Denver House Hacker's Guide

Intro

Home ownership is one of the pillars of the American dream, and remains the predominant way most Americans build their wealth.  A homeowner’s net worth grows consistently each month as the value of the home increases and you pay down your mortgage – there are tax advantages too.  Those who are renting, however, gain nothing from each monthly payment – that money is gone.  In the beginning, the difference won’t be huge, maybe less than $1,000 per month in wealth lost.  But over time, the cumulative effects are staggering:

• For the average person in the middle class, the equity in their home made up 50%-65% of their total net worth - LINK

• The average net worth for homeowners in the middle class is 40x that of renters.  Renters had an average net worth of just $6,300, while homeowners average net worth is $255,000 - LINK

If you’re reading this post, you probably don’t need any convincing, you’re trying to figure out how to get started.  The problem: with interest rates and home prices this high, who on earth can afford to buy a home in Denver right now?

• As of February, the average home price in Denver was $560K and 30-year fixed mortgage rates are hovering around 7%.

• This means you’ll need to have $30,000 saved and an income of at least $150K per year to qualify for an FHA loan, and your mortgage will be ~$4K per month.

Tempted to hold off and wait for better timing? It’s going to keep getting more difficult for the foreseeable future. 

• Lower interest rates won’t save you - if you’re waiting for the fed to lower interest rates and make that mortgage more affordable, understand that as soon as that happens, EVERYONE will be able to afford more home, and this will drive prices up. 

• Institutional buyers will continue pushing prices higher - institutional investors are increasingly buying residential homes and outbuying families in the process.  Blackstone just raised a $30 Billion fund, Jeff Bezos is getting in too.  MetLife projects institutions will own more than 40% of all single family rental units in the country by 2030.  That’s a level of demand that will only continue pushing prices and affordability higher.

If you want to get into real estate and start building the bedrock of your net worth, the sooner you start the better.  Here’s a strategy that can get you into real estate now and position yourself for long-term wealth, without the crippling monthly mortgage payment.  This is House Hacking.  This is how I got into real estate myself, and let me tell you, the grass is greener on the other side.  This article covers the key things to get right when house hacking to make sure your investment is successful. 

What is House Hacking?

House Hacking, at least as I define it, means purchasing a home you will live in, while also renting it out to others to help pay your mortgage.  For some people, that means buying a single family home and having roommates, but the most common application is buying a property with 2-4 units and living in one while renting out the rest. 

The name “Hacking” scared me at first, but it’s perfectly legal, and can reduce your monthly housing expenses by varying amounts, depending on how good you are at it.  It’s not effortless - if you have a ton of money already then maybe it’s not worth it.  But if you’re willing to put in a little sweat equity, it can reduce your housing costs and generate huge returns on your hard-earned money! 

As an example of the concept, let’s assume you bought a Duplex in Denver for ~$600K, on a 6% FHA loan putting the minimum 3.5% down.

Receiving rent offsets the mortgage payment so you pay less than you would renting:

You build considerable equity over 5 years that you wouldn’t have if you rented:

There’s more to it than that – there are tax benefits to consider, and you can gain equity quickly if you can purchase the house below its appraisal value, but more on that later.  The main point is you’re reducing how much you have to spend on housing each month while building up equity that will continue to compound for you.

It’s a very sound, practical thing to do, particularly in today’s market.  That said, if you’re using this strategy, there are some critical things to get right that can significantly improve your results and help you avoid costly mistakes.  It’s an amazing opportunity, but there are no do-overs!  I’ve learned a lot of helpful tips, so I’m going to share those with you to help make your investment successful.

Hiring an agent

I was extremely fortunate to have a great agent when purchasing my first 2 duplexes – he spared me a LOT of pain and helped me avoid several landmines that would have been terrible investments.  I learned a lot from him through each process, and there are a few things that I think are really helpful to take into consideration when hiring an agent:

Experience working with investors

An agent who regularly works with investors will likely find better properties and deals for you and will be more effective at closing the deal.  They have a better network with the sellers, and may even know of pending off-market deals you can get at an attractive price.  They also are more effective at closing the deal, because they understand both parties’ motivations and will find opportunities for mutually beneficial give-and-takes that get you the most of what matters to you.

