Happy Monday everyone! It’s been a while since we’ve done a reader case, so I thought I’d dive into the ol’ mail bag and see what we can find. Today’s reader’s approach to FIRE is using a strategy called House Hacking, so this should be fun.
Let’s dive in, shall we?
Hey good afternoon,
Hopefully you two are doing well and getting to enjoy your FIRE life. First off, I wanted to say thanks for your book and blog, they have re-lite the FIRE for me. I’ve read most of the common FIRE books and blogs over the past years, and was recently recommended your book. I listened to the audiobook back to back! I learned way more than I was anticipating. The yield shield is fascinating to me and provides a nice buffer. I was thinking of FIREing in about 5 years until I looked at my yield shield and that has moved my possible FIRE date up drastically.
I’m sure that you two are busy with many things in life as we all are, but I thought I’d ask if time ever allows for an opinion on when would be appropriate to FIRE/ when would be too early with much more risk/ and how you would evaluate keeping my real estate investments?
I have a few long term rentals thanks to influence from my grandfather and old co-workers. I’ve been house hacking a duplex for ~4 years, which has eliminated my housing cost. This allowed me to save up and purchase a 6 plex 3 years ago, which has been cash flowing and recently appreciated with the entire market.
I’m hoping to FIRE in the next 1 – 5 years (which feels insane and my family/ friends think I’m insane). Obviously counter culture. I’m fairly ambitious and probably won’t sit on the beach sipping drinks for 40 years. I’d love to negotiate part time work with my employer or even better work for myself in some fashion. I really enjoy real estate so I think I could happily be a part time handyman or home inspector with relative ease. One option I’d love your opinion on (Feel free to bash real estate ), is should I keep my rentals or sell, pay the capital gains, and put into VTSAX ? Also, would it make sense to sabbatical or FIRE (lowering my income), then sell my 6 plex to lower capital gains?
I have a W2 engineering job that pays around $100k / yr salary, max out my 401k (+8% match), Roth IRA, and save ~$35k / yr in taxable brokerage. No debt.
My current balance sheet:
-Duplex ($350k+ value, $100k mortgage) – purchased for $145k
-6 plex ($500 – 600k? value, $170k mortgage) – purchased for $235k
-Currently combined cash flows $1250 per month with my living in half the duplex. (3 yr average which includes a few major remodels that won’t be happening in the future, but keeping it conservative)
-Probably would have combined cash flow of $2500+ when I move out
-$365k VTSAX comprised of: (as of 3/9/22 prices)
-$85k taxable, $65k Roth, $215k 401k
(2% yield is ~$7k per yr or ~$600/ month – THANK YOU for bringing this to my attention)
$25k Annual spending (includes living for free, no car payment, no debt), will round to $2k/ mo
-Transportation is $6k / yr, would probably cut to $2k
-I like to adventure/ climb/ ski/ hunt and those are all fairly expensive hobbies
I may sell my duplex after 0-2 years of moving out to not pay capital gains. However, I’ve done a full remodel of everything so maintenance for the next 10 years will be minimal, which makes keeping it as a long term rental an option.
If I stay in my duplex (fine short term, not my preference long term):
-$2k / mo spending – $1250 cash flow – $600 yield = $150/ mo
I could easily work part time as a handyman to pay for $150/ mo of “beer money”. Would need health insurance so call that $1k per month as a high estimate. Seems very reasonable to find an enjoyable part time job to fulfill this need.
If I sell my duplex and 6 plex:
-Duplex has 350-100 = 250 equity tax free
-6 plex has 500-170 = 330 * 0.85 for capital gain tax = 280 equity
-250 + 280 = $530k equity that I’d be comfortable to deposit into VTSAX
If I sold everything, I would probably spend $50 – 100k on downpayment for a house and get a $1200 – 1600 monthly mortgage. Feel free to bash. For easy numbers, let’s assume I spend $100k. I’m hoping to find a multi family property with a mother in-law suite, etc to continue to house hack.
Could have my 365 + 530 – 100 = ~$795k in VTSAX
$795k at 2% = $16k per yr dividends.
Would probably raise my annual spend from $25k to $43k with a $1500 mortgage.
I would really appreciate to hear your honest opinions on my options and what you would do pre-FIRE and post-FIRE with my combo of real estate and index funds. I feel like my situation is relatable for others that have gotten into real estate a few years ago.
Thanks for your time.
To recap, house hacking is a real estate strategy in which an investor divides up their primary residence into rentable units and lives with their tenants. The tenants pay the owner rent, and if done properly, that rent covers part or all the owner’s mortgage, reducing or eliminating their housing costs.
House hacking is a twist on traditional real estate investing. The advantages of this are that you’re always on-site to keep an eye on your property, and hopefully if the math pans out you can live for cheap (or free). The disadvantage of house hacking is that you’re basically living with a roommate or housemate, and if that’s not part of your long-term vision for your life, you will eventually need an exit strategy for this setup, which is exactly the dilemma HouseHacker is facing.
House Hacking and FIRE
But before we go over HouseHacker’s (potential) exit strategy, how well has House Hacking worked for him so far? Has it gotten him closer to FIRE as he hoped? Let’s MATH THAT SHIT UP to find out, shall we?
