What is home piracy? | Think about real estate
If you are new to real estate investing, you have probably discovered that it is not as easy to break into as, say, the stock market. There is no Robinhood for rental property, and you can’t start with just $ 1. But there is a way to Get your foot in the door – home hacking.
How does home hacking work for investors?
Home hacking is an innovative way to overcome the two biggest hurdles new real estate investors face:
- Most traditional mortgage products for investment property will not allow borrowers without prior experience in owning or managing property.
- Invest in tangible real estate (as opposed to REIT) requires a large down payment or an all-cash transaction.
If you don’t have owner experience or a truck full of cash, home hacking might work for you. Home hacking means using your own home to generate rental income and learning how to own a home. You can modify your current home or buy one designed for hacking.
Hacking your home
There are several popular methods for generating income from your personal home. Determine what is best for you by comparing the pros and cons, cost and income of these options.
Buy a duplex, triplex or quadruple
Many homebuyers start their owning careers by purchasing a multi-unit property, living in one unit, and renting out others. It’s a great way to enter the rental market as a first-time investor. Not to mention that many investors can live in their home for free, as the rent from tenants can cover the mortgage or let the investor quickly pay off their mortgage.
- As long as you live in one of the units, you can get an owner-occupant mortgage instead of an investment real estate mortgage. Buying as an owner-occupant allows you to get cheaper financing, less down payment, and less restrictive underwriting.
- You can buy a multiple home rental with a government guaranteed home loan (normally these low or no down payment options are only available to borrowers who will be living in the homes). This means that you only need 3.5% down payment for an FHA loan or zero down payment if you qualify for the VA.
- You will have access to tax breaks that normal homeowners do not get. At tax time, you may be able to deduct maintenance, depreciation, repairs, property taxes, and utilities (check with a tax professional before buying).
- Managing your rental units gives you a low-risk, legitimate owner experience.
What happens when you sell or move? You could convert the entire property to a rental and buy a new primary residence. Or run a 1031 tax-deferred exchange with a 1031 exchange company to buy additional investment property. Many real estate empires started out as small investments that grew over time.
Qualifying for a mortgage, even as a beginner, is not terribly difficult. Banks, mortgage companies, credit unions and other providers offer a variety of terms. Of course, having good credit and a stable income will make the process easier. Some programs will allow you to use rental income (or potential rental income) to qualify for the loan.
Convert unused parts
Homeowners near colleges have been hacking their homes for decades. In some neighborhoods, almost all the houses have been turned into mini-buildings to accommodate students.
Garages and basements become additional units with separate entrances. Large houses with many bedrooms can be divided between owners and tenants. You might need a little more than a locksmith to make these changes. Or you can go a step further and install apartment-style balconies, parking, and exterior stairs.
Finished basements can make great living spaces if you brighten them up with windows, fresh paint on the walls, and good lighting. You will also need to add kitchen and bathroom items to make it livable. A few thousand dollars can convert a basement, attic, bonus bedroom, or loft into a cash-generating rental.
You can finance these upgrades with a personal loan, home loan, cash refinance, or even credit cards (for small jobs).
Buy or build an ADU
Guesthouses, casitas, and mother-in-law’s quarters are all accessory housing units (ADUs). These are legal and licensed accommodations on your property. Make sure you follow zoning laws and building codes. And if you’re buying a home that already has an ADU, make sure it’s licensed. If the ADU is illegal or unauthorized, you probably won’t be able to fund it or you may have issues with your local government in the future.
Recently, many municipalities have changed their zoning to allow UDAs as a solution to housing shortages. ADUs can be bought or built. Many manufactured home builders can deliver and install a small unit in a matter of days or weeks. Or find a reputable local builder who specializes in small projects.
Park of model houses and small houses
Small homes or model park homes that do not exceed 400 square feet are not real property. They usually have wheels and not permanent foundations. These units are legally defined as personal property. In many communities, you can buy them as cars or sheds and park them on your property.
Some people even choose to live in their small houses and rent out their primary residence. Others rent out their tiny houses. In resort areas, cottages are very popular vacation rentals. You may be able to earn more with a cute Airbnb than with a residential rental with a long-term tenant.
Tiny homes in scenic locations or tourist destinations lend themselves well to Airbnb or Vrbo. Just make sure your community or homeowners association allows non-owners to occupy residences. Many places have banned short-term rentals, so check before invest in a pint-sized place.
You can finance a small home with a home equity loan or cash refinance against your primary home. Alternatively, you can finance small homes with personal loans or sometimes dealer financing. And when you move out, you can take your little house with you as it is your personal property.
Good real estate agents are essential
Buying a home specifically for hacking is more complicated than buying a typical home. When interviewing agents, tell them you want to live in a house and use it for rental income as well. Enlist this person’s help in finding the best single or multi-family homes for hacking.
Tips for new owners
If you want more rental income and less headache, figure out who your potential tenants are and what they want.
Will your tenants be seniors looking for economical digs and a quiet environment? Vacationers looking for something cute and practical? Commuters looking for nearby public transport? Students who want to walk to class and (naturally) to bars, restaurants and gymnasiums? Local demographic information is widely available on sites such as areavibes.com and can tell you who your tenants are likely to be.
If you’ve never been a homeowner before, expect to do a lot more than display a sign and collect checks.
Before you hack into your existing home, make sure that you are allowed to have short or long term tenants. You will need adequate parking, secure entrances, rules of living together, and you will need to cover maintenance and repairs.
Screen your tenants carefully to avoid damage, crime, non-payment and lawsuits. Tenant screening services are inexpensive and most landlords pass the cost on to applicants anyway. Follow local coronavirus guidelines when presenting the property.
Require satisfactory home inspections in the purchase contract. Experienced property managers may be willing to buy ‘as is’, but newbies shouldn’t risk getting a bad roof or faulty wiring.
Consider requiring your tenants to carry tenant insurance. It is true that landlords are normally not legally responsible if tenant’s property is stolen or damaged. But that does not prevent tenants from filing such lawsuits. It is simply easier to require insurance and the policies are quite cheap.
Finally, you can choose your level of involvement. Can you handle midnight maintenance calls, tenant disputes, or deadbeats? Otherwise, consider hiring a property manager. You would pay between 10% and 35% for this service (long term rentals are cheaper while vacation rentals have higher management fees). Yet professional management can eliminate much of the risk and aggravation new owners face. And that can be invaluable.