exactly what I'm supposed to do. Buy the house, wait three years, do this, buy this thing, buy that thing. But like we said earlier, real estate can't be put into a box. That economy can't be put into a box. There's so many variables. In three years, the values might've gone down or they might've barely went up. Or in a year and a half they might've skyrocketed. You don't know exactly how it's going to shake out and you don't know what investment options are going to make sense in five years or in 10 years when you have it. In the book that's coming out, Pillars of Wealth, I really talked about how the value of money is changing so frequently. You almost have to stop looking at it like money.

So money itself has three uses. It's a means of exchange, which we all know. I give you money, you give me something. It is a unit of account. So this is something we don't often think about, but if I say, "Hey, how much is that couch worth?" You don't say, "It's worth 60 hours of time as a bookkeeper." "It's worth three chickens, one carburetor, and half a big-screen TV." You give an example of what it's worth based on a dollar amount, and don't let me forget, that's the thing that's tricky. And then the third use is it is a storage of value. So I put in work at my job, I receive money in return, I traded the value that I put in for a dollar that's holding value.

It's the unit of account part that I think gets all the people that aren't good with money confused. They're still looking at a house is worth X amount of money and they're not thinking about that that money is also losing energy. So let's say that you own a house and it's worth $500,000 when you buy it and you look on Zillow and there's a little green arrow that's pointing up that says, now it's worth $502,000. Now it's worth $505k. You feel good. I made a good investment. However, what if inflation is at 15%? Because that's how much food is going up, cars are going up. So the unfortunate realization I've come to is I can't use money as a measurement of account. It's not accurate. I don't know what that means when you say it's worth X amount of money, because it changes so fast. You could be losing money on your investment, but inflation makes it look like it's going up.

I say, we need to look at money as a form of energy. Where am I going to put this energy? Is it going to grow or is it going to bleed? You get to decide where's the best place to put it and then you evaluate your options. Would it make sense to buy a car right now because they're about to go up in value a lot and I want to lock in that Corolla before it's more expensive? Should I buy another house? There are many paths to take and I can't tell every human being what the right path is for them. And I also don't know in 10 years where the opportunities are going to be. But what I can say is that you should always be in the principle of creating energy through hard work and savings and investing energy into vehicles that don't bleed. And if you do that and you're financially savvy, you're listening to podcasts, you're paying attention to how money is flowing and how it works, you'll know where the right moves are to put that money.

And the one thing you could always control that I wish more people paid attention to is what you spend. There's a huge focus on, how do I make more money? How do I grow money through investing? And all the energy that they spend trying to create income is lost to money that they don't even realize that they're spending. If you had $200,000 that was earning you a 6% return, that would be about a thousand dollars a month. Most people can cut a thousand dollars a month out of their spending if they have a budget, if they're looking at where the money's going; that is not as difficult to achieve as what you might think. Earning $200,000 and investing it is very hard to do. So start with what you can control, which is what you're spending, and then you'll respect money more. You'll respect your time and your energy more, and you'll make better decisions with investing as a result of that.

Katie:

That was not what I thought you were going to say, honestly. It's an interesting direction to take, that answer, because again, it I think runs counter to a lot of what you hear in this space. You went in the direction of, well, before you're stressing yourself out about, well, I gotta make a 6% return. It's like, well, are you spending in a way that that money is even going to be valuable to you? So that's interesting. I wasn't expecting that.

We kind of just talked about if someone is consistently making good choices, they are gaining equity, things are compounding, things are going their way. What about if things go the other way? If I said to you, David, house-hacking, it did not work for me and it went horribly wrong, what would be your most likely explanation for what went wrong? When you see risks in this scenario, what do you see as the common pitfalls that people are making when things are not working out as we have described?

David:

House-hacking itself hardly ever goes bad. That's funny that you asked that and I'm trying to think of examples of when it went wrong. Investment properties go bad, Airbnbs go bad, flipping houses goes bad. There's a lot of ways that real estate can go wrong. I'm not here as the homer for real estate trying to say it's foolproof. But I think the reason house-hacking rarely does is if it goes bad, that means you didn't generate as much income as you wanted, but the expenses associated with that property, you would've been paying anyways because you needed somewhere to live.

Katie:

Okay, interesting. So you wouldn't say there's any hero risk here, or any one predominant...

David:

How much upside is there going to be, right? No upside is neutral, and that's why I recommend it to people so often versus buying an Airbnb, where if you can't get bookings, you bought in the right area, you got bad reviews, you messed up, now you got this extra mortgage that's just an anchor that's sucking away all of your other financing or your reserves.

Katie:

Okay. That's actually super interesting to hear. That makes me feel, I don't know, a little more confident about potentially trying this. Who would you say, though, is not a good candidate for house-hacking? Is there a type of person that you would be like, I would never recommend?

David:

House-hacking has much less of a financial risk or maybe say financial cost, but that doesn't mean it's free. It comes at a different cost. It comes at comfort. We all like to have our dream home. And when you're house-hacking, that's what you're giving up. You're giving up the space, you're giving up the convenience, you're giving up peace of mind, you're taking on obstacles. I don't want to make it sound like it's just this infinite banking hack that there's no downside or whatever. There is a cost you pay. But for people that are concerned with money that want to have a strong financial future, like me, I don't mind giving up comfort and convenience in order to have the delayed gratification upside. The people that should not be house-hacking are those people that cannot handle the discomfort. If you're one of those people that's like, I need my space, I need my zen, I need my peace. I can't listen to people walking around in a unit next to me or I can't have roommates, or I'm not willing to lose my personal way of doing things.

Maybe they're a really wealthy person. This is a doctor and they don't want to come home to noise. They need to sleep and be back at work, and they're making $300 grand a year, saving $1,500, $2,500 a month on their housing is not worth what they could be losing in their quality of life. So the person, to sum that up, that shouldn't house-hack is the one that's already making really good money somewhere else. They're running a great business. They have a really good profession. They're good with money as it is, or the person who just can't handle the inconvenience that it's definitely going to bring.

Katie:

Excellent. Super honest. I love that. Thank you. I think I'm getting a clear picture, too, through that answer of who it is good for. If you're bringing home hundreds of thousands of dollars a year in a demanding profession, you have a successful business, it's like, is that incremental cashflow really going to make...? No, probably not. You're risking more of peace of mind, and you might actually end up finding that...

But there are a lot of people that are not in that boat, or I don't even have enough wiggle room in my day-to-day to get myself into that boat. And actually by house-hacking, I'm going to create more freedom for myself to perhaps put myself there. So I think that you're right. It totally depends on where you are financially and professionally right now. So David, thank you so much for lending us your expertise today.

David:

Yeah, this has been a blast. Thank you, Katie.

Katie:

All right. I hope you enjoyed this. I hope it made you think a little bit differently about your housing, potentially, or maybe even gave you the confidence that this isn't the right move for you and you can stop thinking about it as what you should be doing. That's all for this week. I will see you next week, same time, same place, on The Money with Katie Show.

Our show is a production of Morning Brew and is produced by Henah Velez and me, Katie Gatti Tassin, with our audio engineering and sound design from Nick Torres. Devin Emery is our chief content officer, and additional fact checking comes from Kate Brandt.