Why Invest in Rental Homes for Long-Term Wealth

There may be many avenues of investment but one method typically leads the pack in its performance is real estate. Did you know that 90% of millionaires invest in real estate? This is an incredible figure that speaks to the effectiveness of this tool for wealth creation. Rental properties offer distinct and great benefits compared to other types of real estate investments. If you're wondering how to build a solid financial future, it's time to consider why you should invest in rental homes.

Table of Contents

Why Invest in Rental Homes

1. Passive Income Potential
2. Wealth Accumulation Through Property Appreciation
3. Inflation hedge (Rents Rise with Costs)
4. Tax Advantages
5. Control Over Your Investment
6. High Demand & Low Supply
7. Multiple Exit Strategies

Disadvantages of Property Investment

How to Invest in Rental Homes: A Beginner’s Guide

The Bottom Line | FAQs

Why Invest in Rental Homes

Investing in rental houses presents a mix of stability, income, and potential for long-term appreciation. Here are seven good reasons why including rental homes in your investment portfolio may make good sense for your financial future.

1. Passive Income Potential

One of the most appealing advantages of rental properties is the potential passive income they provide. Consider opportunities for additional funds aside from your ordinary work. In fact, in 2024, the median U.S. rental yield varied from 6-8% a year, pointing to the income-generating capacity of rental properties. 

In contrast to stock dividends that can change with the market, rental property income is contractual and paid by the tenants,. This can offer a degree of predictable cash flow, though actual payments are contingent on tenant adherence and factors like vacancy or eviction. Researching the best cities to invest in rental homes can contribute to potentially more stable income from properties, as certain markets offer higher rental yields due to strong demand and favorable economic conditions.

2. Wealth Accumulation Through Property Appreciation 

Apart from rental income, one of the key forces powering wealth in real estate is property appreciation. This means the appreciation of the value of a property over time, so that you can sell it for a profit in the future.

According to a new study by Clever, home values increased 2.4 times the rate of inflation since the 1960s. This reflects the strong long-term growth potential of real estate with a potential return on investment that frequently surpasses the performance of other asset classes.

While the most prevalent type of appreciating asset is the traditional single-family homes, it's worth noting that other forms of rental properties can also benefit from this phenomenon. Even something like investing in mobile home rentals, particularly if you own the land the mobile homes sit on, can lead to appreciation of the land itself. 

3. Inflation Hedge (Rents Rise with Costs)

Among the under-appreciated benefits of how to invest in real estate, particularly when buying a house to rent out, lies its inherent power to serve as an inflation hedge. With the cost of living on the increase, rental levels expand as well. This relationship can form a financial cushion for rental property owners.

In 2024, rent increases varied across different locations. To illustrate, Cotality reports indicated a year-over-year growth of 2.8% in the rate of single-family rental, with the highest rate of increase being in Washington, D.C. (5.6%). This demonstrates that when inflation raises the price of commodities and services, landlords can raise the rate of rent annually to match these increased costs.

While your rental income is rising with inflation, your monthly mortgage payment, assuming a fixed-rate loan, stays the same. That makes the real cost of the mortgage lower over time compared with your growing income, thus enhancing your rental property returns.

4. Tax Advantages

Beyond the monthly cash flow and appreciation, investing in rental homes offers a suite of often-overlooked tax advantages. One of the strongest of these benefits is depreciation. The IRS will allow you to write down part of the value of the property (not the land itself) annually as a business expense, even if the property itself is appreciating in value.

In addition to that, you might be able to claim a wide range of expenses for owning and operating your rental property. They include:

• Mortgage interest: Much of your money goes for interest, particularly in the early years, which has the potential to all be written off.
• Property taxes: Local property taxes are another deductible expense.
• Insurance premiums: Landlord insurance, hazard insurance, and flood insurance premiums can be deductible.
• Operating expenses: Property maintenance costs, repair costs, property management fees, advertising, and even utilities (if paid by the landlord) can typically all be deducted.
• Travel expenses: If you travel to inspect or manage your rental property, those expenses can also be deductible. 

