Rental real estate has long been proven one of the best ways to build wealth through real estate. Residential rental real estate, in particular, is an appealing asset class because it provides housing -- an essential service that will never become obsolete -- with the added benefit of real estate appreciation and tax deductions to boot.
But don't take my word for it. In the five eye-opening charts below, I'll show you the power of rental real estate as a key wealth builder, and you'll quickly see why rental real estate is a smart investment move.
Rental growth consistently outpaces inflation
Hedging against inflation is an important part of growing a lasting portfolio. After all, a 7% return on investment (ROI) is rendered obsolete if inflation is at 7% or above. The key is finding an investment that stands the test of time, growing consistently above the inflation rate on average. Rental real estate does just that.
Image source: iProperty Management.
According to a report by iProperty Management, rental rates have grown year over year at an average of 8.86% since 1980. However, because of the nature of real estate being location-driven, several markets continuously outpace the average, having rental growth in the double digits. Because residential leases are executed on short-term leases, they can adjust and rise as demand increases or inflation jumps, acting as a hedge and helping investors not just keep pace but outperform.
Rental returns are stable
Image source: iProperty Management.
According to data from iProperty Management, the average residential rental property provides a 7.5% ROI -- not huge compared to the average return of the stock market, which is just over 9%. But rental returns aren't the only benefit of investing in rental property.
Depreciation -- the ability to deduct a portion of a property's value over time to reflect the wear and tear of the property -- as well as other tax deductions, can make a massive difference on an investor's tax basis each year. Investors who own rental properties also have the opportunity to benefit from real estate appreciation.
Home values grow
Generally speaking, real estate increases in value over time, which is called appreciation. Not every home or market will appreciate, as demand is the biggest driver for home price growth. Over the past decade, insanely high real estate demand has driven the appreciation rate to an average of 10% per year for the past 10 years, far above the usual growth rate.
Image source: Case-Shiller Home Price Index.
The Case-Shiller Price Index from January 1987 to today has seen the median home price increase 333%. That's 9.7% per year on average. After adjusting for inflation and accounting for the 1987 median home price of $63,732 being $157,615 in today's dollars, the home's value would have increased 75%.
Given that most landlords use the rental income to pay for property expenses -- including mortgage payments, property taxes, repairs, and insurance -- it's like gaining appreciation for free. And you can see how a 20% investment in the form of a down payment can pay off handsomely over time.
Demand isn't slowing
Image source: CBRE Research Q4 2021 Multifamily Figures.
One of the biggest reasons home prices have increased so dramatically lately is the lack of supply. There's a major housing shortage messing with the natural supply and demand balance. Homebuilders and multifamily operators are building as quickly as possible to meet supply, but it will be years before the gap is actually closed. That means investors should benefit from low vacancy rates and continued rental growth.
Completions for new multifamily housing are climbing, but net absorption, the rate at which leases and properties are being filled, is at record highs -- a testament to the fierce demand.
REITs provide alternative access to rental real estate
MAA Total Return Level data by YCharts.
Traditionally, investors had to buy and manage a rental to participate in this growing sector. But thanks to real estate investment trusts (REITs), investing in rental property has never been easier. Residential REITs are a special type of REIT that invests solely in residential rental properties, including apartments or single-family rental homes.
Over the past decade, several top-performing residential REITs have outperformed the S&P 500, with total returns in the 18% to 22% range annually. REITs offer investors passive opportunities to invest, with the company being responsible for the active management and responsibilities of ownership of the portfolio. And because of the unique tax structure for REITs, these companies often pay higher-than-average dividend returns.
As you can see, rental real estate is not just a smart investment today; historically, it's proven itself as a strong long-term investment for active or passive investors. Thankfully there are several ways to get started, including buying your first rental property or investing in your first residential REIT -- or better yet, both.