Our intrepid reader has two properties: a Duplex worth $350k and a 6-plex worth about $500k. After taking into account the 2 mortgages of $100k and $170k, respectively, that means HouseHacker has about $350k – $100k + $500k – $170k = $580k of house equity. These two properties combined give him after-expenses cash flow of $1250 a month. Extrapolating that gives us a yearly cash flow of $1250 x 12 = $15,000 a year. That means HouseHacker is getting a Return-on-Equity of just $15k / $580k = 2.6%.
But, House Hackers are not typical landlords. House Hackers actually live in their rental properties, so they get the added benefit of eliminating their rent. So what happens when we take that into account?
Our reader has indicated that once they move out, they expect to make $2500 a month in cash flow, meaning that they’re estimating that the unit they’re currently living in would rent for about $1250 a month (after expenses). If we add that $1250 of saved rent to his current cash flow of $1250, we get $2500 a month, or $30k a year. At that income level, HouseHacker’s ROE is $30k / $580k = 5.2%.
That’s definitely a better ROE, especially if our reader likes doing the home maintenance stuff himself And judging from the fact that he’s willing to be a part-time handyman “for fun” in retirement, he does.
So given that his House Hacking experiment is working out so far, should he stay where he is or sell?
To Sell or Not To Sell?
To answer this question, we have to figure out his current financial situation. If he quits his job and lives completely off his house hacking income, this is what the numbers would look like.
|Income||$1250 per month, $15,000 per year|
|Expenses||$25,000 per year|
|Assets||$365k (investments) + $20k (cash) + $350k (duplex) + $500k (6-plex)|
|Debt||$100k (duplex) + $170k (6-plex)|
With a $25k spending level and post-retirement rental income of $15k, HouseHacker’s portfolio only needs to provide $10k of income a year. And with a current portfolio of $365k, that portfolio can provide $365k x 4% = $14,600, which does the trick.
Note: While I do talk about living off your yield in retirement, when calculating your FI number you generally still use 4%. Assuming you only live off the dividend yield of the S&P 500 is super conservative, as it implies that in retirement you never pivot towards bonds or any other investment paying a higher yield.
So, it looks like our reader has successfully house-hacked his way into FI! Great job!
Since our numbers look so good, you’d figure that selling everything and putting it all into the markets should do better since we generally use a 6% long-term return rate on a 60/40 investment portfolio. And normally, you’d be right. But because our reader is a house hacker rather than a traditional landlord, selling their property would mean that they can no longer benefit from free housing, and on top of that would need to go find a new place to live which changes their spending number.
Our HouseHacker has said that if he were to sell, he would buy another property to live in. This would add a $1600 (we’ll use the high range to be conservative) monthly mortgage to his budget, as well as shave $100k off his investment portfolio for the down payment. That means he would be left with $365k (investments) + $530k (house equity after taxes) – $100k (down payment) = $795k.
This is what his finances would look like in this scenario.
|Expenses||$25,000 + $1600 (mortgage) x 12 = $44,200|
|Assets||$795k (investments) + $20k (cash)|
|Debt||Whatever the rest of the mortgage balance would be|
Ah, the house hack giveth and it taketh away. Check out how much it affects his expenses, going from $10k a year all the way to $44,200. His FI target also jumps, from $10k x 25 = $250k to $44,200 x 25 = $1,105,000.
After capital gains taxes, he doesn’t actually have enough in his investment portfolio to be FI anymore.
But we can calculate how long it would take for him to get there if he stays at his job. He’s stated that he’s currently maxing out his 401k, his Roth IRA, and contributing $35k to his taxable account, so that means he’s saving $20,500 (401k) + $6000 (Roth) + $35k (taxable) = $61,500 a year. We also have to use his original starting portfolio value of $365k, since he wouldn’t have sold the house hacks until he quits. Finally, we have to take into account that once he quits, he can add that $530k house equity back in, which is why I added a “Total Plus House Equity” column.
That means it will take him…
|Year||Balance||Savings||ROI||Total||Total Plus House Equity|
3 years to get to FI!
As often happens, the road to Financial Independence is part math problem and part lifestyle decision.
Based on the pure numbers, our reader can stop working and become a full-time house hacker right now. But if he doesn’t want to live with roommates for the rest of his life and get a place for himself, that’s going to cost more money and time at his day job.
That being said, with choices of “retire now” or “work for 3 years, sell everything, and then retire,” our reader’s sitting pretty either way.
Oh, and to answer his last question, yes, he should definitely wait to quit his job before selling the 6-plex property. Long term capital gains are taxed very favourably, but the brackets are still tied to your total income. Less income will mean less taxes, which means more money in your pocket, so it makes sense to quit before you sell, preferably in January so you get a full tax year of close to $0 working income.
So there you have it. While FIRECracker and I love making fun of people making bad real estate choices, this isn’t one of those times. Our reader has done a pretty good job house hacking his way to FI so far. His big decision is, does he want to keep doing it forever, or does he want to fully retire from the real estate game?
What would you do? Would you stay in the house hack, or would you sell? Let’s hear it in the comments below!
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