It's crucial to remember that tax laws are complex and vary significantly by individual circumstances. This information is for general educational purposes only. Always consult with a qualified tax professional to understand the specific tax implications for your situation.

5. Control Over Your Investment

As opposed to other forms of investments, investing in rental homes offers a significant degree of control. When you invest in stocks or mutual funds, you're largely at the mercy of corporate decisions and current market fluctuations. Your influence as an individual investor is minimal, if not non-existent.

With rental properties, though, you make the decisions. You select the property, the location, and the amenities. You determine the rental rate, who the renters will be, and the maintenance of the property.

6. High Demand & Low Supply

The National Multifamily Housing Council (NMHC) estimates that the U.S. will require an additional 4.3 million apartments by the year 2035 to satisfy housing needs. This huge shortfall isn't solely about apartments; rather, it is indicative of a general shortage of all forms of rental housing. Fueling this need is a demographic change: Millennials rent for an average of 5+ years longer than the boomers, according to Pew Research. This longer duration of renting equates to a larger, ongoing pool of renters for landlords.

From an investor's point of view, this supply-demand dynamic equates to a booming market for rental apartments. When there are more renters than units, landlords have increased bargaining power to charge competitive rental prices and encounter fewer vacancies. This makes choosing the best area to buy rental property extremely important; targeting areas with strong job markets and growth in population may ensure possible rental income and long-term appreciation.

7. Multiple Exit Strategies

One of the usually under-emphasized benefits of how to invest in home and rental properties is the degree of exit strategy flexibility that they provide. While some investments tend to pin you down on one course of direction, real estate gives you several avenues to profit from your investment, enabling you to adjust to the market as well as your own financial goals.

You're not merely signing on for being a long-term landlord. Here are some of the major exit strategies that are available to you:

• Rent Long-Term: This is the most common investment strategy. You continue to receive passive income, enjoy strong appreciation, and take advantage of the tax benefits over many years. However, it carries risks of market downturns impacting rental demand and value, tenant issues, and ongoing maintenance costs.
• Flip After Property Appreciation: If the property appreciates in value substantially, or when you have added considerable value through improvements, the property can be sold for a profit. This house flipping strategy can yield capital, which can then be reinvested or employed for alternative financial goals. Risks include market dependency for profit realization, potential for over-budget renovations, and illiquidity if the property doesn't sell quickly.
• Refinance (BRRRR Method): The BRRRR strategy (Buy, Rehab, Rent, Refinance, Repeat) is an effective means of scaling your real estate business. After purchasing and rehabbing the property, and subsequently renting it out, you can refinance for the purpose of pulling the equity that you have accumulated. However, this method is dependent on market conditions for property appraisal and refinancing approval, carries risks of illiquidity if refinancing is not feasible,.

Disadvantages of Property Investment

Property investment, though largely promoted as a profitable undertaking, carries with it certain substantial drawbacks that real estate investors ought to take into account carefully. These include:

1. High Upfront Costs: Investment in property usually requires significant upfront expenses. There are also additional costs such as down payments, closing fees, and appraisal fees, besides the cost of renovation or repairs.

2. Illiquidity: Contrary to stocks or bonds that can be sold and purchased fairly quickly, selling investment property can take a considerable amount of time.

3. Ongoing Expenses and Maintenance Costs: Home ownership includes ongoing expenses that can deplete profits. It can be property taxes, insurance, HOA fees, and utility bills.

4. Market Volatility and Economic Downturns: Property values are not guaranteed to appreciate and may be impacted by economic recessions, changes in interest rates, and regional market conditions.

5. Tenant-Related Issues: Having to deal with tenants is sometimes stressful and costly. Issues that may arise include vacancies, damages, evictions, and failure or tardiness in rental payments.

6. Depreciation: Land tends to appreciate, yet buildings depreciate with the passage of time because of wear and tear and obsolescence. Though this will provide advantageous tax savings through allowances for depreciation, this will also indicate the physical aging of the asset.

