The average person buys real estate to have somewhere to live. Rich people buy real estate as part of a larger strategy to build wealth. Real estate not only has value because it appreciates over time, building equity, but because of tax strategies that enable owners and investors to get tax breaks and deductions.
I asked ChatGPT to explain more about how the rich build wealth through real estate.
Wealthy investors tend to prioritize properties that pay them monthly through rental income. Whether this is a single-family home, a duplex or apartment complex or a commercial property depends on what kind of funds an investor has up front, ChatGPT pointed out.
The income covers mortgage, taxes, insurance and repairs. What’s leftover is positive cash flow that can be re-invested into other properties, compounding their wealth.
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The rich rarely buy property in cash, however, as noted above, ChatGPT said. They use loans to control more real estate with less of their own money. A 20% down payment still gives them 100% of the appreciation and rental income, plus they reap tax benefits.
Smart investors get low fixed-rate loans, which enables the debt to “act like a wealth accelerator when values rise,” ChatGPT said. Then, they refinance to pull out that equity and use it to buy yet more property, without selling any off.
Real estate historically appreciates 3% to 5% annually over long periods. Wealthy investors rely on two kinds of appreciation to grow their wealth:
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Market appreciation: This appreciation occurs when home values rise based on supply and demand at the local level.
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Forced appreciation: This appreciation results from undertaking renovations, improving management and other aspects that add value.
Appreciation is a tool that allows owners to earn from the property while tenants pay down the mortgage.
As mentioned above, ChatGPT noted that the tax code is designed to reward property owners. The rich maximize the following tax benefits when they own property:
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Depreciation: They can offset rental income over time on their taxes.
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1031 exchanges: This is a legal way to defer capital gains when selling a property.
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Cost-segregation studies: This is a way of accelerating depreciation by breaking a property into shorter-lived components.
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Deductible expenses: Money spent on essentials like repairs, management, insurance and mortgage interest may be tax deductible.
The overall result is that simply by owning property, the rich may owe less in taxes.
Once people start to amass some wealth in real estate, they stop doing everything themselves and instead create structures to make things simpler and more tax efficient:
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LLCs and holding companies
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Property-management teams
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Maintenance teams
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Bookkeeping and tax infrastructure
ChatGPT said this allows them to expand from one or two units to dozens or hundreds with relative ease.
Then, they start to diversify property types, since different assets “behave differently in various economic cycles,” which helps preserve and grow wealth. So, their real estate portfolios may include a mix of residential rentals, commercial properties, mixed-use buildings, industrial or storage units and real-estate syndications (REITs).
Economic downturns are tough for the average American, but a boon for wealthy investors. During downturns, real estate investors often build their biggest wealth because prices drop, inventory increases, competition slows and financing becomes more negotiable, ChatGPT said.
They prepare cash and credit ahead of time so they can jump right when others pull back.
Quick flips do happen even among the wealthy, but generational wealth is built by holding real estate for decades, ChatGPT said. Long-term ownership means they benefit from rising rents, mortgages that are paid off, deferred taxes and compounded appreciation. Their wealth in real estate becomes passive and transferable
Ultimately, the wealthy treat real estate as a long-term strategy, not a one-time purchase. That’s why their portfolios keep growing while everyone else is lucky to buy a single home.
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This article originally appeared on GOBankingRates.com: I Asked ChatGPT How the Rich Build Wealth in Real Estate: Here’s Its Explanation