Many investors' first foray into the real estate investing world is through house hacking. It's a logical first step to reduce your largest expense and is arguably one of the more immediately impactful investments you can make. I wouldn't be surprised if someone told me that house hacking is the most common entry point to real estate investing and FIRE. For those who live in a low or medium cost of living (COL) market, house hacking is straightforward. You purchase a 2+ unit, live in one unit, rent out the other unit(s), and completely cover your PITI. I consider this the "traditional" house hack. But what about high cost of living (HCOL) markets where the math doesn't quite pencil out?

House hacking in a HCOL market - V1

When we lived in San Diego, Kat bought a condo and house hacked by renting out the other 2 bedrooms. We had roommates, shared common areas and even then, still paid some housing costs. This was a common setup at UCSD and other colleges in expensive neighborhoods: Students would routinely post on Facebook looking for roommates to share bedrooms, living rooms, and even walk-in closets. But it's not just budget-conscious college students doing this. On the BiggerPockets forums, you'll often read about how people rent out all sorts of makeshift living spaces to reduce their housing expense. It seemed like the key to house hacking in a HCOL market was to sacrifice some amount of personal space and comfort.

Roofstock released an article analyzing the U.S. cities with the highest rent-to-price ratios. To save you a click, these numbers were calculated "assuming a 30-year fixed mortgage, 20% down payment, and a 5.22% interest rate". As expected, in low and medium COL markets rents fully cover the mortgage and homes are significantly more affordable. The data is interesting to look through and further illustrates the difficulties with house hacking in a HCOL market compared to more affordable ones.

Moving to Seattle

When Kat received her Microsoft offer, we had to decide if the compensation bump was worth moving to Seattle and giving up a successful house hack. We reasoned that even with higher living expenses, the higher pay and lack of state income tax would allow us to save more and funnel more into our real estate business.

In the beginning of 2020, we moved into a $1,550/mo 570 sq ft one bedroom apartment in Capitol Hill. The unit was cramped, especially so with our three cats, but we planned to spend most of our time outside. The most important thing was that the apartment was affordable by Seattle standards and in a great location. Of course, no one could have predicted a global pandemic and shutdown. Within weeks, our world shrunk to the 570 sq ft we called home. When our lease renewal came in the mail 9 months later, I told Kat we needed to find a larger place.

Traditional house hacking in a HCOL market

At that point in the pandemic, rents had started to increase across the board. For a 2 bedroom apartment near Cap Hill, we were looking at spending $2,200-$2,500/mo, a sizable increase compared to our current 1 bedroom. We brainstormed ways to house hack in the expensive Seattle market. Given the following criteria, what was possible?

• buy a home with 2+ units or a MIL (no roommates)
• buy in an appreciating & safe neighborhood
• live near our workplaces and/or convenient public transportion (for when we had to return to the office)
• be near downtown in a walkable neighborhood
• fully cover our living expenses

In late 2020, a duplex in Queen Anne, Cap Hill, or Central District would cost you at least $1M. We'd be looking at a $4200+/mo PITI payment. Compared to a 2 bedroom rental, we'd be paying >$2,000 more every month (not including additional maintenance, capex, and other general home ownership costs). At 20% down, did this even make sense? We'd be diverting cash that would otherwise be used to purchase BRRRRs in the Midwest.

House hacking in a HCOL market - V2

Kat had always wanted to try running a short term rental but we never had a good opportunity to do so. Our real estate business was all out-of-state and we weren't sure how well you could automate the processes required. On top of that, would we even do a good job?

When she suggested trying the strategy in Seattle, I'll admit that I was skeptical. It sounded like a lot of hands-on active effort, antithetical to our efforts to build a passive cash-flowing business. But the more I researched, the more feasible the strategy sounded. There was automated pricing software and automated messaging, and whatever didn't exist, I could fill in the gaps with hands-off scripts -- I might as well make use of my software development skills!

