Have you heard of the Rule of 72?
It’s a quick and simple way to quickly calculate a rough idea of how long it will take your dollars invested in a duplex, stock, or anything else to double in value given the investment’s rate of return.
For example, if you have money in the stock market, and it’s earning an average rate of return of 8 percent, it will take 9 years for your money to double. 72/8 percent = 9 years.
Does it work for real estate too?
The trouble with real estate however, is there are so many rates of return you can use to calculate your doubling time! (This is a good thing.)
First, remember the money you have invested in the property (down payment) is what the calculation of the return is based on.
Let’s say your down payment on a $100,000 property was $20,000. After expenses and your mortgage, your annual positive cash flow is $1600, which gives you a cash on cash rate of retun of 8 percent. Using the Rule of 72, we divide 72 by 8, which gives you approximately 9 years for it to double.
How about if you add all the benefits of investing in real estatate and divide it by your down payment?
As a reminder, those are cash flow, principal paydown, tax savings and appreciation. While I never count on or calculate appreciation, let’s say in this case you get an annual rate of 2 percent.
Using just made up numbers, let’s say you get $2000 in appreciation, $2000 in cash flow, pay off $1200 worth of the loan and save $500 on your taxes. In all, your $20,000 investment generates $5700 in benefits. That is the equivalent of a 28.5 percent overall rate of return. Take 72 and divide it by 28.5 and you get your total investment back out of the property in 2.6 years.
Yes, I realize the math doesn’t work exactly. However, the Rule of 72, isn’t meant to be scientific or precise. Rather, it’s meant as a way for you to get a bird’s eye view of how fast you will get your money back out.
And two or even three years in real estate to be made whole is faster than eight or nine years in stock.
As great as this rule is, one thing about the Rule of 72 has always puzzled me.
Who had enough time to figure it out anyway?