Experience with home repairs and maintenance

Even if you think you are handy and will recognize problems on your own, your agent provides a second set of eyes to find lurking problems that can be costly.  If you don’t have a lot of experience inspecting properties, they are your ONLY set of eyes.  As I’ve learned over time maintaining my properties, some of the most severe red flags for a property’s condition aren’t the most conspicuous or intuitive.  Noticing a severe issue quickly at minimum spares you time and money going under contract and finding it during inspection, at best it can help you avoid a money-pit you can never climb out of!

Network of general and sub-contractors

One place an agent can really provide value is with their network of contractors and handymen they can point you towards.  Finding a new contractor can often be a crapshoot, but a good agent will have contractors they can put you in touch with that will provide quality, reliable work at a reasonable price. 

Acquiring Financing

Minimize your barrier to entry and maximize your leverage with an FHA loan

Make sure you talk with your loan officer to understand all of your options, but FHA loans are the predominant mortgages used to finance a house hack, as they only require a 3.5% down payment.  This gives you a lot of leverage you can use to buy more house for less money – an $800K house will only require a $28K down payment, whereas a conventional loan at 15% down would require a $120K down payment, which can be much more difficult to save up for many.  A couple things to know about FHA loans:

Debt-to-Income Requirement

In order to be eligible for an FHA loan, you’ll need to have a debt-to-income ratio < 43%

Primary Residence Requirement

An FHA loan requires that you occupy the property as your primary residence.  You generally have 60 days after closing to be moved in. 

Mortgage Insurance Requirement

Because you are buying the property with a lower down payment, your mortgage payment will include mortgage insurance in addition to your principal, interest and escrow costs each month. 

Max Loan Amount

The max loan amount is based on the unit count and your local area.  As you can see, you can currently take a loan out for as much as $1.5M for a 4-unit property in Arapahoe county:

You can only have 1 FHA loan at a time

Keep this in mind when considering your future plans – if you want to purchase a new property using an FHA loan you can, but you will need to refinance the current one to something different. 

Selecting a Property

Find a property priced below the neighborhood average

You want to purchase your property at a price that is well below the average value of other homes in your neighborhood.  This will put upwards pressure on the value of your property over time as a slow, powerful tailwind – you want these market forces to be in your favor.  If you are buying your property at a price higher than other properties in your area, your long-term value will be pulled down when these properties get used as comps for valuation. 

Look for Value-Add Opportunities

You generally want to buy as much house as you can - a 5 bedroom house has more opportunities to add value than a 3 bedroom house.   More opportunities to add value gives your investment a higher ceiling, and the higher the better.  You can get creative here, and the best do, but there are generally 3 primary opportunities to add value to a small multi-family property you should look for:

• Cosmetic Renovation – a property with worn or outdated paint, flooring, appliances, appliances, etc. presents a great opportunity to increase your equity in the home by completing those projects yourself while you live there!

• Add a Bedroom or Bathroom – If a home has more square footage per bedroom than most, or has a space that feels unused, adding a bedroom or bathroom down the road can increase your home’s value dramatically.

• Finish a basement – an unfinished basement presents a great opportunity to add value to your home.

• Add an ADU – adding an entirely separate unit to the property will provide you with an additional source of income and will greatly increase the value of the property!  In Colorado, generally any property in a Single-Unit zone district with a “1” at the end of the district name (ie U-SU-C1) will allow an ADU.

  • For other helpful info on ADUs, see the City of Denver’s ADU Guide

A good agent will have an eye for these opportunities and will help you find an investment with the highest possible ceiling, while also helping you increase your floor by avoiding costly setbacks.

Take special care to avoid critical infrastructure issues

Cosmetic repairs present opportunities to improve the value of your home so they should be expected and even appreciated!  Critical infrastructure issues, however, should be avoided under any circumstances, regardless of any concessions made by the seller.  I wouldn’t consider any property with the following issues:

• Roof Issues:  Roof issues can be tremendously expensive and are often overlooked.  Look for damaged/missing shingles or sagging roof lines on the outside, and for any water stains on the insides that might indicate leaks. 

• Foundation Issues: Foundation issues can be disastrous for a new homeowner – make sure your house has a good set of “bones” without any issues.  If you see cracks that are either stair-step or horizontal, do not proceed with any deal until you have a professional evaluate it. 

