The 3 Sources of Real Estate Yield: Rental Income, Value Appreciation, and Depreciation Allowance (AfA)
As a capital investment, real estate generates returns from three sources: rental income, value appreciation, and AfA volume, which is the total amount for “depreciation for wear and tear” that you can use over many years to reduce your taxable income, thereby lowering your tax liability.
The AfA volume is reestablished with each sale of the property (but not with a gift/inheritance); the new owner can thus fully utilize the AfA volume anew.
While rental income is evident to everyone, some consider the value appreciation of the property questionable, as it is supposedly uncertain or at least not foreseeable in its magnitude.
And the third pillar of property returns, the AfA volume or tax benefits in general, is sometimes dismissed as mere hocus-pocus.
Yet, AfA volume and other tax benefits of real estate are very real and financially advantageous, especially for high earners.
The Higher the Tax Burden, the Greater the Impact of Tax Benefits
One reason why the monetary value of tax benefits may not be recognized or acknowledged by everyone is that tax benefits only fully unfold their impact with a correspondingly high tax burden.
Those with lower tax obligations find real estate AfA and other tax benefits less interesting. In contrast, tax benefits are particularly attractive for high earners. The higher the income, the better.
Thus, misunderstandings or rejection of the tax argument may sometimes include envy or annoyance that precisely those who already earn a lot benefit most significantly (in absolute terms) from tax advantages.
Sometimes skepticism toward “tax benefits” may also stem from a failure to realize that saved taxes are equivalent to income, and indeed tax-free income.
If you no longer have to pay 1,000 EUR that you would otherwise have owed in taxes, you have ultimately earned 1,000 EUR, and that’s tax-free.
The saved taxes are not counted as imputed income or similar. Instead, the tax office either transfers you 1,000 EUR, or you simply don’t have to pay that 1,000 EUR, even though you otherwise would have had to.
Even in the latter case, where you don’t pay something that you otherwise would, this ultimately counts as income and, as noted, is tax-free.
Value Appreciation in Good Locations is Reliable
As a tangible asset, the value of real estate (except in abandoned regions) rises approximately in line with inflation.
Since the inflation rate is around 2 percent in the long term, it seems reasonable to assume a 2% increase in value rather than the 1% increase often seen in example calculations.
For condominiums in Germany’s TOP 7 metropolitan areas, the annual increase in value between early 2016 and late 2023, over a period of 8 years, was not 1 or 2 percent but 7 (in words: seven) percent.
And this 7 percent is the average across all condominiums, not just investment properties, nor only for Munich, but as an average across the 7 largest cities.
At Meine-Renditeimmobilie, calculations for your personal real estate investment are NOT based on value appreciation.
Instead, we calculate the cash flow, which should almost or fully cover the investment.
Positive, neutral, or slightly negative cash flow refers to a situation where you come out ahead, break even, or face a slight shortfall on a monthly basis when comparing income and expenses for the investment property.
Even a slightly negative cash flow initially does not necessarily make an investment property unprofitable.
After all, any minor contributions you may have to make each month represent an investment in a six- or seven-figure asset, which will eventually be yours and paid off.
The tenant pays the lion’s share, even with a slightly negative initial cash flow. And the initially negative cash flow turns neutral and later positive as you increase rent while the loan rate remains the same.
The assumed value appreciation is provided by Meine-Renditeimmobilie for illustration purposes with a conservative 1 and 2 percent as additional example calculations.
The shared apartment concept at Meine-Renditeimmobilie is profitable – even in Munich – based solely on cash flow without the need to factor in value appreciation.
Value appreciation only really comes into play upon sale or refinancing. Nonetheless, this value growth is real and always works in the background.
Demographic developments are occasionally seen as a problem for long-term value development. However, Germany, along with the USA, is one of the world’s top immigration destinations.
Even if Germany’s population were to unexpectedly decline, this would happen in such a way that smaller places and rural areas would be abandoned (and – at least in Germany – also deconstructed), while prime locations would remain stable or even grow due to migration from surrounding areas.
An investment property is, of course, chosen in a good, future-proof location. Therefore, when consulting tables on property appreciation, it’s important to remember that these refer to all properties, not just those in good locations.
It’s evident that well-selected investment properties will tend to achieve somewhat higher value appreciation than the nationwide average of all residential properties.