When you’re crunching numbers on your rental home, there are a lot of ‘rules’ and shortcuts that can help determine the value of your investment. The ‘Rule of 72’ is one of them, which we’re going to cover in this explainer.
What is the Rule of 72?
The Rule of 72 is a simple formula that is used to estimate the time it takes for an investment to double in value, based on a fixed annual rate of return. It is more commonly used to determine compound interest, but it can be used in real estate too.
How to apply the Rule of 72 to a rental property:
1. Identify your annual rate of return
While rental returns can fluctuate and change depending on things like expenses, debt and vacancies, start with a cash flow analysis to determine the average annual rate of return you expect to earn from your rental home from income. This can also include factors that add to your overall profit such as property appreciation and tax benefits. It should be a single number without any decimal places, such as 8%.
2. Divide 72 by your number
Once you have an estimated rate of return, divide 72 by this number. The result will be the number of years it takes for your investment to double in value.
For example, if you expect an annual rate of return of 8% from your real estate investment:
72 / 8 = 9
According to the Rule of 72, it would take approximately 9 years for your investment in real estate to double in value, assuming an 8% annual return. If your annual return was 3%, that number would increase to 24 years. The Rule of 72 is a simplified estimate and may not be perfectly accurate, but it can provide a quick and easy way to consider potential growth of an investment or rental property.
Rule of 72 limitations
The Rule of 72 is typically used for interest rates and has limitations that rental homeowners should be aware of. For starters, this simple formula works best when your annual rate of return sits between 6 - 10%. If it exceeds 15%, it will no longer provide an accurate estimate.
There is also a “Rule of 69.3”, which is used in the same way by replacing 72 with 69.3. In most cases the Rule of 72 is more easily divisible and understood, however the Rule of 69.3 may be more accurate.
Of course, the biggest drawback of this calculation is that it assumes your annual rate of return won’t change. In reality, the appreciation of your home is subject to current market conditions — as is the amount you can charge for rent. There’s also the condition of your home and the potential for expenses to fluctuate or vacancies to occur.
Ultimately, the Rule of 72 only provides an estimate, and rental property owners should consider other financial metrics when they make investment decisions.
How does the Rule of 72 apply to rental homes?
The Rule of 72 is best used as an estimating tool in evaluating potential investment properties. You can also use it to estimate the return on your investment for your current rental property.
For example, suppose you have a real estate investment property valued at $100,000, and that property has an 8% annual return. In that case, you can estimate that your initial investment will take nine years to reach $200,000.
This could be useful when comparing two homes or planning for the growth of your investment portfolio. If you’re planning to invest in capital improvements, you may also look at how quickly you could expect to make your money back by projecting your predicted rate of return.
Rule of 72 during inflation
Recent years have seen high rates of inflation, which can also impact your purchasing power. If for example, the inflation rate is around 8% (as it was in 2022), dividing 72 by the rate of inflation shows that in 9 years, the purchasing power of your money will be reduced by 50%. This could help make decisions about when to buy as the cost of living increases. Again, not a perfect calculation however as inflation fluctuates and is not always as high as recent years.
Simplify how your rental home makes money
Simple math is one thing, but Belong prefers to simplify the entire renting experience. Whether you’re new to the real estate investing game, dealing with a problematic property management company or burnt out chasing rent every month, Belong can help.
Our smarter, future-ready services include:
- Guaranteed rent every month, regardless of if or when your residents pay
- Optimized rental pricing that uses technology and real-time demand to price your home with accuracy
- The Belong app that gives you and your residents access to everything you need
- Innovative financial products including the option to spread maintenance payments over the term of your lease agreement
- Access to dedicated landlords insurance to protect your asset (as well as coverage for your residents)
- Integration with the most popular rental platforms to get your home loved faster
- Instant access to an expansive vendor network of over 10,000 professionals that can handle everything from routine repairs to home upgrades
…and we’re just getting started! Belong is simplifying the rental experience across the US and helping more homeowners reach their financial goals with the most hassle-free property management service; Belong PRO.
Visit our local pages to learn more:
- Seattle Property Management
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Disclaimer: It’s important to consult with a professional and consider your personal circ*mstances before making any decision on finances or investments. This article provides a simple formula to a complex calculation and should not be considered financial advice.
