Hacking the American Dream

While watching TV the other night, I couldn’t help notice a new commercial for Principal Financial Group. It shows a man searching for a home for his aging father, and ultimately deciding to build a backyard cottage for him on his own property. It’s incredibly touching, and a very human situation that many of us either have dealt with or will have to deal with at some point in our lives. It’s a subtle commentary on so many issues, all in under a minute. It’s so subtle that I’d actually forgotten which company was advertising.

That backyard cottage shown in the commercial is an example of what planners wonkily call an ADU, or Accessory Dwelling Unit. The traditional terms you may have heard are carriage house, granny flat, mother-in-law quarters or garage apartment. In the days before zoning (typically before the 1920’s), these types of units were naturally-occurring in our cities and towns. Perhaps the apartment was part of a garage, or perhaps its own small outbuilding. They filled a common desire to find additional space for a relative, or create more income for a homeowner through renting to a tenant. As such, ADU’s were a common means of using one’s own real estate to generate more personal wealth or house extended families.

Today, ADU’s are a prime example of what is often called “house hacking.” House hacking has become a commonplace tactic within the burgeoning financial independence community, as a way to lower one’s housing expense. After all, for most households, housing is the #1 expense. If you care about getting a handle on your finances, starting with the biggest number is a smart approach. Once you look at your housing arrangements differently, you’ll find endless variations on house hacking, from duplexes or triplexes to renting rooms out, having an ADU and much more.

In this post, I’d like to share my personal experiences with house hacking (I’d apparently been doing it long before I ever realized it was a hip term), and talk about a specific variation of it tied to the themes of this site. I hope to relate an approach that can dramatically improve your own finances and make your life more flexible and enjoyable.

Buy or rent?

House hacking is essentially a “third way” in the routine, but boring, debate of buying vs renting a home. Our national myth related to the American Dream has become a cartoon that suggests only one path: buying a big, single-family detached house with a 5% (or less) down and a 30-year mortgage. If you care about money at all, this is a lousy idea. The numbers simply don’t lie.

You might say, well, owning a home was lucrative for my parents or my grandparents. They might even tell you tales of how they bought a house for $10,000 and sold it 20 years later for $250,000. It’s true, some people have done well, and some have been very lucky. But in the real world of cold, hard data, housing has appreciated at exactly the rate of inflation for decades. In some cases, housing hasn’t appreciated at all. By any serious financial measure, that’s not a good investment.

For a great many people, it’s also true that renting is a lousy financial idea. Why is that? Aren’t I contradicting myself? The harsh truth is the average household is terrible with money, and buying a home forces at least some amount of savings. I hold no delusions that the average buyer, if convinced instead to rent, would have the discipline to save money and invest it. They wouldn’t. Just look around you. Just see people’s actual behavior. It doesn’t happen. When people talk about choosing to rent instead of choosing to buy, the explicit notion is to save the difference between the cost of renting and the cost of owning, and invest it. If you have discipline and do that, you’ll very likely come out ahead over the low-down payment, 30-year mortgage. But if you don’t save, you really will be putting yourself in deep financial doo-doo down the line.

Many others have written about this, so I won’t go into a deeper analysis. I’ve linked to several interesting pieces by others at the end. But I will relate one other aspect that many people and sites overlook: it appears very likely that our whole system of housing production and regulation (through zoning) is going to see significant disruption in the coming years. How that will impact traditional measures of appreciation is impossible to say, except that as financial advisors often warn: past performance is not indicative of future results.

I also understand all of the non-financial reasons to own. Personally, at this stage of my life, I like owning. I like to have projects around the house. I like to tinker in the garden. It gives me pleasure, and distracts me from the other, more stressful aspects of life. It’s incredibly rewarding for me to build something, to fix something, or to plant something and see it grow. Not all life decisions can be reduced simply to the numbers.

There are certainly other ways to own a home that can make sense. By no means am I saying the way I’m getting to in this piece is the only way. If you can do an all-cash buy, or pay off a house in under five years, it has the potential to be a very good financial decision. The trap that most people fall into very easily, though, is over-improving a home and the ever-present creep of lifestyle inflation. It’s SO easy to do that when you own, which is why I think the smartest hedge against that is having income on the property, too. Which leads me to house hacking. 

House Hacking ++

I’ve house hacked three times now, and am looking forward to a fourth attempt in the future. In each case, I’ve pursued a particular version of house hacking that super-charges the benefits. For readers of this site, it should be no surprise to hear I mean doing it in a place where you can also easily walk, bike, take public transportation and drastically reduce your own transportation expenses. The combination of these two approaches is remarkable.

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Transportation is the #2 expense for most households, and that’s 100% due to the expense of cars. Cars can be a lot of fun, and I love a good ride or road trip as much as anyone. But they are outrageously expensive as a means for getting us around town for our daily needs. For many households, especially lower-income households, transportation now equals or exceeds the cost of housing. In my opinion, that’s insane, and a great failure of policy and design in our country.

