House-hacking, leapfrog investing:
I am a real estate investor and landlord with approximately 20 years of experience. As a renter, I took part in what is known as “house-hacking” in the real estate industry. As a home owner, I utilized my primary residence to obtain and maintain wealth through what is known as “leap-frog investing."
Investing in real estate, in my opinion, is the smartest compliment to participating in the equities markets.
My experience “house hacking” occurred while I was in college in the 1980's. I rented a four-bedroom condominium that I shared with three college roommates. The out-of-state landlord of the condominium wanted one rent check written to him each month for the total rent amount. I was the only student there who worked and attended school, so I became the default on-site landlord.
I took it upon myself to find, replace and sometimes remove roommates, when necessary. I then managed the property on a month-to-month basis. I increased the room rents, which allowed me to live rent-free during my college years. The landlord was happy because I always paid the rent on time and never bounced a check. I enjoyed learning how to be a landlord while living rent free.
The owner visited the property only once per year, which included a dinner that he covered! This experience taught me a lot about saving money, while at the same time living on a college student income.
What I call Leap-frog or trading up investing, which in my case involved trading up my primary residence every three to fI’ve years (note this strategy works best in a rising housing market). When I would sell my primary residence I was able to utilize the benefit of the IRS tax exempt provision (IRS 121) that allows you to avoid paying any taxes on the property gain up to $500k for married couples. This is a recurring provision that only requires a two year time period of primary residence home ownership (use) to apply.
Using a simple math example, if you buy a house for $500k, and sell it years later for $1,000,000 dollars. You will owe zero taxes on the $500,000 dollar gain you made from the sale. In a normal tax scenario making $500k after tax requires you to make $640k using a 28% tax bracket for example. Consider how long you need to work to make $500k in take home pay.
When you live in your primary residence you enjoy plenty of benefits, such as the mortgage interest deduction, avoidance of rent increases, etc. Real Estate investing using your primary residence is therefore my first and favorite side income stream.
Leap-frog/trade up investing may sound extreme, as you have to pickup up your belongings, your family and familiarity with each move. This is probably one of the reasons people generally stay in their primary homes for seven years on average. However I was able to mitigate these challenges by following a few guidelines for each move.
1- If feasible, always purchase homes in the same area and school district, this way your children will never have to change schools.
2- Keep your possession volume low and live lean, as moving is so much easier when you have less to move.
3- Purchase furniture and decorate in a manner that can be applied to the types of house structure and house size you plan to purchase.
4- Always consider new construction homes, as they are generally easier to sell than older homes.
5- Avoid overpaying for upgrades in your new construction home - home builder upgrade costs for items like flooring and countertops are marked up as high as 300%. You can do your own upgrades with your own selected contractor after the purchase at a significantly lower price.
I recommend reading up on your specific real estate area and opportunities, your specific tax implications, etc. I can tell you that moving my primary residence multiple times over the years was not without stress, but the excitement of living in a new place with a different view, layout, backyard size, etc, updating the house to your specific needs is a lot of fun. The end result of these moves can put you in a position with multiple rentals, and/or extra funds made tax free, or a paid off house.
In my experience obtaining these types of results will not occur when you purchase one home, obtain a thirty year mortgage and pay significantly more through your amortized loan throughout your working years.
I hope this article has motivated to look for opportunities in your area. If you are serious about this unusual strategy, I recommend finding a realtor in your area, or obtaining a license yourself. I always preferred to work with a realtor with whom I built a good relationship- Her name is Margaret. I call her whenever I have questions, and I benefit from her years of experience buying and selling houses in my area every year.
Note that I am not a financial or legal professional, nor am I licensed to sell securities, or any other financial instruments. Given this statement, I strongly recommend that you consider this blog as entertainment value. Although, I sincerely hope that I can motivate you to learn to build your own financial knowledge and wealth.
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