Passive Income through Real Estate – Part 3 of 3 (The Grand Finale)

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Passive Income Through Real Estate

Tax Advantages, Real Estate vs. the Stock Market & Summary

September 2026

This report is for general educational purposes only and does not constitute financial, tax, or legal advice. Consult a qualified CPA, attorney, and licensed lender before making investment decisions.

This is the final part of a 3-part series. Part 1 covered leverage and financing; Part 2 covered cap rates by property type, short-term vs. long-term rentals, and appreciation. This installment covers tax treatment and closes with a full recap of the series.

Beyond Cash Flow: The Tax Advantages of Real Estate

Parts 1 and 2 of this series focused on cash flow, leverage, and appreciation. But one reason investors accept a modest cash-on-cash return — like the roughly 2.9% illustrated in the Part 1 case study — is that real estate’s after-tax return is typically much higher than its pre-tax cash flow suggests. Unlike most stock market returns, rental real estate offers several layers of tax benefit:

  • Depreciation: The IRS allows owners to deduct the building’s value (not land) over 27.5 years for residential property or 39 years for commercial, as a non-cash paper expense that shelters rental income — often making cash flow that is taxable income on paper look like a loss for tax purposes.
  • Operating expense write-offs: Mortgage interest, property taxes, insurance premiums, repairs, management fees, and other operating costs are all deductible against rental income.
  • Cost segregation: A cost segregation study reclassifies portions of a building (fixtures, flooring, certain site improvements) into 5-, 7-, and 15-year categories, allowing much faster depreciation in the early years of ownership — often the single largest tax lever available on a 5+ unit acquisition.
  • Active vs. passive investor status: Real estate professionals (or, in some cases, spouses who qualify) who materially participate can use rental losses to offset other active income, not just passive income — a benefit generally unavailable to ordinary stock market investors.
  • 1031 exchange: Gains from the sale of investment real estate can be deferred indefinitely by rolling proceeds into another like-kind property, an option that has no equivalent in stock investing.

This section is general information, not tax advice. Depreciation recapture, passive activity loss limitations, and real estate professional status rules are technical areas — a CPA should confirm how these apply to any specific situation.

Real Estate vs. the Stock Market

Investors often benchmark real estate cap rates or cash-on-cash returns directly against stock market returns, but the comparison is incomplete without accounting for a few structural differences:

  • Leverage access: Stock investors can use margin, but rarely at 60–95% loan-to-value with 30-year fixed amortizing debt the way real estate buyers can.
  • Forced amortization: A portion of every mortgage payment pays down principal, building equity automatically — a return stream with no equivalent in a stock portfolio.
  • Tax treatment: As outlined above, depreciation and expense write-offs can substantially reduce the effective tax rate on rental income, whereas dividends and realized capital gains are taxed with fewer offsetting deductions.
  • Liquidity and volatility: Stocks are far more liquid and can be sold in seconds, but real estate values are also less volatile day-to-day, which suits investors seeking steadier, less headline-driven returns.
  • Illustrative total return stacking: Cap rate/cash flow, plus principal paydown, plus appreciation (historically ~5% annually in California, per Part 2), plus tax shelter from depreciation, is how real estate investors typically justify a total return that looks competitive with, or superior to, long-run equity market returns — even when the cash-on-cash yield alone looks modest.

Full Series Summary

Here’s everything from this series in one place.

Financing & Leverage (Part 1)

CategoryTypical Down Payment
1–4 unit residential (investment)15% – 25% (as low as 3.5–5% if owner-occupied)
5+ unit commercial multifamily20% – 35% (agency/bank/CMBS)
Hospitality, self-storage, special-use commercial30% – 50%

Cap Rates by Property Type (Part 2)

Property TypeTypical 2026 Cap Rate
Industrial / Multifamily Class A4.5% – 5.5%
Multifamily Class B / Self-Storage / Medical Office5.5% – 7.5%
Multifamily Class C / Senior Housing (Assisted Living)6.8% – 9.0%
Skilled Nursing~6.2%+
Hospitality / Hotels7.75% – 10%

Short-Term vs. Long-Term Rentals (Part 2)

MetricSTRLTR
Gross revenue vs. equivalent+30% – 80%+Baseline
Operating expense ratio45% – 60%30% – 40%
Management intensityHighLow

