Real estate returns are often explained with a simple story: raise rents, increase value, exit at a higher price. While intuitive, this narrative overlooks one of the most powerful drivers of real-world investment performance. For many long-term investors, depreciation—not rent growth—is what ultimately determines how much wealth is retained.

This distinction becomes especially important in income-oriented real estate such as workforce housing, where rent growth is constrained by affordability, but depreciation benefits are structural and persistent. Understanding the difference between these two drivers is essential for evaluating returns honestly, particularly on an after-tax basis.

Why Rent Growth Dominates the Narrative

Rent growth is easy to see and easy to model. Higher rents increase net operating income, which increases value under income-based valuation methods. This relationship is mathematically straightforward and visible in year-over-year performance metrics.

Because of this clarity, rent growth tends to dominate marketing materials, underwriting assumptions, and investor conversations. However, what rent growth adds in visibility, it often lacks in reliability. Rent growth is cyclical, market-dependent, and sensitive to macroeconomic conditions, wage growth, supply cycles, and regulatory risk.

In contrast, depreciation is rarely highlighted because it does not change operating performance. It does not increase cash flow or improve headline NOI. Its impact is quieter, but often more durable.

What Depreciation Actually Does to Returns

Depreciation is a non-cash expense that reduces taxable income without reducing economic income. In practical terms, it allows investors to keep more of the cash they already earn. This matters because returns are ultimately realized after taxes, not before them. Two investments with identical pre-tax returns can produce very different outcomes once tax treatment is applied.

Depreciation converts taxable income into tax-deferred income. The investor receives cash today while postponing tax liability into the future, often years later. The time value of money makes this deferral economically meaningful.

A Simple, Verifiable Comparison

Consider two stabilized rental properties with identical purchase prices, leverage, and operating performance. Property A relies on rent growth. It assumes consistent annual rent increases to drive value and returns. Property B assumes modest rent growth but benefits from significant depreciation deductions due to high building value relative to land.

Before taxes, Property A may appear superior in growth years. After taxes, Property B often retains more cash because a portion of its income is shielded. This is not a theoretical outcome. It is a direct result of how the tax code treats income versus depreciation. Rent growth increases taxable income. Depreciation reduces it.

Rent Growth Is Front-Loaded With Risk

Rent growth is uncertain by nature. It depends on tenant ability to pay, local supply dynamics, and broader economic conditions. During expansions, rent growth can be strong. During downturns, it can flatten or reverse. Because valuation is tied to income, rent growth assumptions compound risk. If growth underperforms, both cash flow and exit value are affected. This double exposure makes rent growth a volatile return driver.

Depreciation, by contrast, is known at acquisition. The depreciation schedule is determined by purchase price, allocation, and tax law. While tax policy can change, depreciation does not depend on tenant behavior or market cycles.

Why Workforce Housing Highlights This Difference

Workforce housing provides a clear case study in depreciation versus rent growth.

Rents are constrained by affordability. Operators cannot push rents aggressively without risking occupancy. As a result, rent growth is steady but modest. If an investor underwrites workforce housing assuming outsized rent growth, they are misunderstanding the asset. However, workforce housing often has high building value, older construction, and significant depreciable components. This creates strong depreciation efficiency.

In this context, depreciation often contributes more to after-tax returns than incremental rent growth. Investors who recognize this tend to underwrite more conservatively on income and more accurately on net outcomes.

After-Tax IRR Tells a Different Story

Internal rate of return is often quoted on a pre-tax basis. This can materially misrepresent performance. When after-tax IRR is calculated, depreciation frequently shifts rankings between deals. Investments with lower pre-tax returns but strong depreciation can outperform higher-growth deals on an after-tax basis.

This is especially true for long-term holds, where tax deferral compounds over time. Rent growth that appears attractive in early projections may be offset by higher annual tax burdens.

Depreciation Works Even When Rent Growth Stalls

One of the most underappreciated aspects of depreciation is that it continues to operate even when rent growth pauses. During periods of economic stress, rent growth may slow or stop. Depreciation does not. It continues to reduce taxable income year after year, cushioning after-tax returns during flat operating periods.

This stabilizing effect is one reason depreciation-heavy assets tend to show less volatility in net outcomes across cycles.

The Role of Depreciation Recapture in the Equation

Depreciation is not tax elimination. It is tax deferral. At sale, a portion of depreciation may be recaptured. However, recapture does not negate the benefit. Taxes are paid later, often at different rates, and after years of capital compounding. The net present value of deferred taxes is typically positive.

Rent growth, by contrast, is taxed as it occurs. There is no deferral benefit. Each dollar of increased income increases current tax liability.

Why Institutional Investors Focus on Depreciation Efficiency

Institutional investors evaluate assets on a risk-adjusted, after-tax basis. They understand that volatile rent growth can inflate headline returns while increasing downside exposure. Depreciation improves predictability. It reduces reliance on aggressive assumptions and enhances capital efficiency without increasing operational risk.

This is why depreciation-heavy strategies such as workforce housing, core multifamily, and long-duration real assets are favored in institutional portfolios.

Common Investor Mistakes

One common mistake is treating rent growth as the primary value driver while ignoring tax structure. Another is dismissing depreciation because it does not increase cash flow.

Both mistakes stem from evaluating investments on a pre-tax, short-term basis rather than a long-term, after-tax one. Returns are not defined by what the property earns. They are defined by what the investor keeps.

Conclusion: The Quiet Driver Usually Wins

Rent growth is visible, exciting, and easy to model. Depreciation is quiet, technical, and often overlooked. But when returns are measured honestly—after taxes and across full holding periods—depreciation often plays a larger role in wealth creation than incremental rent increases.

For investors focused on durability, predictability, and retained capital, depreciation is not a secondary benefit. It is one of the primary engines of real estate returns.