Play the House Hack Long Game

I rarely see blogs, podcasts and YouTube videos discuss the long-term investing options that house hacking present. Yes, they do a great job of focusing on living for free or near free for a year or two, but they don’t put it into context of what house hacking can do for you over the next few decades. Well, this section will!

I rarely see blogs, podcasts and YouTube videos discuss the long-term investing options that house hacking presents. Yes, they do a great job of focusing on living for free or near free for a year or two, but they don’t put it into context of what house hacking can do for you over the next few decades. Well, this section will!

This module covers:

  • Cash flow
  • Equity build
  • Different scenarios for achieving $10,000 / mo
  • Rate and term refinance to increase cash flow
  • Cash-out refinance
  • Determining the amount of equity
  • Return on Equity
  • Return on Investment
  • Case study comparisons

Four Learning Options!
Ultimate House Hacking Guide for Denver
  1. Order the book on Amazon or grab a copy from us
  2. Listen to episode “#217: UHHG – #14 Play the House Hack Long Game” on the Denver Real Estate Investing Podcast
  3. Watch the YouTube video (at the bottom.)
  4. Read this blog post, which is from the book.
Start at the Ultimate House Hacking Guide for Denver Overview for a list of all the modules.

As you’re buying multiple house hacks, there are three main themes going on:

#1: Experience and Knowledge

Gaining experience and knowledge is vital, but it doesn’t show up on a spreadsheet or your profit and loss statement! It’s very hard to measure, but every deal you buy and every year that you own a property builds your knowledge and experience. We often cite house hacking as a great launching pad. As you accumulate capital and want to move into bigger deals and partnerships, this knowledge becomes invaluable and a powerful resource.

The experience that Joe, Jeff and I have each gained from our investing experience has helped us win deals and make smarter investing decisions. I have represented Jeff on a couple of his house hack purchases where we’ve run against other offers coming in. Guess what? My team and I “sell” Jeff and his experience as an experienced investor as one who can perform and won’t get stuck on minor details during the inspection process. It’s helped us win the properties!

As you grow, keep this in the back of your mind. Both during the good times and the bad times. There will be both, and they will make you a better investor.

#2: Cash Flow

After reviewing a couple of deals, it’s obvious that you’re not getting rich off the initial cash flow. That’s fine and is to be expected. If you’re patient and play the long game, your cash flow should increase. What’s your biggest expense on a property? It’s your monthly mortgage payment. It’s a fixed monthly amount. Your payment in month one is the same as month 201. In Denver, rents have grown an average of 4% per year. Can we guarantee that they’ll continue to grow? No, we can’t, but there’s a high probability that they will. Remember, your mortgage payment, assuming a 30-year fixed loan, is inflation proof!

In addition to the cash flow, you’ll receive the depreciation tax benefits. They’ll put cash flow back into your bank account every year.

#3: Equity Build

There are two ways you build equity in a property:

  1. Appreciation
  2. Debt pay down

Is appreciation guaranteed? No, it’s not, but it’s highly likely. Over the last 45 years, Denver has seen an average appreciation rate of approximately 6%. In the last 44 years in Denver, every year, except for four years, prices have appreciated. Will we see a 6% appreciation growth in the future? I honestly don’t know. I do think Denver will continue to appreciate. With all the job and population growth, how can it not? I’ve asked this question to hundreds of people and to-date not a single person believes Denver will be worth less in the future than it is today. Now, I’m not saying there won’t be plateaus or possible down periods, but overall, I’m bullish on Denver and want to ride the wave of growth.

Every time you pay your monthly mortgage, a portion of your payment goes toward principal reduction. As long as you make your payments, you’re building equity.

The next page shows the “Long-Term Analysis” tab of Joe’s spreadsheet of the room by room house hack Aurora example. Spend a few minutes to really study it. Here are some items to focus on:

  • Compare row 31 (Annual Mortgage Payments) to row 29 (Net Operating Income). The annual mortgage payments stay the same! The net operating income shows the money left over after both increased rents and expenses. The spread or profit is increasing!
  • Look at row 32 (Annual Mortgage Insurance). It drops off between years 9 and 10. Thus, increasing your cash flow!
  • Row 38 (Total Equity) shows the equity from appreciation and debt paydown. Every year it grows quite a bit. We’re using a conservative 3% appreciation rate.
  • Look at the ROI Quadrant™ returns on rows 41 to 45. Not bad for only 5% down.

Due to limited space, we couldn’t show out to year 30. Plus, the text may be hard to read. If you’d like a copy of this spreadsheet, reach out to us and we’d be happy to share it so you can study it in detail.

long term analysis house hack spreadsheet
Click image to enlarge.

Different Scenarios for Achieving $10,000/mo.

Let’s continue with the common goal of achieving $10,000/mo. in rental income. Remember, you’ll need approximately $15,000 in gross rents from properties with no mortgages. Using the same Aurora house hack example, you would need six houses bringing in a long-term rental income of $2,500/mo. (6 * $2,500 = $15,000). For long-term modeling, I revert back to traditional rentals. Self-managing six rentals with room by room rentals is not a hands-off retirement. The simplest plan is to house hack six times and then use the debt snowball method to pay them off.

Is it possible? Absolutely. It’s the most straightforward and simple plan. However, very few investors will house hack six times. Many people get fatigued or life changes after three or four properties. It’s a great initial plan to start with because everyone needs a simple plan to start working towards. It’s not worth stressing about the details of property #6 when you’re still on property #1.

