Previously, I wrote about the real estate investment strategy called "house hacking". You can learn more about it here. Today, I'd like to share another strategy with you that I like to call the "live-in fixer upper" strategy. This is a more common strategy than house hacking because, although it is hard and stressful, it is more realistic for most people's circumstances.
What is the "Live-In Fixer Upper" Strategy?
The strategy involves purchasing a fixer-upper as your next primary residence. You then live in the property for the next two years (minimum), all while fixing the property up, then you sell it, and repeat the process.
Why Does it Make Financial Sense?
The tax code says that if you live in a property for two out of the last five years you do not have to pay taxes on the gains from appreciation and sweat equity that you have received. For example, let's say you purchased a property for $200,000 that was a fixer-upper with great potential. For the next two years, you work on this property on the weekends to fix it up and make it look amazing. After two years the property has appreciated because the market has appreciated 3% per year. Additionally, your sweat equity has increased the value of the property another 20%. now your property is worth over $250,000 and you owe less than $200,000. That $50,000 of profit or "capital gain" for the last two years has absolutely no tax.
What are the Risks?
The risks with this strategy have to do with your buying choice and the condition of the market. You must buy the right property, in the right area, for the right deal, with the right potential for growth and improvement. You need a good real estate agent who knows the market to help you on this one. You must also have the skill necessary to put in valuable sweat equity that will increase the property's value. And also, the market must continue to appreciate in those few years. However, let's say the market goes down for those two years. Then you have several options. You could hold on to the property until the market rebounds and then sell. Or you could move out of the property and live in another fixer-upper for the next couple years and then sell the first one. My understanding is that you would still have the benefits of no capital gains tax on your increase from the first property as long as you lived in the property two out of the last 5 years from the time you sell.
Why Don't More People Do It?
It's not easy to find a good fixer-upper deal in a hot real estate market. And once you have the deal, it's not easy to spend your nights and weekends working on house projects. For those reasons, many people will not purchase a fixer-upper but look for a move-in ready home and purchase it at retail value.
Personally, I am following the fixer upper strategy now. We looked for a full year before finding the right fixer-upper property. We now are spending the next 2 to 5 years working on the property to make it amazing. At which time, as long as the market continues to appreciate, we will sell the property and repeat the process. If the market does not appreciate, we will continue to live in this property until it makes financial sense to sell. All the while, we're living in a beautiful home that we are fine to stay in for a long time if necessary and we're spending time together working on our projects.
I Can Help You Do This
I'm doing this strategy myself. I can help you do the same. If you are in Utah, Salt Lake or Wasatch Counties, let me help you find the right fixer upper.
I am not an accountant. All of these figures, recommendations, and stats should be verified with your accountant.
Sounds a little sketchy doesn't it? This is something that makes complete financial sense. The issues arise when it doesn't make "family" sense given your circumstances.
What is House Hacking?
The simple definition of house hacking is buying a multi unit property such as a fourplex (a 4 unit apartment building), living in one of the units and renting out the other units. Oftentimes, the other units will pay your entire mortgage and you live basically rent free all while putting a 3.5% down payment.
Why Does it Make Financial Sense?
Traditionally, to qualify for a typical investment property loan, you will probably have to put at least 20% down payment towards your purchase. If you are buying a $400,000 fourplex that means you'd have to come up with $80,000 cash to put towards your down payment. And the interest rates for investment properties are typically a bit higher than your primary residence. If your primary residence interest rate is 4%, then an investment property loan will probably be 4.75-5%.
Here is where things get exciting. When you follow this house hacking strategy and purchase a multi-unit property such as a fourplex for your next primary residence, and plan to live in one of the units, you get the benefits of primary residence loan interest rates as well as minimum down payment requirements. So let's say you find a fourplex that you would feel comfortable living in and renting out the other three units. You can purchase this fourplex using a minimum down payment of 3 1/2% for FHA loans and 5% conventional loans. So if you are purchasing a $400,000 fourplex, instead of having to come up with an $80,000 down payment, all you need to do is come up with a $14,000 down payment. AND the interest rate you will get will be much lower than the interest rate issued for investment properties because you are living in the property as your primary residence (banks view it as less risky if you plan to live in the property).
Once You Purchased It, Then What?
Once you have purchased your fourplex and have lived in the property more than one year, lending guidelines allow for you to move out. So basically sacrificing to live in a fourplex for at least one year allows you to purchase a the investment property with minimum down payment, a lower interest rate, and live virtually rent-free for that year. You can then move on and either repeat the strategy or buy your single-family home and have an income producing property for as long as you would like.
Why Don't More People Do It?
Simply because it is a sacrifice. Typically, families are looking to purchase a single family residence to live in long-term. It is not convenient to live in an apartment for an extended period of time and there is the hassle of managing the other tenants in the building as well. While this investment strategy is not for everyone, those do it, will experience the financial benefits.
Personally, I'm following a different strategy - purchasing a fixer-upper with great potential, living in it for a few years while fixing it and then selling and repeating the process. That doesn't mean that I don't believe in the house hacking strategy. On the contrary, it makes MORE sense than the fixer upper strategy. I actually tried to convince my wife to House Hack but due to our growing family circumstances she decided it would be better to buy and live in a fixer-upper. This aligned with our family goals a little bit better and was a lot easier on the comfort zone of my wife. More on the fixer upper strategy later.
Interested in learning more about this strategy, let me know!
This data report is for single family residential buyers in Utah and Salt Lake Counties. Below you will see the sold numbers for Utah & Salt Lake Counties here in Utah for January 2016 (UT county shown first). This information is good to know so you can see avg days on the market (Median CDOM) and the # of listings within each price range.
*Important statistic to note: The average days on market for a home has decreased dramatically since April 2015 which indicates a sellers market. If you are interested in selling your home, now is a great time.
These statistics and tons more is available for free by contacting me directly. I'm happy to assist you in understanding the market and assisting you with all your real estate needs.
If you've ever wondered about the market conditions for Utah right now, here is a market summary report as of December 31, 2015. This market report is for Utah & Salt Lake Counties and pertains to single family residential properties only. I can provide region specific reports and do all sorts of cool things with this data to assist you with your investment decisions. Just contact me for a more specific report based on your needs.
Some things to bring to your attention based on these numbers:
The above comments are my opinion - you are welcome to develop your own conclusions based on your own statistical analysis.