In each of the three cases where I’ve house-hacked, it’s been in neighborhoods that I consider car-lite. That is, some things were easy to access without a car, but not everything. As a result, I always owned a car, but I drove it far less than the average American. With the rise of services such as Uber and Lyft in the last few years, the options for people to not own a vehicle have only increased. In fact, when both of those companies came to Savannah, it was a catalyst for us to sell a car and become a one-car family. Even with two kids, it’s almost never been an issue to have one vehicle instead of two.

3 House Hack Case Studies

House Hack #1 - a triplex, with one unit per floor.

My first house hack was a triplex. Historically it was built as a large, single-family house in a prosperous neighborhood. But like many such houses of its era, it was converted to three apartments during the Depression and WWII. When I purchased it in 1996, it needed quite a bit of work as the basics had been neglected for many years. Everything was dated – electrical systems, plumbing, the roof – you name it. But those factors all worked in my favor. As a triplex, it was outside the norm of what most buyers were seeking. Knowing it needed work also deterred some buyers. All of that combined to keep the value down and affordable for someone like me looking for a non-typical arrangement. House hacking is still a minuscule part of the overall buying market today, so it creates opportunity for those willing to see it. If you start looking for a house hack, also bear in mind that you can purchase up to a 4-unit building with a conventional mortgage, as my friend John Anderson likes to remind people.

I lived in one unit in the triplex, rented out the other two, and gradually improved the house over about a ten-year period. The rent from the other two units paid the entire mortgage, plus a little extra, and I lived rent-free in a comfortable, two-bedroom apartment. It wasn’t as large or nice a place as some of my peers, that’s true. But having no housing expense made it far easier for me to take the risk at thirty years old of working as a self-employed architect. In fact, that first year was very risky. I barely made enough money to buy groceries. If I’d had rent to pay or a typical mortgage, I would have been forced to give up the dream and go find employment with someone else. Instead, I was able to scrimp and get by, until enough clients came along. After a year, that happened, and I owe it all to the decision to purchase that particular triplex. It allowed me to be patient, and pursue what I really wanted to pursue. Whatever your own dream or field of work is, house hacking can give you more flexibility than either renting or owning a typical single-family house. 

House hack #2 happened while living in #1. After about eight years of living in the triplex, I decided I wanted to find an empty lot in a nearby neighborhood and build a new house from scratch. It’s a classic architect’s dream, or unhealthy delusion depending on your point of view. At first, I intended to build and sell the house as my first development project. Eventually, I decided to sell house #1 and buy house #2.

House hack #2

The large, 1BR carriage house in back

The new house was a three bedroom, two and a half bath house on its own lot, with a three-car garage and spacious one bedroom apartment above. Truth is, this was not my smartest financial moment. I over-payed by quite a bit for the new home. This was right around 2005, and housing was so hot that almost any decision seemed like it would work out just fine. I fell into that trap. I didn’t pay close enough attention to the details. I frankly chose too large of a house for the block and market. But the fact it had income on the property still allowed me some breathing room and options when I purchased it. The garage apartment rented very easily, and it helped offset my otherwise foolish choices.

Today, that same house values at around $350,000.

For my fellow architects, there’s no better way to design and build your own house, and come out financially in good shape. In fact, experience tells me it’s the only way, since we are all inclined to over-design and over-spend on our own projects.

That’s a mortgage somewhere in the ballpark of $2,000 with 10% down, today’s rates, insurance and taxes. The apartment rents for about $1,000. Simple math says that someone can own and live in that comfortable three bedroom house for $1,000 per month. The house is a five minute walk from the heart of the neighborhood, which includes a couple of dozen restaurants, bars and shops. It’s a ten-minute bike ride from a supermarket, drug store, and dozens and dozens more eating and drinking options. All of that means an easy car-lite lifestyle, which helps dramatically with transportation costs.

By comparison, a similarly-valued single-family house with its mortgage in the suburbs, means an additional $1,000 per month in expense. Since suburban areas almost never allow carriage houses or accessory units, there’s no possibility of rental income to offset the mortgage. And, there’s very likely nothing to walk to, so that means one car per adult just to go about living your daily life. Factor in another $500 per month for that, conservatively.

Just the housing expense savings of $1,000 per month, over a ten-year period is $120,000. Add in a reduced transportation expense of one less car (assuming two adults), and it’s another $60,000 over ten years. Those numbers are simple math, without any compounding. If you are able and disciplined enough to invest that savings of $1,500 combined per month, and it sees an average 7% return over ten years, you’ve added $259,500 to your net worth. In ten years. Cut out all the lattes you want, but you’ll never touch those numbers. Or another way to look at it is, it dramatically raises the bar on what someone can afford on one, modest salary. Which brings me to the final case study.