Most importantly, the numbers looked promising. We planned to put 15% down and targeted an 8% return on the down payment which equated to a net of $3,000/mo. An 8% return is the minimum we would accept for a real estate investment and we were very conservative with this one because it was going to be our first time operating a short term rental. The 8% return would cover most of the housing expenses and we would be building equity in the home so we believed it was still going to be a good investment. This is a simplified equation that neglects to take into account capex, maintenance, and appreciation but paints a good general picture of our analysis.

Details:
Purchase: $1,000,000 @ 2.75%
Down Payment: 15%, $150,000
PITI: ($4,500)/mo
STR Net (Pre-PITI): $3,000/mo

Scenarios:
(S1) Housing Expense: ($4,500) + $3,000 = ($1,500)/mo or ($18,000)/yr
(S2) Equivalent Rental: ($2,500)/mo or ($30,000)/yr

Calculation:
Savings (S2 - S1): $12,000/yr
Year 1 Return: $12,000 / $150,000 = 8%

In early 2021, we closed on a 4/2 single family home in Central District. The home had 2 units with separate entrances, a 2/1 upstairs and a 2/1 basement unit. More importantly, the home was in a great location for running a STR and even came with private parking. As with most deals, this home was not without its faults.

Even though the home was fully renovated, it was not selling because the basement unit only had a ceiling height of 6'4". Many buyers must have considered the basement "unusable" space and passed on the home. We recognized that low ceiling height might negatively impact our STR strategy but we found similar basement units in the market doing well. On top of that, we had a few options if things didn't work out.

Exit Strategies
Option 1: Rent out the entire home. We could likely get $3600+/mo.
Option 2: Lift the house to increase ceiling height.
Option 2: Move into the basement unit and use the upstairs as the STR

Given these options, we thought the home still made sense and we were bullish on the original STR strategy. Even if we failed, this would provide great education on what it takes to run a STR and house hack in Seattle.

The results

Given the lack of buyer interest, we were able to purchase the home for under asking.

Details:
Purchase: $935,000 @ 2.75%
Down Payment: 16%, $155,000
PITI: $4000/mo or $48,000/yr

We've been running the STR for 1.5 years and feel that we have enough data to compare our performance against our expectations.

As you can see, we were able to consistently do better than our minimum monthly net of $3,000. Before taking PITI into account, on average year over year we net an average of $56,000. Repeating a similiar equation as before.

Calculation:
(S3) Avg. Net after PITI: $8,000/yr
Savings (S3 + S2): $38,000/yr
Year 1 Return: $38,000 / $155,000 = 24.5%

Even when we take into account the STR set-up costs, we still have a respectable return year 1.

Adjusted for STR costs:
Furnishing: $18,000
Adjusted Year 1 Return: $20,000 / $155,000 = 12.9%

Through this strategy, we were able to completely remove our housing expense and bring in some additional cashflow. It turned out to be a great return on our down payment! As the cherry on top, after holding the home for only 1 year, we were able to open a 90% LTV HELOC for $140,000 @ 3.49%.

Conclusion

I'd be remiss if I didn't take a moment to address the unique market conditions and advantages we had. In 2021, interest rates were at a historic low and I was fortunate enough to have a down payment to take advantage of it. In markets all across the country, we were seeing record year-over-year value increases. There was certainly an aspect of luck but I also believe that there is always a viable investment strategy or opportunity no matter the market cycle. When Kat and I talk to seasoned and successful investors who were around pre-2008, the common denominator is that they continued to invest day in, day out. Optimal strategies may come and go but they always looked for new opportunities and markets at every phase of the cycle.

Real estate investing is a huge space. In my opinion, the most successful investors are creative and quick to adapt. Is it possible to house hack in a HCOL market? I'd say yes! It's certainly not as straightforward or simple compared to other markets but if I was able to find a workable solution, there must be many more creative strategies out there.