There are many benefits to buying rental properties. I will cover the main reasons why I decided to become an investor: leverage, inflation, and tax advantages.

Leverage

Leverage is a powerful tool in real estate investing. It allows investors to amplify their potential returns using borrowed funds. This strategy, promoted by Robert Kiyosaki, involves using other people’s money to increase your wealth.

Example of a Leveraged Real Estate Investment

An investor buys a rental property valued at $500,000 by paying 20% down, which is $100,000. The remaining $400,000 is financed at an interest rate of 6%. Assume the property appreciates at a historical average of 4% per year.

• Appreciation: Each year, the value of the property increases by 4%, making the property worth approximately $1,622,000 after 30 years.
• Mortgage Payments: The monthly mortgage payment on a $400,000 loan at 6% over 30 years is about $2,398. Over 30 years, the total amount paid in mortgage payments is about $863,448.
• Net Gain: The net gain from the property, excluding operational costs, taxes, and potential rental income, is the final property value minus the total amount paid in mortgage, which equals $1,622,000 – $863,448 = $758,552.

Inflation Hedging

Inflation is a sustained increase in the general price level of goods and services, reducing the purchasing power of currency. The Consumer Price Index (CPI) tracks the average change in prices for a basket of goods and services like food, housing, transportation, and medical care.

Investing in rental properties can be rewarding, especially with long-term appreciation of real estate values. Over the last two decades, the median sales price of houses in the U.S. has surged by 239%, as reported by the Federal Reserve. While annual increases in home prices are not guaranteed, historical data supports buying and holding properties over an extended period for appreciation.

Recent economic shifts, such as an inflation increase from around 2.0% to upwards of 8.0%, have influenced the investment landscape. Historically, periods of high inflation, like the 1970s, have shown that real estate often excels as an asset class. Here’s how inflation typically benefits real estate investors:

• Rental Income Growth: As inflation rises, rental prices generally increase, enhancing cash flow over time.
• Property Value Appreciation: Inflation often drives up property values, increasing the worth of your investment.
• Debt Reduction in Real Terms: As you repay your mortgage with inflated dollars, the real cost of your debt diminishes, making your investment cheaper over time.

Inflation effectively transfers wealth from savers to borrowers who leverage loans to invest in appreciating assets like real estate. It’s advantageous to be on the borrowing side of this equation.

While the Federal Reserve has raised interest rates to control inflation and revert to the 2.0% target, many economists speculate that the era of low inflation might be behind us. The COVID-19 pandemic exposed vulnerabilities in the globalization model, demonstrating the risks of over-reliance on international supply chains for essential goods. Recent USA-funded wars in Ukraine and Gaza have required the government to print more dollars, decreasing the value of the dollar.

Leveraging Rental Properties During High Inflation

By taking out a mortgage loan to buy a rental property, you lock in a fixed debt payment over the long-term loan period (e.g., 30 years). During high inflation, the value of the rental property and the rents you can charge tenants tend to increase. However, your mortgage payment remains fixed at the original amount borrowed. This means the actual value of your mortgage debt is eroded by inflation over time, while your rental income and property value rise with inflation.

Maintaining that fixed-rate mortgage debt allows you to pay it back with cheaper, inflated dollars in the future, while your leveraged asset (the rental property) increases in value. This strategy of using leverage during inflationary times is popular among real estate investors because it allows them to build wealth and equity faster as their mortgage debt burden diminishes relative to the appreciating value of the income-producing property. Paying off the mortgage eliminates this leveraged inflation hedge. While being debt-free reduces risk, you would miss out on the beneficial effects of inflation eroding your debt burden over time.

Tax Advantages

Depreciation

Depreciation is a non-cash deduction that allows you to recover the cost of the property (excluding the land) over time. For residential rental properties, this is typically over a period of 27.5 years. By depreciating the building’s value annually, you can offset your rental income, significantly reducing your tax bill. Robert Kiyosaki has said this is one reason he pays no income tax on his properties. For example, if you own a rental that has a positive cash flow of $3,600 annually and the property is valued at $400,000, the annual depreciation would be around $14,000. Even though you have an annual income of $3,600 from the rental, the IRS will see it as a loss of $10,400.

Mortgage and Property Tax

You can deduct the real estate property taxes paid on the rental property from your taxable income. This directly reduces your taxable income, although there are limits on how much property tax can be deducted if you own multiple properties or if used personally for part of the year.

Repairs and Maintenance

Costs for repairs and maintenance to keep the property in good working condition are fully deductible in the year they are incurred. Immediate tax benefits from expenses such as fixing leaks, painting, or servicing equipment can be claimed.

Operating Expenses

All operating expenses necessary for managing and maintaining a rental property are tax-deductible. Expenses include:

• Property management fees
• Property taxes
• Insurance
• Utilities (if paid by the landlord)
• Advertising for tenants
• Legal fees
• Office supplies
• Travel expenses related to property management

Buying rental properties can be a great investment strategy. Leveraging borrowed funds, hedging against inflation, and taking advantage of tax benefits can help build significant wealth over time.