Reader Case: House Hacker Dreams of FIRE

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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?   

My story:

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)

-$20k cash

$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.

My options:

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. 
HouseHacker


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%.

That’s…not great.

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.

SummaryAmount
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.

SummaryAmount
Income$0
Expenses$25,000 + $1600 (mortgage) x 12 = $44,200
Assets$795k (investments) + $20k (cash)
DebtWhatever 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…

YearBalanceSavingsROITotalTotal Plus House Equity
1$365,000.00$61,500.00$21,900.00$448,400.00$978,400.00
2$448,400.00$61,500.00$26,904.00$536,804.00$1,066,804.00
3$536,804.00$61,500.00$32,208.24$630,512.24$1,160,512.24

3 years to get to FI!

Conclusion

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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21 thoughts on “Reader Case: House Hacker Dreams of FIRE”

  1. I am a long-term landlord and have been going back and forth with selling vs keeping my rental properties, so thank you for this breakdown! One of my tenants gave notice and it’s been tempting to sell and buy a duplex for a house hack myself, the problem is, finding something that has not been overinflated with this crazy market. Capital gains also get sticky too.

  2. Thank you for the interesting article. It doesn’t mention which country this reader is from. IF the reader is in the USA I wanted to point out some taxes that are not accounted for in the analysis. The reader is correct that they can move from the duplex and rent their unit for 0-2 years and then sell while enjoying the primary home capital gain exclusion (as long as the reader lived in the unit for 2 years first). However, the exclusion will only be for 50% of the gain since 50% of the duplex was a primary home and the other 50% is a rental property. So the sale will result in capital gains tax on 50% of the gain from the duplex sale. The other tax that applies to the sale of rental properties is called depreciation recapture which is a tax of 25% of all depreciation claimed on the property. A few years back I was househacking in a 3 unit building. When I wanted to sell I spoke with my CPA who advised I could use the primary home capital gain exclusion for 40% of the sale as it was estimated that I used 40% of the property and my tenants occupied 60%. So if I sold I would be paying capital gains tax on 60% of the gain as well as paying the depreciation recapture tax. I opted to keep the property as it cashflows nicely.

    Again these taxes only apply if in the USA. If the reader is in Canada or somewhere else this does not apply.

    1. Interesting summary. I really enjoyed the part where you discovered that you’d have to pay tax on 60% of the capital gain on your 3 unit building if you sold it. It’s an eye opener. So many people think teal estate investing is so easy and tax efficient and it isn’t, even house hacking. I’d have to conclude from that the taxes to be paid selling it would be significant enough to wipe out most of your profit. On that note, I can understand why you kept it.

      That’s why I’ll stay far away from any real estate transactions that include tenants. It can create future shackles and take away choices.

      I’m quite happy to stick with a balanced and diversified portfolio of ETFs instead. Passive. Liquid. Tax efficient (I only sell the chunks I actually need). And I can spend my time focussing on other things.

      1. I didn’t mean to sound negative on real estate. It truly is heavily tax advantaged. I just wanted to point out the taxes that need to be accounted for when selling a househack or investment property. In my case the capital gains tax would not have come close to wiping out the profit. If I had sold at the time I would have made a profit of $85,000 (after paying commissions) that would be subject to capital gains tax of $7650 (15% capital gains tax rate on 60% of the profit) as well as a depreciation recapture tax that is 25% of however much depreciation was taken while I owned the property. I don’t have a number for the depreciation tax since that would be a lot of work to look back at how much depreciation was taken. So taxes weighed somewhat on the decision to keep the property, the other reason to keep it was it has been a little golden goose. The property had a purchase price of $240,000 which I purchased with a $10k down payment & an FHA mortgage. At the time I was quite broke and struggled to come up with the $10k down payment but so grateful that I managed to get it. I lived there for 1.5 years for free as the tenant rents covered the mortgage. After moving the property has returned around $10k a year after expenses every year for the last few years with minimal efforts as I use a very good property manager and ensure the property is well maintained. Househacking can be an incredibly powerful wealth builder. But it should be understood that even though the property is a person’s primary home they may not get the entire primary home capital gains tax exclusion as it is pro-rated depending on what portion of the property is a primary home and what portion is used as a rental. Understand I am not a CPA, this was simply my experience with my house hack and the tax information I was advised on at the time. I strongly recommend consulting with a CPA for any tax advice.

        1. I get what you’re saying and that’s why I appreciate the viewpoint you provided. It was thorough and detailed. You know what you’re talking about because you’ve lived it. Nonetheless, the tax implications sliced off certain choices and paths you intended to take financially. As well, when you need to include intermediaries like a property manager and/or a CPA and/or more intermediaries, it becomes complicated and cumbersome. I’m sure some love all that sort of stuff. That’s ok. I just don’t. I like things replicable, consistent, and profitable. As well as simple and hands off. A balanced and diversified portfolio of marketable securities like ETFs does the trick for me.

    2. Thanks for bringing up depreciation recapture… that’s one of the factors that is keeping me from selling our rental units, in addition to capital gains and lost revenue.

