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We’re in the market for a new house. Because I’m cheap we’re on the path to financial independence, I want to incorporate a rental property. Fusing the two is a form of house hacking, a method of turning your single family home into a small multi-family rental property. Today, I’m going to walk through how we are analyzing the cash flow for a house hack where we combine our primary residence with a rental unit.
A friend of ours passed along a community for us to look into. I figured it’s worth showing our evaluation approach (OK, it’s my evaluation approach. My wife is much more interested in the big picture rather than how the math is done).
The community is in Fulton, MD. (Montgomery county for those of you that read my last post on growing counties in MD). Fulton is a planned community under construction. It has a Town Center with a community area complete with exercise facilities, a pool, and common spaces. There’s a mix of neighborhoods, ranging from apartments, condos, and townhouses to single family “estates”. The community is in the southern part of Howard County MD, so it definitely checks our box for good schools.
Let’s talk more about the math of evaluating a mixed use rental property where we live in one part, and rent out another. While we’re not explicitly looking for a duplex, that’s essentially how I’m approaching this topic. Here’s two of my favorite bloggers weighing in on general rental property evaluation: Afford Anything, and Financial Samurai. Finally, here’s an article specifically about duplex investing on Bigger Pockets, one of the biggest real estate blogs out there.
Analyzing Cash Flow When Hacking Your House
Let’s start with cash flow. For a typical owner “un-occupied” (rental) property, cash flow must be positive to even think about moving forward (rents must be higher than expected costs). In your personal residence, total costs should be less than some % of your gross income. We’re looking to blend the two, For better or worse. See how this seems different: we’re looking to buy a place with a portion of the costs offset by a renter. If it was a classic duplex, we’d likely want to “live for free” such that the renter covers not only their portion of the costs but 100% of ours as well. Somewhere between “live for free” and rents subsidizing our lifestyle is the trade space we’re looking into.
With that said, the math still ends up being pretty straightforward. Here’s a link to the spreadsheet I’ll be using to evaluate potential properties that fit into this kinda-sorta-duplex. (Note: I am tweaking a spreadsheet that I use to evaluate potential rental properties, so don’t worry too much about the Cap Rate, Cash on Cash %, or NPV metrics.)
We can estimate what an individual property will cost us to own and operate/maintain as our primary residence. We can estimate market price point for a rental property that looks like ours. E.g., a 1 BR1BA basement apartment. We can subtract the two to find out what our net cost of living will be.
If you add up the monthly costs above, it would cost over $5,000 a month to live this way! But, by taking on a renter, we can drop our estimated net costs to about $3,500 a month (and that is before any tax benefits).
Next, appreciation. Zero (this one is easy). I never assume we’ll benefit from any appreciation on a rental property. There’s some good reasons for this: real estate tends to appreciate only as fast as inflation. This keeps the math simple when evaluating prospective properties, and keeps my analysis conservative.
Finally, taxes. I figure out what the estimated property taxes will be so I can factor them into cash flow. The source for the tax information is either based on the listing (if available) or the historical tax records…You know those are all public records, right? Here’s the MD website. And, here’s a link to an online public records search site so you could look start your search anywhere in the US. After that, any deductions, expenses, etc are all gravy. I would never advocate buying a rental property just because of the tax benefit. The underlying investment needs to be sound first.
So, how does our primary residence/rental unit stand up?
Now the good news. A 1 br/1ba in this neighborhood is also a pricey affair. I saw $1,900/mo as the nominal rent for such an apartment. So long as we don’t mind neighbors downstairs indefinitely, we could end with a net monthly cost of $3,468.19. That’s still a big number, but it helps to illustrate why I’m so keen on having a rental property baked into whatever becomes our next home. Note that I took a wild guess to arrive at ~20k to convert part of the basement into a rental unit. Here’s hoping that’s in the realm of reasonable! Because these numbers are still pretty big for us, I’m leery of making this kind of commitment without doing some serious homework.
What do you think? Would you ever accept a long-term rental situation in order to afford a big honkin’ house? Is there another way to make this kind of move and keep it affordable?