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The 5 Unique Benefits of Residential Investment Property
There are 5 unique benefits of owning Residential Investment Property, by which we mean deeded, freehold single family homes or 2-4 unit properties leased out to tenants. When combined together, these 5 benefits make a residential real estate investment fundamentally unique from any other asset class.
#1) Cash Flow
This is your passive monthly stream of income from the property, by which we mean the rent you collect minus all your expenses, vacancies, repairs, etc. Most real estate investors are primarily buying the property for its monthly income stream and they use real estate investment analysis to ascertain what they conservatively expect that stream to be prior to closing on the property.
#2) Appreciation Potential
Market Appreciation happens when your property goes up in value over time. It is more speculative than cash flow and should be considered a bonus if it occurs, but savvy investors often attempt to buy property in the path of growth—where population and job growth are positive and where demand is trending upward—to give themselves the best chance of appreciation even though they are satisfied with the stream of income that exists regardless of appreciation. Savvy investors also try to buy at an advantageous point in the local property cycle, ideally when property prices are beginning to rise after a contraction cycle.
#3) Tax Benefits
Residential Investment Property is about the most tax-advantaged asset class around. Your operating expenses (property taxes, insurance, repairs, etc) are all tax deductible, leaving you only with your net positive cash flow. This is where it gets good! The IRS allows you to “depreciate” residential investment property over 27.5 years, even if the property is appreciating in value! You can only depreciate the value of your property structure (not the land). So, to use easy numbers, if you purchased a $350,000 property and you deemed the land to be worth $75,000, the property structure (“basis”) would be worth $275,000 and could be depreciated at a rate of $10,000 per year for 27.5 years! That $10,000 is taken as a “phantom loss” (because you didn’t “really” lose it) against positive cash flow you collected. So if you collected $825 net positive cash flow after all your expenses each month, you would end up with $9,900 positive cash flow for the year, but you can write it off against your $10,000 “loss” from depreciation and owe no taxes on it.
Financial institutions are more willing to lend you money for a residential real estate investment than most any other type of asset. If you choose to “leverage” your property by getting a mortgage, say a 30-year fixed principle and interest loan, then your “money out of pocket” is dramatically less (anywhere from 20% to 50% down payments are common, depending on buyer qualifications, instead of 100%). As long as your rent covers your mortgage payment (in addition to your other expenses) then you have a situation where your tenant is paying down your principle every month for you, reducing your mortgage debt over time. Often when you use financing, your “cash on cash return” is much higher because you put down substantially less money out of pocket.
#5) Hedge Against Inflation
Residential investment property is one of the only inflation-adjusted asset classes around. Property prices rise with inflation and so do rents (which you typically renew and raise each year with your tenant accordingly). Plus if you have used financing and locked in a 30-year loan at a fixed principle and interest rate, then as inflation increases and the purchasing power of the U.S. Dollar declines, you will benefit by paying the loan back in “nominal dollars” that are worth increasingly less than “real dollars”. Just remember that calculating “real” appreciation requires you to adjust for inflation as your property goes up in value.