How Real Estate Builds Continuous Automatic Wealth

1. Tax Benefits

The tax benefits of owning real estate are plenty and vary across different property types. Let’s say for example you own a home that counts as a primary or main residence. A “primary residence,” according to the qualifications for the popular Federal Housing Authority (FHA) loans, means that you live there “a majority” of the year (HUD, March 2011).

Whether you use a FHA loan or not, owning a primary residence and paying your mortgage is like paying yourself without getting taxed on it. This concept is called imputed rent (Tax Policy Center, May 2020). So while you build your home equity and it increases in value you get to reap the longer term benefits of your asset increasing in value (assuming you made a strategic purchase).

Furthermore you can still rent a portion of your home to cut your personal mortgage responsibility as still reap the tax benefits.

Take this beautiful brick home in Baltimore, Maryland:

Imagine you’re living, studying and/or working in the Baltimore area and you realize it would be great for your life journey be more invested in and purchase there. The location, price, and financial cost of the transaction align with your financial capacity and personal goals. You get a 30 year fixed rate mortgage at 2.5% (the current average at the time of writing!), so your monthly payments work out to be lower than the rental payments that you were paying for a similar place. You get to rent out one to two of the three bedrooms at a rate that works well for both you and your roommates.

That rental income:

• is tax free
• offsets your overall living expenses
• allows you access to a higher savings rate
• allows you to access more investment opportunities

On top of the tax benefits of imputed rent, owning property allows you to write off or deduct a number of things on your annual tax return that people who rent cannot. Viable deductions can include mortgage interest, property taxes, home insurance, maintenance fees, and so forth and so on.

Another major tax benefit of property ownership is potential favorable tax rates. Let’s say you own a property under an LLC. Your property is treated, evaluated, and taxed as a business and you can end up having more favorable tax rates and tax deductions depending on how you file. LLC’s are a great way to “establish a level of personal liability and asset protection, while minimizing [ ] tax liability” (Koontz & Associates PL Blog, June 2013).

All in all, these tax benefits put you in the wealth building position to optimize those benefits into more opportunities.

It also means that more of your money/earnings remain in your pocket and you have more authority over what happens with it.

2. Value Appreciation

Value appreciation is essentially a property’s increase in worth overtime. It occurs based on a number of factors that are typically distinguished as either natural value appreciation or forced value appreciation.

Natural value appreciation is the growth in what your property is worth without you uniquely doing anything. Larger social, political, and economic factors tend to impact at this level. For example, average New York City property prices increased by 250% between 1974 and 2006 (The Furman Center for Real Estate and Urban Policy, 2008) due to these broader factors. That means if you bought property for $100,000 in 1974, and everything remained the same, it would be worth about $350,000 in NYC in 2006. Imagine what it’s worth today in 2021!

Alternatively, forced value appreciation is when you alter the property to directly influence price and demand. You can make profitable improvements and renovations to a space that meet modern needs and neighborhood trajectory. What “profitable improvements” look like and the return on investment ultimately depends on the area where the property is located.

As your property increases in value, you can access self-financing options like leveraging your property’s appraised value for a loan or using your property’s equity to fund other income producing assets.

3. Inflation

Inflation ironically helps property owners! While the value of the dollar is decreasing overtime, the value of your property as an asset is (generally) increasing, again, assuming you made a strategic purchase.

If you have property in a resilient neighborhood, the value could continue to go up even in tough financial times for the country and rest of the world.

4. Cash Flow

 

If you have the ability to rent out a portion or all of a property in ways that notably lower your overall expenses, you are reaping the benefits of increased cash flow.

Treat this money responsibly, making sure it is going toward the property and its expenses first and foremost (including savings for the property).

When your cashflow outpaces your expenses, that’s the sweet zone toward even faster wealth building because you have more flexibility toward additional investments.

Outpacing your expenses also gives you more time wealth because it opens you up to options that give you more access to time that you’re not exchanging for for wages or money.