House hacking is a common topic of conversation on BiggerPockets. And why wouldn’t it be? House hacking is an efficient, practical tool to reduce or eliminate what’s likely your largest monthly expense and accelerate your journey toward financial freedom.
For the uninitiated, house hacking is simply a co-living arrangement that generates income to offset your own living expense. While many house hacking strategies exist, each offers varying degrees of cost savings, expectation of privacy, risk mitigation, and upside potential. However, in my opinion, one such asset type is better than the rest.
Here are five reasons why the fourplex is the perfect house hack:
1. Greater Privacy
Many of my 20-something friends are faced with the following dilemma: spend 40 percent or more of their income to live alone or give up their privacy by partnering with roommates to share costs (and possibly bathrooms!) in a single family home or apartment rental.
The fourplex blends the best of both worlds if you live in one unit and rent the other three. Your tenants are effectively “roommates” that help share costs, but you all receive the added benefit of separate entrances, separate living spaces, separate lives.
If you have a family, significant other, or plan to have either, privacy is critical and makes a single living unit impractical and a fourplex attractive. Yes, the same privacy benefit holds true for a multifamily of any size, but we’re just getting started.
2. Greater Cash Flow
One of the best features of the fourplex is that it will generally cash flow better than one- to three-unit properties—primarily because its price is usually lowest relative to the income it generates. Much of this comes down to a relative lack of demand for the product.
On one end of the spectrum, you have substantial demand from single family buyers, who represent the vast majority of the owner-occupied market, bidding up prices based on emotional factors, the view of the lake, or the strength of the school system.
A minority of them will look to a duplex, or maybe a triplex, to either offset costs or to be used as a multigenerational living arrangement. But the thought of managing three other units is generally intimidating enough to keep single family buyers away.
A quick way to see whether fourplexes are undervalued relative to one- to three-unit properties in your market is to keep an eye on the ratio of gross monthly rent to purchase price.
Where I invest in MidCoast Maine, the fourplex usually wins the one- to four-unit category. And while you might find a five-plus unit building with an even better rent/price ratio, my next point reveals why four units is the maximum number you should consider for a house hack.
3. Exceptional Financing Terms
A common reaction I receive from friends when I suggest house hacking a fourplex is, “There’s no way I can afford such a large building!”
However, they are usually unaware of several aspects of financing a fourplex that make them the perfect house hack.
First, conventional bank financing is available for one- to four-unit properties. This means a 30-year, fixed-rate term.
Unlike commercial loans required for properties of five units or more, your interest rate and corresponding payment will never change with conventional financing nor will you ever face a pre-payment penalty or balloon payment. Add the appeal of historically low conventional mortgage rates, and there has never been a better time to finance a fourplex.
Owner-occupied fourplexes can also be purchased with a modest down payment of 3.5 percent when utilizing an FHA loan. This type of loan is a government-insured product designed for low- to moderate-income borrowers without significant credit history.
Think about it: 3.5 percent of $500,000 is just $17,500. Or on a $200,000 fourplex, 3.5 percent is just $7,000—certainly within reach for most financially disciplined, working Americans.
And if you’re still thinking about house hacking a five-unit instead, know that your down payment on a $200,000 building just increased to at least 20 percent, or $40,000.
Another under-reported benefit of conventional financing is that 75 percent of the existing rents from the fourplex will be counted toward qualifying income on your loan application.
Let’s say three units are already rented at $1,000 each. The bank would add 75 percent of $3,000 ($2,250) per month, or $27,000 per year, to your qualifying income.
If you make $50,000 per year at your job, you’ve just given yourself a 54 percent raise toward qualification.
If you consider the general rule of thumb that says you can afford four times income, existing rents would increase your buying power by $108,000 for this hypothetical fourplex!
4. Maximized Economies of Scale
A huge advantage of the fourplex is that they provide the best economies of scale available to conventionally financed property.
Consider this: for properties of similar location and condition, regular expenses on a per-unit basis are likely to be lower on a fourplex compared to one- to three-unit properties. For example, if insurance on a 2,500-square-foot duplex is $100/month ($50/unit), then the premium on a 3,500-square-foot fourplex might be $150 ($37.50/unit).
The same tends to hold true on expenses like taxes, lawn care, and snow plowing.
In addition, at some point in time, you are going to have a vacancy. If you’re house hacking a duplex and your tenant moves out, your income goes to zero. For the period of time that the unit is empty, you have completely lost the benefits of house hacking.
However, if you house hack a fourplex and you have one vacancy, you still have income from two units to help offset your expenses while you work to fill the third unit. There is tremendous downside protection afforded by a fourplex, as it is very unlikely that all three of your income-producing units would be empty at one time.
The fourplex also maximizes the multiplier effect of community upgrades that increase rent. For example, let’s say you install raised beds in the backyard so that your residents can garden in the summertime. That project might cost you the same to build whether you do it at a duplex or a fourplex.
However, the new amenity might enable you to charge an extra $20 in rent to one unit (if you house hack a duplex) or $20 to each of three units (if you house hack a fourplex). If the project costs $1,000 either way, that’s a nice 24 percent annual return with a duplex—but a whopping 72 percent annual return with a fourplex!
5. Training Wheels for Commercial Multifamily Buildings
Finally, the fourplex will provide a valuable opportunity to employ many of the same strategies and tactics used in large commercial multifamily while doing so from a relatively safe position of a smaller asset, limited capital at risk, a fixed debt obligation, and perhaps even a homestead exemption.
First, you’ll build your “core four” team members (agent, property manager, contractor, and lender) before you even look at any property—just like the “big boys.” Sure, you’ll likely start out being the property manager while you house hack. But you know that eventually you’ll move out and move up and wouldn’t think of buying in a market unless you first know there are a couple of good managers who can eventually take over. Every big player in commercial multifamily starts first by building a team.
Second, you’ll conduct a market analysis, evaluating similar metrics employed by the most successful multifamily syndicators. You’ll research demand drivers that affect your market’s trajectory, such as employment opportunities, the quality of the schools, the crime rate, and population trends. Every successful multifamily operator buys into a market before they buy a building, and you will, too!
When it comes to due diligence, you’ll bring in the experts to look at the roof, HVAC, foundation, and more. You’ll know the limits of your own expertise and rely on others to fill the gaps—similar to the savviest of multifamily investors.
Finally, you’ll crunch the numbers just like the pros. Yes, your bank will look at comparable sales data, but you’ll look at cash flow and rate of return. You’ll sift for opportunities to add value and increase rents, as well as opportunities to reduce expenses and vacancy.
You may even employ the BRRRR method and eventually refinance your invested capital out of the building completely—the Holy Grail of investing to which all large multifamily operators aspire.
The bottom line is that if you can successfully house hack a fourplex, you’re well on your way to becoming a successful commercial multifamily investor, as well. The money the house hack saved you might even go toward a down payment on a larger building, further accelerating your real estate journey.
And if the house hack experience reveals that future multifamily investing isn’t for you, that’s okay, too! In the meantime, you’ve saved a lot of money, developed valuable life skills, achieved personal growth, and own a cash-producing asset.
The experience will be irreplaceable, and no matter what you do next, you’ll be miles ahead of the crowd!
If you’ve been considering house hacking but have yet to pull the trigger, what’s stopping you?