House Hacking - How Doctors CAn Invest in Real Estate with Almost No Money

House Hacking: How Doctors Can Invest in Real Estate With (Almost) No Money

How can you buy a house in 2020 with almost no money? Are you tired of hearing stories about people who bought real estate pre-2008 and now they’re loaded? Me too. Those stories are inspirational, but not always helpful. Let’s talk about how to start investing in real estate right now, even if you don’t have much cash to invest. 

I realized shortly after undergrad that I needed to start investing in real estate to build wealth, but I had almost no money.  I was already sold on the need for passive income as I’d just finished reading Rich Dad Poor Dad. It’s no secret that the wealthy make their money work for them, instead of trading their time for cash. I wanted to do the same, but I wasn’t exactly rolling in the dough.  So how did I get started in real estate investing?  

My House Hacking Experience: My First Multifamily (& First House!)

The term “house hacking” hadn’t been coined yet (by Brandon Turner at Bigger Pockets), but that’s exactly what I did. With a total of $8,000 from selling my CD collection and raiding my nascent IRA, my boyfriend (now spouse) and I bought a fixer-upper duplex in Woburn, MA from a family friend. With the upstairs tenants paying the mortgage, we had enough leftover every month for the rehab. Two years later, we sold, collected a tidy profit and fled New England winters forever (apologies to any readers in snowy locations). While I wouldn’t recommend living in a house you’re gutting, the money we earned was life-changing and let us move to Southern California. 

Of course, that was a long time ago and the market has changed. You’re not here for my story from the pre-2008 crash anyway – you want to know how can you can house hack in today’s market – without a lot of cash. If I were starting all over again, what would I recommend to start who wants to start investing in real estate without a lot of money? (Disclaimer: yes, there is some risk involved and anyone who tells you that you can make a lot of money without taking on risk is lying to you.)Subscribe to the Financial Residency Podcast

What is House Hacking?

“House Hacking” is using your home as a way to generate passive income while you still live there. The idea of house hacking has grown to encompass any way to earn income off your primary residence in order to reduce your cost of living. House hacking has the same benefits as buying a traditional home, such as a lower down payment and better interest rates, as well as the mortgage tax deduction, while also having the benefits of owning a real estate. How would you like someone else to pay your mortgage for you? With house hacking, someone else pays for your home, in exchange for using a little piece of your house. Think of house hacking as a financial strategy to decrease your cost of living

How Can You House Hack?

Do you have an accessory dwelling or mother-in-law suite to rent out? An apartment over your garage, a room in your house or even a basement suite? No room inside? Then look outside! Renting out a garage, driveway or parking space in parts of the country short on parking or storage can turn your house into an income stream. The simplest house hack though is to just buy something made for multiple families – a multi-family! Anything under 4 units still qualifies for a conventional mortgage with a low down payment. 

Can Doctors House Hack?

Yes! Doctors have an extraordinary advantage here – they are able to qualify for a “physician mortgage”. These loans may have as little as $0 down and require no Private Mortgage Insurance – a type of insurance most people pay when their down payment is less than 20% – since doctors have a default mortgage rate of 0.2%, compared to the 1.2% typical of the general population. 

How To House Hack in 2020: A Real Example

Here’s a real-life example, pulled from the MLS in Dec 2019. Let’s pretend a medical resident at UMass is looking for a place to live – since it’s a 3-year program and she wants to stay in the area long-term, she wants to buy, not rent. Our imaginary resident, Kristin, doesn’t just dive in, of course. Internists like to deep dive so she does her homework first.  

Through her research, she learns that she needed to factor in the location of the property to get the best rent. The desirability of living in a certain area, as well as population growth, job availability and local amenities all needed to be measured along with the purchase price. She finds a multifamily not too far from the hospital – It checked all her boxes: close to work, desirable area, great price, updated units, and close to amenities. She decides to go for it, purchasing a triplex on Chandler Street in Worcester, Massachusetts. 

She paid $450,000 and got a first-time home buyers loan. She put 3% down, or $13,500, and moved into the top floor. After looking at comparable rents in the area, she set the first and second-floor units at $1,450 per month each. Each unit had separate meters for gas and electric, something she was happy she didn’t have to tackle herself. She wrapped her closing costs into the mortgage, which were $6,000. Subtracting her down payment, her mortgage totaled $442,500, and she had a 3.9% interest rate. The monthly payment came out to $2,092, and the monthly property tax was set at $450, making her total monthly expenses $2,542. Her monthly income was $2,900, however, it is recommended to assume a 10% vacancy rate for tenant turnover time, so her monthly income was actually $2,610. At this point, her net expenses to live in the house BEFORE maintenance costs were -$68!

Kristin knew she needed a cash reserve for unexpected expenses, so she set aside $10,000 for that at the time of purchase. One can always borrow the down payment or put nothing down with a physician mortgage, but it is essential to have an emergency fund. An unexpected roof repair or basement issue can really put you into crisis if you aren’t prepared for it. No bank will loan you money once you’ve run out of it. 