House hack #3 has been our home in Savannah. My wife and I purchased a two bedroom, two and a half bath townhouse (or rowhouse, depending on your lexicon) with a small courtyard in back. The property is about 100 feet deep, and comes with a two car garage with a small, but very livable one bedroom apartment above. We knew we wanted something like this arrangement, so we sought out a property that interested us, and made an offer for it when it was not on the market. With the help of a realtor acting as our agent, we were able to purchase it this way at a discount to other listed properties in the area. Aside from the house hack itself, this is a good technique for finding something you want. Don’t assume a property isn’t for sale, just because it doesn’t have a sign hanging out front or its listed on the MLS.

Street view of house hack #3 - the end unit on the left

Aerial view showing the line of carriage houses and yards

View from our yard of the carriage house

With this particular garage apartment, we had the option of typical long-term rentals or vacation rental. For us, the vacation rental idea, while very lucrative in Savannah, seemed like more daily work than we wanted. And, we preferred a more consistent tenant presence since it’s our home. Your mileage may vary. Different strokes for different folks, as they say. We ultimately landed on a variation on typical rentals that catered to monthly tenants, with a nicely-furnished unit. Over the course of the three years we’ve lived here, the rent has covered anywhere from 75-100% of our mortgage.

The upside: beyond just the money, having such a low housing payment gave us much more flexibility when our kids came along. It enabled us to more easily and comfortably choose to have one of us as a stay-at-home parent. Having that option, and being able to act on it, has been beyond wonderful for all of us. If you have kids, you know what I’m talking about. It makes everything in life with small children more manageable. And, ultimately, the same financial freedom enabled us to afford trips like we did this Fall with the whole family.

Take Care of the Big Rocks First

As you think about your own housing options, I’d encourage you to think beyond renting or buying as the only options. Life usually isn’t either-or. Like the 90’s band Live sang, I wish we could all come to appreciate the beauty of gray. House hacking is a fun term, but it actually represents something that was commonplace for generations. By no means does it mean a downgrade in lifestyle. In fact, when combined with a neighborhood that is walkable or allows a car-lite lifestyle, it often feels incredibly enjoyable and luxurious. The homes I’ve lived in have all been very comfortable compared to any realistic standard. And, if you’re inclined to ever get into real estate development (as taught by people like the Incremental Development Alliance), house hacking is probably the best, first step you can take.

In our case, we feel house hacking takes care of the “big rocks” for us. Other than health care, the rest of our life expenses are ones we can control quite easily. This approach gives us the flexibility to pursue our interests and have plenty of quality family time. We have always and continue to spend too much money on entertainment and travel, but that’s a conscious choice we can more easily afford to make because of our choices with the big expenses.

And Here’s the Catch

Here’s the only real challenge we have to acknowledge. The backyard cottage shown in that Principal commercial, and the homes that I’ve owned: they’re functionally illegal in most neighborhoods in the country. Our zoning laws, largely adopted in the 1920’s through the 1960’s, were created to build American suburbia. Zoning intentionally outlawed many of these traditional types of housing, or made them very difficult to build new again. That’s true often even in older neighborhoods where they have now existed for decades and decades. It shocks and confuses most people when they learn this, and I wish I had better explanations as to why it’s the way it is.

Fortunately, some cities are realizing this is a major flaw of today’s zoning, and taking steps to make change. Cities such as Fayetteville, Arkansas, Minneapolis, Olympia, Washington and even the whole state of California have passed new measures. That’s a great start, and very encouraging. But we have a long way to go. You may have to get creative in your own community to make house hacking work, or simply go find somewhere else where it’s easy. Often, it’s easiest to buy an existing property that is grandfathered in, like my first house hack.  

For my friends in high cost-of-living areas, just a few last words. You likely won’t find easy options to house hack in your city. Real estate by now is so inflated in certain markets that this option is very difficult to find. It’s entirely possible you’ll have to move somewhere else to do this and take full advantage. If you’re willing to move, you’ll find copious options outside the most popular neighborhoods in the most popular cities. You may even find a place with a lifestyle you enjoy more. There are numerous mid-size and smaller cities in this country (some even gasp! In Flyover country) that also have great coffee shops, farm-to-table restaurants and craft cocktail bars. Many cities have much better salaries relative to total cost of living. Many also have great schools for kids and a more easy-going daily existence. And, you may find somewhere that you’re needed more. I’m just saying: don’t limit yourself.

The one-two punch of house hacking in a walkable place is obviously something I’m passionate about, and have enjoyed the benefits of for many years. It’s hard for me to personally imagine owning in any other scenario, unless I suddenly became flush with millions of dollars. If you have an interest, I’d encourage you to explore your options. Don’t be dissuaded no matter your age, stage of life or current financial situation. If you have questions or want some advice from someone like me that’s done it a few times, please feel free to drop me a line. 

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Some other thoughts on home ownership:

• Paula Pant: Renting is throwing money away, right?

• JL Collins: Why your house is a terrible investment

• Mad Fientist: Denouncing the cult of home ownership

• Can I Retire Yet: Renting vs buying: the true cost of home ownership