• Sewer Line Issues: Repairing a sewer line is another massive job that can have a devastating cost to the homeowner.  ALWAYS pay for the sewer line inspection with your normal inspection before purchasing your property, and if it has sewer line issues, disqualify it immediately.

Having an experienced agent can help you avoid these properties immediately which will save you time.  When it comes to your inspection, generally added costs are worthwhile as this is your chance to avoid VERY costly mistakes.  I would highly recommend you attend the inspection yourself so you can familiarize yourself with all the issues and reconcile them with what you see in their report.  Inspectors are paid to identify everything so they will, but being there in person helps identify what needs your attention the most.

Make sure at least one unit is vacant before you close

With an FHA or any residential loan, you have 60 days to occupy the home as your primary residence, or you’ll be in big trouble with the banks and the federal government.  Don’t put yourself in a position where you depend on a current tenant moving out, because if they refuse to leave after you’ve closed you’ll have an eviction on your hands.  That will be costly, there’s a risk they’ll be destructive to the property, and you still likely won’t have them out within the 60 days you need.  This is a potential landmine you just need to avoid.  Even if you get a signed agreement from the tenant that they will move out in time, you just can’t do it – it needs to be vacant. 

If the other units are occupied, make sure you are inheriting a high-quality tenant.  It’s great to be receiving rent from day 1 without having to renovate and find a new tenant, but inheriting a bad tenant can be incredibly stressful and costly.  Be on the lookout for a buildup of junk or other signs the tenant is taking poor care of the property.  I can’t emphasize enough how big of an impact the tenant has on the performance of your investment – a great tenant makes a great investment, while a terrible tenant makes for a money pit that will be very expensive to solve. 

Renting the Property

Don’t disclose you’re the owner, just that you’re the property manager

One thing I’ve learned is that if a tenant knows you are the owner, they will feel more comfortable asking for things, and it can become more confrontational to deny these requests.  Having the “Owner” as an anonymous 3rd party means you can use them as a scapegoat and avoid having to argue about any given decision or change that is made.  Given they will be your neighbors, avoiding that dynamic will be helpful. 

Tell the tenants that you are the property manager, and they should come to you for all issues and you’ll get approval from the “owner” on how to proceed.

Always have a current, written lease

Letting a lease go month-to-month might be tempting and avoid an awkward conversation about renewal with the tenant, but it’s very important that everything be by-the-book with the tenant and you have a current agreement in place.  This will also be important for any financing needs you have in the future, as a Bank will want to see proof of the income you’re generating from the unit to qualify, and they won’t accept an expired agreement.

Run the rental as a business and enforce the rules

If you treat the property as a hobby, it will pay you like a hobby.  Treat it like a job to make it pay you like a job.  It might feel easier to let a tenant get away with small incidents, having a new pet, paying late, smoking, etc. but gradually these exceptions will become expectations.  Run everything by-the-book, and what I mean by that is:

• Consistently enforce every rule in the lease.  If they are late, charge the fee.  Once you allow rules to bend, all rules will feel negotiable and you’ll find yourself dealing with issues that hurt your performance and take your time. 

• Tenants are not contractors.  Their job is to pay you rent, and your job is to maintain the property.  Allowing a tenant to perform maintenance on the property in exchange for either money or lower rent is a slipper slope that can result in never-ending problems and disagreements.  I used to allow this, but have stopped as it leads to the tenant constantly complaining about small issues and expecting to be paid for resolving them.  Keep a clear line of separation and always either hire the work out or do it yourself.

• Renovate for functionality and conformance.  Too often investors lose sight of the property as an investment.  They start making fancy, 1-off upgrades as a hobby, which cripples their long-term ROI.  You want to make everything functional and conforming in a rental – that is your best recipe for the property to eventually sell well in the future.

Conclusion

Generally, House Hacking is a great way to get into the real estate market and open the doors to high returns.  While the strategy itself is great, it can still produce a wide variety of outcomes for the investor depending on how well they execute.  I hope you find the strategies above helpful, as I attribute my successful house hacks to these strategies! 

If you are interested in purchasing a home, I can help you find and acquire the right home for your objectives and set you up for success as you start your investing journey!  Reach out for a quick informal consultation and I can walk you through your next steps.