    3. “the exclusion will only be for 50% of the gain since 50% of the duplex was a primary home and the other 50% is a rental property. So the sale will result in capital gains tax on 50% of the gain from the duplex sale” That’s good for Canada too. Also, if he keeps the duplex, rents the second unit and pockets the cash flow, he should mandate a pro to do an assessment and ask his CPA to notify the CRA of the usage change. That way, when he’ll sell in a lot of years, the capital gain exemption for primary residence will still be possible for half the equity of year 1 to 4 (based on his unit being half the building, if he uses the basement too, it could be applied to more %).

  3. “$795k at 2% = $16k per yr dividends.”

    ———————————————-

    You’re not going to get 2% for VTSAX. It’s currently at 1.4%, and it’s been that way for a long while (that is, sub-2%) and probably will never go above 1.5% in the foreseeable future.

    As for house maintenance costs, even if you do most things yourself, there are still going to be some really big expenses (for things you can’t do yourself).

    For example, a new roof can easily cost $30000 . New windows $20000 . New paint job (interior and exterior) $12000 .

    If the water heater dies, that’s $7000 (with installation). Need a new HVAC? That’s $30000 . New refrigerator? That’s $4500 . The bathtub is cracked? That’s $14000 (with installation). These are just a few examples. There too many to list here.

    It’s also commonly suggested that you renovate the place very 10 years or so. That kind of renovation can easily cost you $60000 to $120000!!

    Don’t ever underestimate maintenance costs.

    Also note that homeowner insurance is going up faster these days (the average YoY increase now stands at 17%).

      1. “If the water heater dies, that’s $7000 (with installation). Need a new HVAC? That’s $30000 . New refrigerator? That’s $4500 . The bathtub is cracked? That’s $14000 (with installation). These are just a few examples. There too many to list here.”

        If above is what you are paying for those things, please contact me because I have magic beans to sell you!
        Water heater – $1100 to $1700 (10 years lifespan)
        HVAC – $4500 to $6500 (20 year lifespan)
        Fridge – $1500 (10 year lifespan)
        Tub – $2000 ($14000 will get you a whole bathroom from scratch)

    1. While I generally agree with the sentiment of “owning real estate will cost you big ticket items, some of which are unpredictable,” I join others in wondering where these price estimates come from.

      I did my roof last year, during Covid and a spike in wood prices. We unexpectedly had to add a full layer of plywood to the roof before reshingling with quality shingles, nearly doubling the original estimate. The final tally came in at $26,000 for a 2,300 sq ft house plus 2 car garage. So “easily $30k” for a routine replacement is a little overstated. As for the tub and appliance costs, that’s just crack pipe pricing. For example, my parents just had their water heater done and they felt that at just under $1,000 installed, it was a little high. I’m also skeptical of needing to renovate every 10 years or so. My house is pretty much all original at 32 years, and while that’s getting a bit dated and the windows are coming due, it’s still perfectly serviceable.

  4. It’s a good reader case !!
    I would never factor in home-equity or a property’s market value as ‘assets’,,,but I will factor in the mortgage balance as debt. House hacking..never.

  5. Some good points from the article and follow up advice in the comments … the person in question seems younger and hasn’t mentioned if they are married or want children which is important to consider – also they seem to want a nice house eventually ? (which is a lifestyle – emotional choice which helps in raising a family? but not essential …) … he said he would work part time which should help… also because of inflation a million bucks is on the low end for LEAN FIRE these days … most folks making a 100 grand year should shoot for 2ish plus million for Medium Fire to FAT Fire … especially if they (will) have kids – Our Rich Journey Vloggers on YouTube started with 2.5 Million before moving to Portugal with their 2 kids – they have AirBnBs, Index Funds and Vlog/courses income – and have bought an inexpensive villa? in Portugal where they grow a lot of their own food, their kids go to a private school there etc … GoCurryCracker (bloggers) which started out much like Millenial Revolution traveling and renting forever … after having 2 kids … and now have grown tired of the gogo life … at age olderish ? … have 40 to 60 thousand? blog income, at least a 2-3 million? in Index Funds, an electric car and bikes and a million dollar home in California (Fat FIRE) etc etc … so these examples may help in you deciding what kind of FIRE scenario you want to aim for ? IMO

  6. No comments on the house hacking. But, hey, nice Montreal triplex picture! Sometimes we wonder whether we should just move back to Montreal one day.

  7. A point many sometimes forget, wait to retire or a low income year to sell an investment, or rental property. Or, sell your home within the primary residence exemption period (at least in the US).

    At the end of the day, hopefully house hacker takes time to visualize what he wants his life to look like in 3,5, 10 years, and then feel good about a low maintenance strategy of investing versus sustaining real estate, unless that’s something you draw significant value from.

  8. I integrated multiple courses while I was a college student, and I also believe that this is normal. I experimented with various possibilities, particularly in the early years of my studies, and some looked preferable to me simply because they were simpler to comprehend. This did not resolve my issues with difficult course tasks. I was still having a hard time handling it. Reviews of https://www.tmcnet.com/topics/articles/2022/02/24/451626-best-essay-writing-services-2021-everything-should-know.htm aided in making the right decision and finishing the challenging coursework.

  9. I don’t think ROE is the correct formula to use as a comparison to stock market returns. You should use cash on cash return, which looks at the money you used to purchase the rentals (down payment plus closing costs) in the denominator. This is reasonable given the opportunity cost of tying up the money in a rental versus buying an index fund. Once you factor in depreciation and appreciation the number look very good. I think your bias against home ownership is starting to negatively impact your writing.

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