4 Benefits of Owning Rental Property
Why the Wealthy Invest in Real Estate
There are many reasons to invest in real estate. Listed below are the four main financial benefits of owning property rentals that accelerate wealth growth.
1. Equity Pay Down
Equity pay down is the fact that someone else is paying off your mortgage. There isn’t much that you can purchase 100% ownership of, only pay 3.5-40% of the purchase price, and have someone else pay off the other 60%-96.5% of the cost.
If the payments are amortized over 30 years, you will have a completely free and clear property on year 30, paid by someone else, and all of the rent will be income in your pocket.
Note: If you make one extra mortgage payment per year, that 30 year mortgage can turn into 23 years, so on and so forth. (Whether that’s the best idea for you depends on your goals).
San Diego multifamily real estate has historically appreciated 4.84% since 2004 according to data collected from the multiple listing service. That means your $1,000,000 asset (that someone else is paying off for you) will be worth $1,266,587 in year 5, and $1,604,242 by year 10 (which is why I, as an advisor, will always encourage my clients to scale to acquire more or larger properties when it’s time).
3. Tax Savings
The tax benefits of owning real estate is reason enough to invest in rental property. If you are an income earner, owning rental property will reduce the amount you spend on taxes and accelerate your ability to build wealth. Here are all the tax benefits of owning income property:
1. Tax Deductions, including:
a. Interest paid on mortgage payments
b. Real estate expenses, including:
The cost of property maintenance and repairs
Capital Improvements made to the property
Operating expenses such as pest control and utility bills
Services such as attorney fees and management costs
2. Depreciation: Depreciation is the perceived degrading quality of real property as it is used over time, which can be deducted from the owner’s taxes. For multifamily property in San Diego, you can calculate how much ‘depreciation’ you can use as a tax deduction by taking the assessed value at the time of purchase and dividing that by 27.5 years. Therefore, a $1,000,000 property will be able to deduct $36,363 from your taxable income.
3. 1031 Exchange: A 1031 exchange is an exception to the tax code under Section 1031 of the IRS which allows the tax on capital gains to be deferred if the relinquished property is sold and exchanged for another like-kind property within certain timelines. The current tax code allows gains to be deferred until a final sale of a property that was exchanged into, if the sale does not include purchasing another property, or until the death of the owner (or spouse). At that point, there will be a new assessed value of the property and all capital gains will be wiped clear.
In short, your appreciating asset can be sold and exchanged into a larger asset, which will yield even greater appreciation, and you can continue to grow your capital this way until you or your spouse dies, without having to pay taxes on the appreciation. This is of benefit to you because instead of paying a percentage of your gains to the IRS, you can put it towards your next purchase and ultimately buy more property than you otherwise would have been able to afford.
Example: The $1,000,000 asset that is now worth $1.6Mil ten years later, can be sold and 1031 exchanged into a larger property, without having to pay any taxes on the $600,000 in gains.
4. Cash Flow
An obvious benefit to owning rental property is the passive income, which increases over time due to implementing consistent rent increases over the course of tenancy as well as the ability to raise the rent to the leading market rent in the neighborhood of the property when there is a vacancy. Rents that start at $1,500 today will be $1,914 five years from now if you only implement 5% rent increases annually, yet a mortgage payment will stay the same. This equates to, at minimum, a 5% raise annually, which will help you keep up with inflation. Does your current salary keep up with inflation?
As you can see, investing in real estate is a smart financial decision. You might notice that the benefit of cash flow is at the end of this list. Cash flow may be the reason most people invest in real estate in the first place, but the other three benefits of investing in real estate listed above are not to be overlooked, especially in the San Diego market.