California Appreciation (Part 2)

MarketLong-Run Avg. Annual Appreciation
Los Angeles, CA5.26% per year (since Jan. 2000)
San Francisco, CA5.29% per year (since Jan. 2000)
U.S. National (20-City Composite)5.08% per year (2001–2026 average)

Choosing a Property Type for Passive Income

Property TypeTypical LeveragePassivityYield Profile
Single-family / condo / townhome75–85% LTV (15–25% down)High (with property manager)Lower cap rate, strongest appreciation history, easiest financing
2–4 unit residential75–96.5% LTV (3.5–25% down)High to moderateBest leverage available; house-hacking option
5+ unit multifamily65–80% LTV (20–35% down)High (with property manager)Balanced cash flow, appreciation, and passivity
Self-storage50–75% LTV (varies)Very highComparable or better cap rate than multifamily, minimal tenant management
Senior housing (independent/active adult)50–70% LTV typicalModerate (operator-run)Demographic tailwind, moderate cap rate
Skilled nursing / assisted living50–70% LTV typicalLow (operationally intensive)Highest yield in the healthcare-adjacent category, highest complexity
Hospitality / hotels50–70% LTV (30–50% down)Lowest — essentially an operating businessHighest cap rate, highest management burden
Short-term rental (STR) — any residential unitSame as underlying unit typeLow to moderateHighest gross revenue potential, highest expense ratio and regulatory risk
Long-term rental (LTR) — any residential unitSame as underlying unit typeHighLower revenue ceiling, most predictable and passive

Closing Thoughts

There is no single “best” property type for passive income — the right choice depends on how much capital an investor has for a down payment, how hands-on they want to be, and how much weight they place on cash flow today versus appreciation and tax efficiency over time. Smaller residential properties (1–4 units) offer the most accessible leverage and the deepest financing options; larger multifamily and alternative property types (self-storage, senior housing, hospitality) require more equity and either professional property management or an experienced operating partner, but can offer stronger risk-adjusted yields for investors who structure the deal correctly.

As always, every acquisition should be underwritten on its own numbers — actual rent rolls, actual expenses, and current loan quotes — rather than the market averages presented in this series, which are intended as directional benchmarks.

Disclaimer: This report is provided for general informational and educational purposes only and does not constitute financial, investment, tax, or legal advice. Cap rates, appreciation figures, and financing terms are market averages current as of the data available in 2026 and are subject to change. Prospective investors should consult a licensed financial advisor, CPA, real estate attorney, and mortgage professional before making investment decisions.

Disclosure

This document is provided for educational purposes only and does not constitute financial, investment, tax, or legal advice. It should not be relied upon as the sole basis for any investment or financing decision. For guidance specific to your situation, please consult a licensed financial advisor, tax advisor, lender, and/or estate planner.

For more info on the above or to get prequalified for any type of real estate aquisition or refinance, please contact me.

Rob McCarthy
Senior Mortgage Advisor
https://www.101loan.com
650-465-8957 c  rob@101loan.com
CA DRE #01165697 NMLS #121019
101 Loan – 99 South Almaden Blvd, # 600. San Jose, CA 95113

Products/Services/Accolades:

* Residential Financing for Purchases and Refinances on 1 to 4 unit properties.
* Reverse Mortgage Financing to include Conforming, Jumbo, HELOC Jumbo’s.
* Commercial & SBA Financing to include Multifamily, Office, Retail and Light Industrial.
* Construction Financing and Private Money, also know as Hard Money
* Access to over 60 banks with over 300 “Five Star” Reviews on Yelp, Google & Linkedin.
* Over 30 years of lending experience with over $2b in closed loan volume.

Make Better Real Estate Decisions…

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I recently finished a four-part series on the following topics, as it relates to Real Estate locally and abroad, helping you make better decisions in buying, selling or exploring the world of real estate. 

Click below for more info…

In addition, if you are looking to buy, sell and trade-up or trade-down real estate, please see the following:

Lastly and Important…

Did you know that the CalHFA loan (Zero Down Loan) is only available until the end of the month.  If you have a client, colleague, friend or family member that wants to buy in California and has no down payment the CalHFA program may help.  To learn more, go here or follow the instructions below and then contact me.