The rest of this module will discuss three strategies that you can use to accelerate you towards your goal. They are:

  • A rate and term refinance to increase cash flow.
  • A cash out refinance to buy more properties.
  • A 1031 exchange transaction to buy more rental properties.

Is one better than the other? Nope. There are a lot of factors as to which, if any, you should do. They are all options that are available after owning a property, typically for at least a few years. Let’s run through some examples.

Rate and Term Refinance to Increase Cash Flow

A rate and term refinance is when you refinance the loan on your property to change the interest rate and, possibly, the term of the loan. Investors typically do this if interest rates are lower than when they purchased the property and/or to drop mortgage insurance.

At the time of publishing this guide, Jeff just finished doing a rate and term refinance on his fourplex house hack with Joe. He purchased the fourplex with an FHA loan to utilize the favorable low down payment option that it provided. However, he had mortgage insurance of $400/mo. for the life of the loan. Since purchasing the property, two things have happened:

  1. Interest rates have dropped.
  2. He has enough equity of 25% to do an investment refinance loan.

The table below compares not only the loan differences, but also the equity and rent differences as well. It’s a great example of what happens when you have patience with real estate:

 2017 FHA Loan2020 Conventional LoanDifference
Interest Rate3.75%3.625%0.125%
Payment (Principal and Interest)$2,754.28$2,656.58$97.70
Mortgage Insurance$400$0$400
Property Value$630,000$815,000$185,000
Rents$3,785$4775$990

In Jeff’s case, interest rates dropped. Even if rates didn’t drop, refinancing would still make sense (as long as rates didn’t increase too much) to drop the monthly mortgage insurance of $400/mo. Between dropping mortgage insurance of $400 and reducing his monthly payment by $97, his monthly cash flow increased by almost $500/mo. That’s a significant increase in cash flow!

It costs money to refinance a loan. Since Jeff has a significant equity increase, he paid zero out-of-pocket to refinance. Joe was able to wrap the refinance costs into the new loan.

In addition to saving money with the refinance, rents also increased by $990/mo. Between the increased rents of $990 and monthly savings of $497, his cash flow has increased by $1,487 since purchasing the property.

This is a great example of what happens when you’re a smart investor and play the long game.

The one downside is that Jeff’s FHA loan had 27 years left on it. The new loan has 30 years left on it. An extra three years to save $500/mo. is a smart trade off.

Here’s a key point: regardless of whether Jeff refinanced or not, once the loan is paid off, the property will perform the same and generate the same cash flow. The difference now is that he can use the extra $500/mo. to save towards buying additional properties.

Cash-Out Refinance

A cash-out refinance is when you refinance the loan to take cash out. Don’t expect to buy a property at 5% down and do a cash-out refi the following year. That is highly unlikely. It often takes three to seven years to build enough equity in order to take cash out because you still need to leave 25% equity in the property for an investment loan. Let’s discuss two examples of taking cash out for investing purposes.

Example #1: Cash-Out to Buy Future Nomads™

In 2019, one of my clients wanted to start Nomading™ to build a rental portfolio. The clients have two young kids, so house hacking with roommates was not a good fit for their family. They wanted to start acquiring properties.

Years ago, before they became interested in real estate investing, they purchased a house. We sat down to discuss options with the current house. The house made sense to keep as a rental property. Like many Denver homeowners, they were sitting on a significant chunk of equity. During our investment strategy meeting, we realized that tapping into the equity would allow them to buy Nomad™ properties quicker than if they relied on their savings rate alone.

We had Joe run two different scenarios for doing a cash-out refinance:

  1. An owner-occupant refinance. Just like when they purchased, these have lower interest rates and have a one-year requirement to live there. Yes, even though they’ve already lived there, if they did this option, they are required to live there for one year from the date of the new loan’s closing.
  2. An investment cash-out refinance. These come with a higher interest rate but have no occupancy requirement. They can move out at any time.

The table below compares the two options:

 Owner Occupant Cash-Out RefiInvestment Cash-Out RefiDifference
Interest Rate3.5%3.875%0.375%
Payment (Principal and Interest)1,549$1,622$73
Mortgage Insurance$0$0
Cash-Out Amount$88,700$82,042$6,658

The important question we wanted answered was, “Is the owner-occupant refi savings worth staying there another year?” As you can see above, they would save $73/mo. and get an extra $6,685 cash-out at closing. They get more cash with the owner-occupant refinance because there were less points for them to buy down. For both options they were using the equity in their home to pay for all the closing costs and point buy down.

Before we answer the question, it’s important to understand more about their personal situation. They have two young boys who start kindergarten in three years. Once they start school, they’ll most likely stop Nomading™ so the kids can stay in the same school. Their goal is to acquire a few rental properties before settling down within a school district.

The monthly savings of $73/mo. and an extra $6,685 in cash was not worth it to them to stay there another year. I agree with their decision. They decided to go with the investment cash-out refinance loan option and bought their next property in Q1 2020.

They are disciplined clients who took the cash-out refinance to help fund the down payments on their future properties. The cash from their first place is going to help them buy three more properties!

Example #2: Cash-Out Refinance to Buy Rental

This analysis is covered in the Case Study: Investing $100,000 from a Primary Residence Cash-Out Refinance post.

Return on Equity

Get more details by reading the Return on Equity: Playing Adult Monopoly

YouTube Video: Play the House Hack Long Game

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Authors
Chris Lopez
Chris Lopez is a Denver area real estate entrepreneur and investor, as well as the host of Bigger Pockets’ House Hackerz and the Denver Real Estate Investing Podcast.
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