She knew she needed to set aside money for maintenance and capital expenditures, outside of the emergency fund. Experts recommend about 15% of the total rent, so she assumed $7,800 per year and saved 15% of the rent every month (including her own “rent”) for future repairs.

All in: $13,500 down payment + $10,000 emergency fund = $23,500

OK, $23,500 isn’t no money. True. For real estate in Massachusetts though, it’s pretty good. In other parts of the country, the numbers are much better. Kristin could also ask her family to help with an emergency reserve until she can save it herself so that she needs less cash upfront. 

Lower Your Cost of Living with House Hacking

It cost our IM resident $582 to live in the triplex every month! Not bad, if you look at rent in Massachusetts. Is she living for free? No. But her expenses are a lot lower than with a single family home. 

Taking all her numbers into consideration, she paid just over 1/3 of what a comparable rental in her neighborhood would cost.  House hacking allowed her to cut down the amount she spent on housing, something that the average American household currently spends 33%-50% of their total income on. Her budget was well below that threshold.

Kristin’s Triplex: During Residency/Fully Rented
Rental income $2,900
Mortgage -$2,092
Property taxes -$450
Maintenance/Capital Expenditures -$650
Vacancy reserve (10%) -$290
Total expenses -$3,482
Net Income -$582

Building Long Term Wealth with House Hacking

Kristin finishes her 3 years of residency, during which she welcomes a baby boy. She decides it’s time to move out, and she was able to rent out her former unit. Rents had gone up 2% per year for the last 3 years, so rental income is now $4,616 per month. She’s a new mom and a busy nephrology fellow, so she hires a property manager to handle maintenance requests and tenant issues, as well as the task of finding and screening new tenants. Her property manager charges 10% of the rent, plus one-months full rent for every new tenant, typically every two years when a tenant leaves. And she continued to set aside a 10% vacancy reserve. 

Her expenses also rose 2% per year, or $690 per month. Her mortgage payments remained the same, at $2,542 for the mortgage and property tax. After expenses, she was bringing in $440 per month, or $5,280 per year. 

Kristin’s Triplex: During Residency/Fully Rented
Rental income $4,616
Property Management Fees -$654
Mortgage -$2,092
Property taxes -$450
Maintenance/Capital Expenditures -$690
Vacancy reserve (10%) -$290
Total expenses -$4,176
Net Income $440

Not having any responsibility in the day-to-day operations of renting a property anymore freed up her mind to focus on her baby and her fellowship. She considered it absolutely worthwhile to keep the property for a return over $5,000 extra per year. It covered diapers and some daycare costs, while someone else paid off her real estate.

3 years after she moved out of her rental, and 6 years since she purchased the triplex, she is finally finished her fellowship. She decided to move out of the state to take her first attending job as a nephrologist. The house, which she bought for $450,000 6 years ago has risen in value through appreciation. The increase was about 3% per year, and the triplex was then worth $540,000. She still owed $389,947 on her mortgage.Physician Wealth ServicesBefore 36 months have passed since she moved out, she sold the triple, right before the end of her fellowship. She got her asking price of $540,000 and paid a 6% commission, leaving her with $507,600 from the sale. After subtracting what she owes on her mortgage, she walked away with $117,653. And because of a tax rule that says you can sell your rental property without paying capital gains tax if you’ve lived in it for 3 of the last 5 years (up to $250,000 for a single person), she gets part of that money tax-free. She does still have to pay capital gains tax on 2/3 of the profit, as the IRS only gives you a free pass for the house you live in (and technically Kristin lived in only 1/3 of the triplex)

Money Gives You Freedom and Freedom Gives You Choices

How would you have liked to leave training with over $100 grand in your pocket? Kristin has options now –  paying down her student loans was the first thing that came to mind. She could also use the money as a down payment on her new home, or purchase another rental property and house hack all over again.  She can invest the profit and retire a few years earlier than planned. Finally, she could put it away in an education fund for her son, secure in the knowledge that his education is completely paid for. The point is, she has options she would not have had before, thanks to real estate investing. 

House Hacking: What’s the Downside?

There are a few pitfalls to understand when house hacking. 

Tenants are not your friends. Living close to your tenants means it’s easy to develop a social relationship with them, but taking landlord duties seriously needs to be the first priority.  Setting boundaries is crucial in order to have a successful landlord-tenant relationship. Your friend wouldn’t expect you to fix their toilet after all, but your tenants will. 

You give up some privacy. Someone shares your space in any form of house hack. A multi-family minimizes this, but you still inhabit the same building and will know every time your tenants have a party. Because you’re downstairs (and maybe not invited.)

Oh, and it’s work! Being a landlord does take up some of your time and there is no getting around that. 

You Can House Hack!

If you’ve convinced yourself you can’t buy or can never live in the part of town you want, take another look and see if house-hacking can work with your lifestyle. Or if you’ve been wanting to get your feet wet with real estate investing and want to dip a toe in the pool, house hacking can be a great place to start. Start making your home pay you instead of working to pay for your home! 

I love house hacking and so will you. Need a place to start? Reach out to me for some advice on what to do at drcathycarroll@gmail.com.

Cathy Carroll, MD, CFA