Do This First: For the CalHFA program, you first need to complete a registration application for a Voucher thru the CalHFA website.  CalHFA will then have a random drawing for a Voucher for the program.  Please be sure to register asap as the registration window closes April 29th.

Any questions, please contact me.  Thanks.

Best Regards,

101 Loan
Senior Mortgage Advisor
www.101Loan.com
650-465-8957 c  408-377-4123 o
CA DRE #01205444  NMLS #326829
101 Loan – 14435 C Big Basin Way, Saratoga, CA 95070

Products/Services/Accolades:

  • Residential Financing for Purchases and Refinances on 1 to 4 unit properties.
  • Reverse Mortgage Financing to include Conforming, Jumbo, HELOC Jumbo’s.
  • Commercial & SBA Financing to include Multifamily, Office, Retail and Light Industrial.
  • Access to over 60 banks with over 300 “Five Star” Reviews on Yelp, Google and Linkedin.
  • Over 30 years of lending experience with over $2b in closed loan volume.

Note: Interest rates and loan programs quoted are subject to change without notice or until locked and approved by lender.

Interesting Times in Real Estate – Recent Changes in Commercial & Construction Financing – Part 4

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This is the final article of my series titled “Interesting Times in Real Estate” that covers the following key real estate trends:

  • Housing Inventory
  • Interest Rates
  • Recent Changes in Residential Real Estate
  • Recent Changes in Commercial and Construction Financing (Today’s article)

If you have questions about these or any other topics related to real estate, real estate financing or real estate trends, please feel free to reach out to me.

Now for Part 4 – Recent Changes in the World of Commercial and Construction Financing.

First of All…What is Commercial and Construction Financing?

Answer: Any building, structure or location where business is conducted and where revenue may be created that needs financing.  In addition, any residential style property equal to 5 units or more, often referred to as multifamily or apartments where renters reside.  Lastly, if the structure or building is not built, often times investors or buyers will build out the property and have the need for financing, also called Construction financing.

Next…

What are the Types of Commercial Property?

  • Multifamily/Apartments
  • Retail
  • Office
  • Light Industrial
  • Auto Dealerships
  • Parking Structures
  • Skilled Nursing
  • Anything Hospitality

What Happened Last Year and This Year?

Do you remember these three letters, SVB?  Well in 2023, Silicon Valley Bank closed their doors only to be purchased by First Citizens Bank on March 23, 2023.

Why did SVB close? 

For two reasons, that include a lack of diversification where much of their customers’ deposits were from tech companies. SVB then invested those funds in long term U.S. treasuries and mortgage-backed securities, which got crushed when the Federal Reserve increased rates in 2022 and part of 2023 causing these assets to lose significant value.  That was followed by a bank run where customers withdrew their money as news spread that SVB may go out of business, which it did, creating mass losses for the bank and for the FDIC to the tune of $20B.

Other banks followed suit including First Republic and Signature Bank as well as others.

As banks closed, consumer confidence suffered not only for depositors but for other banks throughout the U.S. as well.  This caused banks to tread carefully in creating lending relationships with new clients but also seriously looking at existing clients that lost liquidity or showed declining income or declining cash reserves.  The bank’s focus in lending went from focus on the property to the borrower and if the borrower was not perfect, the lender would cease ties to them especially if they had a lending relationship with them.

Interesting how this feels like SOX in that one company can have a negative impact on the entire real estate and banking industry and its banking customers.

What is Commercial Lending Like Today?

In one word – conservative!  Or maybe better yet, two words – very conservative!

In the past, banks that loaned on commercial type properties mostly focused on the property in terms of location, cash flow and condition of property.  With construction, bank financing would typically be based on what was being built and the potential market for the finished product whether the property was a home, townhouse, condo, 4 unit or commercial property.

Today those property factors are still a concern, but now lenders are very much concerned about the borrower’s experience, relationship with the bank, cash reserves, credit, solvency etc.  If any red flags emerge, the bank will simply decline the deal with little explanation.  In fact, some banks aren’t taking on any new business whatsoever until consumer and banking confidence increases.

Imagine if you’re a commercial loan officer at a bank that currently isn’t willing to loan to anyone…What do you do?  Quit and go to another bank that could do the very same thing?  Better yet, imagine you’re the customer and you’re looking to get a deal done where financing is needed and the bank says, we are not lending right now and have no plans in the immediate future to lend.

