As a real estate investor, you should know some rules of thumb to be able to do quick evaluations when analyzing potential investments. One of the most widely used rules of thumb among real estate investors – regardless of their real estate investment strategy – is the “Rule of 72”.
What exactly is the rule of 72? How does it work? When would I need to use it in real estate? Keep reading to find out the answers to all these questions.
What Is the Rule of 72?
The rule of 72 is a simple way to find out how long an investment will take to double in value given a fixed annual interest rate or rate of return. It is a helpful mathematical shortcut in investing as the full-length equation for compounding interest is very complicated and usually requires a calculator. Investors can, therefore, use the rule of 72 to get a quick and decent estimate of an investment’s doubling time without having to do any fancy or complex math.
How the Rule of 72 Works
To use the rule of 72, all you have to do is divide 72 by the annual interest rate or rate of return on your investment. The result you get is the approximate number of years it would take for your invested money to double in value.
Here’s what the rule of 72 formula looks like:
Years it would take to double your money = 72 / Annual Rate of Return
Let’s illustrate the rule of 72 with an example. Say you invest $100,000 in real estate which brings you an 8% return annually and you want to know how long it will take to double your money. Plugging in the rate of return into the formula gives you:
Years it would take to double your money = 72 / 8 = 9 years
According to the rule of 72, it will take approximately 9 years for your initial investment to reach $200,000 at the return rate of 8%.
Note: When using the rule of 72, you do not divide the percentage rate of return by 100 as you would normally do when calculating with percentages, i.e. the 8% return rate in our example is entered as 8 and not 0.08.
Rule of 72 in Reverse
The rule of 72 can also be used in reverse. A real estate investor who wishes to double their investment in a certain amount of time could use the rule to determine the rate of return they would have to receive in order to achieve their goal. In this case, the divisor and the quotient in the rule of 72 would have to be flipped so that the formula would look like this:
Annual Rate of Return Required = 72 / Years to double your money
For example, let’s say you wish to double your money in 6 years. What rate of return would you need to earn in order to reach your goal? Simply divide 72 by 6:
Annual Rate of Return Required = 72 / 6 = 12%
According to the rule of 72, doubling your money in 6 years will require an annual rate of return of about 12%.
When Would You Need to Use the Rule of 72 in Real Estate?
Comparing Investment Options
Real estate investors use the rule of 72 when comparing different real estate investment options. The rule can help them figure out which investment will help them grow their money quicker. For example, suppose you are deciding between Investment A which is expected to bring you an 8% return and Investment B with an expected return of 15%. With Investment A, your money will double about every 9 years: so, if you invest $100,000 in 2020 with an 8% return, you will have $200,000 in 2029, $400,000 in 2038, and $800,000 in 2047. As for Investment B, your money will double about every 5 years: so, if you invest $100,000 in 2020 with a 15% return, you will have $200,000 in 2025, $400,000 in 2030, and $800,000 in 2035. That’s 12 years sooner than Investment A. In this case, it is worth pursuing Investment B as it will help you grow your money quicker.
Real estate investors also use the rule of 72 when planning for their retirement. It helps them get an idea of how their savings might grow in the future. For example, let’s say you are 45 years old and have a goal to retire by 63 – i.e. in 18 years. If you currently have $400,000 in savings and expect an 8% annual return on your investments, you would expect your savings to grow to $1,600,000 at retirement – doubling twice over 18 years. That’s because, per the rule of 72, it should take you 9 years to double your money at a return rate of 8%. So ideally, your savings should double to $800,000 by the age of 54 (in 9 years), and then to $1,600,000 by the age of 63 (in 18 years). The rule of 72 gives you a good idea of what you’re going to need to retire early.
Related: Our Guide to Real Estate Investing for an Early Retirement
As you can see, in most cases, using the rule of 72 in real estate entails you to know the rate of return on investment. How can you calculate the rate of return on a real estate investment? Well, you could use the simple formula:
Rate of Return = (Gain from Investment – Cost of Investment) / Cost of Investment
Your gains from the investment would include any revenue you have earned from your investment (e.g. rental income, equity, etc.) while your costs would include any expenses you pay that go directly into the investment (e.g. mortgage payments, maintenance costs, etc.).
Related: How Do You Calculate Rate of Return on Investment in Real Estate?
If you’re considering investing in rental properties and looking for a quick and effective way to calculate the rate of return on potential investments, you can use Mashvisor’s investment property calculator. It provides accurate projections of return on investment metrics (such as cap rate and cash on cash return) for rental properties for sale across the US. It’s a must-have tool if you’re looking to make money in real estate.
Related: Using Mashvisor’s Investment Property Calculator to Estimate Rate of Return
You now know what the rule of 72 is, how it works, and how you could use it when you invest in real estate. Keep in mind, however, that it provides a close approximation of an investment’s doubling time, not the exact value. Moreover, it’s worth mentioning that the rule of 72 works best with lower rates of return. Once the rate of return becomes higher than 15%, the rule becomes increasingly inaccurate.