How to Invest in Rental Homes: A Beginner’s Guide

This step guide will take you through the key considerations and process on how to invest in a rental home, guiding you from the start of the process all the way to being an investor in the rental market.

1. Educate Yourself and Set Clear Goals

Understand the market before getting into a particular investment. Educate yourself about the general real estate market and then narrow down to particular areas of interest to you. 

2. Assess Your Finances and Understand Investment Methods

How to buy rental property or investing in rental income streams all starts with a clear understanding of your financial position and exploring the various ways that you can participate in. 

Traditional Direct Ownership (Single-Family Homes, Multifamily Property)

This includes buying a physical property (residential properties, duplex, apartment buildings) with the purpose of renting it out. This does call for considerable capital for down payments (usually 20-25% for rental properties), closing costs, and a reserve fund for repairs and vacancies. You will usually have to arrange a loan from a banking institution or financial institution.

Fractional Investing in Real Estate

Fractional real estate investing means that several rental property investors pool together to own a fraction or part of a larger, typically professionally managed, rental property. You buy units or shares in a property without owning the entire asset yourself. Platforms (both local and international) facilitate this. 

Real Estate Investment Trusts (REITs)

REITs are corporations that own, manage, or finance income properties. They list on the stock exchange, just like stocks, so that you can invest in a diversified range of properties (e.g., apartments, office buildings, retail space) without actually owning them. This has a low entry barrier, as you can buy shares like any stock. 

Real Estate Crowdfunding

Similar to fractional investing, but often involves pooling money with other investors for specific real estate projects (e.g., a new apartment complex development, or a single rental property acquisition). You invest in a debt or equity position in the project. Crowdfunding varies by platform and project. It can be more accessible than direct ownership, but typically higher minimums than REITs. 

3. Research and Choose the Right Location (for Direct Ownership & Fractional/Crowdfunding): 

Location dominates in real estate, no matter what your investing approach. For actual ownership or for individual crowdfunding deals, this means solid rental demand, cheap costs compared with rental yields, or vacancy rates.

4. Find and Evaluate Potential Investments

This is where you actively apply how to invest in a rental home using your chosen method. With direct ownership, you can hire a real estate agent that specializes in investment properties. Target properties that have positive cash flow after paying all costs. With fractional investing, REITs, and crowdfunding, research well-established platforms or listed REITs comprehensively. Evaluate their performance record, fees, property types, as well as investment structures.

Through examining these varied approaches and carefully adhering to the provided steps, you'll have a solid grasp on how to buy rental property or invest in rental income streams, laying the groundwork for a potentially successful real estate portfolio.

The Bottom Line

To invest in rental homes, in the form of direct ownership, fractional investment sites, or REITs, presents an attractive avenue for long-term wealth and passive income. Yet, this is not a "get rich quick" program, and it does take planning, research, and a solid grasp of the market and the method of your choosing. Keep in mind that patience and long-term thinking will serve you well for achieving success in the ever-changing world of rental property investing.

Frequently Asked Questions (FAQs) 

Is investing money in a rental home a good idea?

Investing in a rental property can be a good idea for constructing wealth and earning income, with benefits such as capital appreciation potential, stable cash flow, and beneficial tax deductions that can act as an inflation hedge. But there's a considerable amount of cash needed upfront, an illiquid asset, and there's the potential risk of market declines and vacancies.

How much can you make in investing in rental homes?

The returns from rental housing investments tend to be volatile, depending on factors such as rental income, capital appreciation, and accretion of equity through loan principal repayments, all of which depend on the property purchase price paid, the location of the property, the available interest rate, and good management.

What is the best type of property to invest in?

There is no "best" property in real estate investing because the optimal choice will always relate to the investor's budget, risk tolerance, amount of time they wish to invest, and the characteristics of the local market. Single-family homes and condos tend to appeal to beginners since they're relatively easy to work with and have high tenant rental demand.