This year and last year, I had many commercial banks that were once my “go to” for financing, but today some are simply saying they aren’t lending in the current climate regardless of what the client has in reserves or in experience or what the property cash flows at.  As a mortgage broker, having access to multiple banks is critical in today’s climate and I’m grateful to have access to more than 60 banks, many of which are still lending at favorable terms.

Recent Story about Lending…

Recently I had a client looking to obtain construction financing equal to $15M to build 5 custom homes and all of the big banks stated that there was too much risk in building homes on spec (to be sold in the future).

My response to these banks…Wait a minute…the borrower owns the land, residential inventory is at an all-time low and demand is at an all-time high.  What risk?  We ended up getting it done with a local bank that asked the client to deposit a little less than 10% of the loan proceeds (something that is very common right now).

Another Story…

Another client that was looking to purchase a medical office and use SBA which is super expensive as rates are at an all-time high coupled with high fees. I offered a better solution that uses the client’s income and the current rents from the property to qualify.  It requires 15% down versus 10% down but saves the client about 1% in rate and about $20k in closing costs.

Being a mortgage broker in this market sure has its benefits as it gives our clients much more freedom and flexibility than working with a large bank that has lots of rules and no flexibility all due to what occurred last year with SVB and First Republic.

Last Story…

Have a client that rents an office space and their landlord which is also the owner of the building recently had a “margin call” from their lender after finding out that the building they purchased 3 years ago has lost 50% of its value.  This was due to declining rents and lack of tenants as so many businesses work out of their home today.  As a result, the owner of the building has decided to walk away from the building and let the bank have the property.  The owner just wanted to inform their tenant.  Aren’t you glad you’re not the owner.  BTW…Property was worth $80M 3 years ago and today its worth $40m and their loan is $40m.  OUCH!  Hope they did not personally guarantee that loan!

Conclusion…

Real estate has its ups and its downs just like any industry, but working with people that understand the changing markets and adapt to those markets are the ones you want to work with.  If you have any need in Residential or Commercial Real Estate, please feel free to contact me.

All the Best,

101 Loan
Senior Mortgage Advisor
www.101Loan.com
650-465-8957 c
CA DRE #01205444  NMLS #326829
101 Loan – 14435 C Big Basin Way, Saratoga, CA 95070

Products/Services/Accolades:

  1. Residential Financing for Purchases and Refinances on 1 to 4 unit properties.
  2. Reverse Mortgage Financing to include Conforming, Jumbo, HELOC Jumbo’s.
  3. Commercial & SBA Financing to include Multifamily, Office, Retail and Light Industrial.
  4. Access to over 60 banks with over 300 “Five Star” Reviews on Yelp, Google and Linkedin.
  5. Over 30 years of lending experience with over $2b in closed loan volume.

 

 

 

 

Commercial Lending…What Not to Do!

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I have been practicing residential financing for over 30 years and commercial financing for over 20 years and have provided commercial financing on Multifamily (Apartments), Office, Retail, Medical (Dental and Doctor Offices) and Light Industrial properties (data storage units and auto dealerships).

During that time, I have witnessed that residential interest rates were always lower than commercial rates until the Federal Reserve started raising rates in January of 2022.  In looking at the current interest rate market, residential rates are varying between 6.5% to 7.5% depending on the loan amount, ltv, fico’s, property type and points paid, etc.  Commercial lending on the other hand has ranged recently from 5.5% to 6.5% depending on loan term, property types and points paid.

Most Important…

Commercial loans all have prepayment penalties (where residential loans do not) and they usually follow the term of the loan so they tend to not only be costly (if one breaks them) but they also tend to be very long in duration!

For Example…

  • 5 Year Fixed Loan (on a commercial loans) have a 5 year prepayment penalty that works like this with a 5-4-3-2-1 Prepay.  Year 1 of loan, the loan has a prepayment of 5% of the loan amount if the loan is paid down or paid off.  Year 2 is 4%.  Year 3 is 3%.  Year 4 is 2% and year 5 is 1%.  After the 5th year of 61 months out, the prepayment penalty drops off.
  • 7 year fixed with 7-6-5-4-3-2-1 Prepay…Year 1 of loan, the loan has a prepayment of 7% of the loan amount if the loan is paid down or paid off.  Year 2 is 6%.  Year 3 is 5% and so on like the 5 year fixed.  There’s also 10 and 15 year fixed loans.

