Gateway to real estate: 'House hacking'
If you've always wanted to invest in real estate but don't know where to start, "house hacking" may be your first step.
Simply put, here's how to do it: buy a property with two, three or four units using similar favorable loan types that owner-occupants enjoy. Live in one unit and rent the rest. Learn the ropes for a while and stash any cash flow for repairs and reinvestment. Use the living expenses you save to move out and buy another property. Repeat.
This live-in strategy for building real estate wealth is gaining traction nationwide, and for good reasons. Owners can benefit from as much as a 7 percent annual appreciation rate, according to Realtor.com data, which is the same rate at which rents are rising nationwide. Some metropolitan markets are even experiencing double-digit increases.
It's not all upside, of course. Owning a multiunit property is a business that requires upkeep and diligence. There's rent to be collected and you live alongside your tenants, who might become problematic or even require eviction, which can be a drawn-out and expensive proposition. There's also a potentially larger mortgage liability, paying for unexpected repairs and being stuck with possibly long vacancies.
Yet owners can also take tax deductions for depreciation of the rented portion of the property to save taxes on the income, said enrolled agent and tax consultant Alan Pinck of A. Pinck & Associates. And certain multiplexes qualify for Federal Housing Administration and Veterans Affairs loans with favorable terms, said Ron Haynie, a senior vice president of the Independent Community Bankers of America.
Terms on VA loans, for which only military veterans are eligible, include no money down and lower interest rates, while FHA loans require as little as 3.5 percent down with low closing costs. Both loans allow buyers to finance energy-efficient improvements. Borrowers must demonstrate good credit and income verification.
"There's so many different ways to use ownership of housing. For us, we really like [this way of investing] because of the training ... and offsetting your costs," said Josh Dorkin, CEO of the real estate investing website and podcast, BiggerPockets, which says it coined the phrase "house hacking" and consistently lauds it for beginner investors, especially the young and single with open minds and lifestyle flexibility.
Sales of owner-occupied "multiplexes" — properties with two, three or four independent units — were up 24 percent in 2015 over 2014. By comparison, single-family properties were up just 16 percent, said Jonathan Smoke, chief economist at Realtor.com.
The values of multiplexes are up 21 percent — also slightly more than single-family homes. The fastest growth is among four-unit properties, where sales increased 52 percent in 2015 compared to 2014.
"Now that I'm doing it I realize there's a little more work to it. You really have to develop that mindset and commit," said Scott Trench, 25, who bought a Denver duplex in 2014.
Though he had to spend $8,000 on repairs and upgrades to make the property tenant-ready, Trench said he hasn't minded living next to his renters. Their rent, plus the money from a housemate in his side of the duplex, allows him to live rent-free plus collect an extra $250 a month.
The ease of financing a multiplex can depend on the lender. Prospective buyers may need to qualify for the property on their income alone, which can limit a beginner's buying power in some markets, Haynie said.
That may explain Realtor.com's data that show duplexes made up more than 80 percent of owner-occupied multiplexes in 2015. The more units, generally the more money you'll need to close. The lender also may require up to six to 12 months' worth of payments stashed in the bank for reserves.
There are other things you need to be aware of as well.
"Fannie Mae requires landlord counseling for buyers on two to four unit properties. It's one thing to take care of your own property, but to take on being a landlord, dealing with tenants ... these loans pose additional risk," Haynie said.
"You'll see varying policies from different lenders depending if they are a portfolio lender or selling to the secondary market. You have to go into these things eyes wide open," he said.
Trench put 5 percent down on the $240,000 property using an FHA loan and brought a total of $12,500 to the closing. If he didn't live in the property, the bank would have required 20 percent down. He's using the money he's saving on living expenses toward the FHA purchase of another duplex, which he will move into while renting out his first purchase.
Dorkin said you should enlist the help of a real estate agent who is experienced in working with investors, but it's important to always personally scrutinize the numbers using cash flow calculators and learning about market rents and risks. Keep ample reserves for vacancies and repairs.
"Everybody goes into real estate with different goals. There are certainly markets where you can buy these properties and you will not have positive cash flow no matter what you do," Dorkin said.
However, for those willing to entertain the risks, "you're still getting that experience of owning an investment property. No matter how many books you read, until you actually do it, you're not doing it. Getting your hands dirty is the most important thing," Dorkin said.
— By Kayleigh Kulp, special to CNBC.com