So…Here’s the Million Dollar Question…Why is it so Important in This Market to Not Have a Prepayment Penalty on a Commercial Loan?

Answer…If you have a prepayment penalty on your commercial loan and rates drop, then how is one able to refi without breaking the terms of the loan and paying the prepayment penalty?  There Isn’t.  All you can do is a get a loan with a shorter prepay if one exists.

“Voila”…We have that option and banks like Chase, First Republic, Heritage to name of few don’t!

Last week we had a client with $2m dollar commercial loan that was comparing us to another lender and our rate was .5% higher in rate than the other lender or $650 per month more, but our prepayment on 5 year fixed was a 2-1 and theirs was a 5-4-3-2-1.  On $2 million in loan amount, year 2 (let’s say 18 months out after closing, rates drop) and the client wants to refi.  The client then pays $80k for the prepayment penalty with the other lender.  Our lender charges $20k plus the spread of the monthly payment equal to $650 or $11,700 at the 18th month or $31,700 in total.  The other lender charges the client $80k.  Hmm…$31,700 from our lender or $80,000 from the other lender with the lower rate.  Our option would save the client $48,300.  Again, which option is better?  Which lender should the client use??  Us or them???

See the logic of going with a lesser prepayment even if the rate is higher by a tad?  Having the lesser term or prepay is the logical way to go.  Unfortunately, this client was fixed on one thing…the rate where I was focused on the long term solution…Flexibility and the probability of lower rates and payments in the future, per this report from Morning Star, a publication that definitely is the closest to a crystal ball!

In Closing…

In the world of commercial lending just like residential lending there is more to just making a decision solely on the rate as illustrated above.  If you want our help and sage experience in making the best decision when it comes to choosing a loan product or making a financial decision, please contact us.

Below is a List of What we Do:

BTW...if you’d like to review my current market report, please go here.

All the Best,

101 Loan

Senior Mortgage Advisor

www.101Loan.com

650-465-8957 c  408-377-4123 o  408-608-1921 f

CA DRE #01205444  NMLS #326829

101 Loan – 6090 Hellyer Ave #100, San Jose, CA 95138

Note: Interest rates and loan programs quoted are subject to change without notice or until locked and approved by lender.

Cash Out Refi’s Might Go Away?

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 First and Foremost…
I just read an interesting report on how lenders may eliminate cash out refinances on conforming and jumbo loans. We have seen the “add” for cash-out refinances get super expensive lately.  It appears the Federal Reserve doesn’t want borrowers pulling equity out of their homes.  They feel home values may go down due to the negative impact of Shelter in Place and Covid-19.
For more info, see quote and link below:
 
“Many lenders have eliminated or restricted cash-out refinances, financing for investment properties and some for second homes as well,” Cohn says. “Jumbo lenders have also tightened their guidelines.”
 
https://www.cnet.com/personal-finance/6-things-to-know-about-refinancing-right-now/ 
 
Next…
A listing agent in the east bay recently posted a great Yelp review on the service we provided her. I just love when we can help Realtors and their clients successfully & smoothly close on purchases. 
To view the review, click here: https://www.yelp.com/biz/101-loan-mortgage-san-jose-2  (See Testimonial from Bette dtd. 4/28/2020)
If you’d like the same care, please contact me.
 
Best Regards,
101 Loan
Senior Mortgage Advisor
www.101Loan.com
408-377-4123 o 650-465-8957 c 408-608-1921 f
101 Loan – 14435 C Big Basin Way, Saratoga, CA 95070
101 Loan LLC – CA DRE #01205444  NMLS #326829
Products/Services/Accolades:
1. Residential Financing for Purchases and Refinances on 1 to 4 unit properties.
2. Reverse Mortgage Financing to include Conforming, Jumbo, HELOC Jumbo’s.
3. Commercial & SBA Financing to include Multifamily, Office, Retail and Light Industrial.
4. Access to over 50 banks with over 200 “Five Star” Reviews on Yelp, Google, Facebook and Linkedin.