The Rule of 72 serves as an important indicator of cash flow. It’s useful for investors who want to know how much time they need to break even.
In multifamily investing, it’s essential that you get a higher return for the initial amount you invested. Seeing that multifamily properties provide a higher rate of return in the form of passive income, you may want to know the number of years it usually takes for your money to double.
We may have to use a bit of math here. If you’re not fond of numbers, don’t worry. The rule is very simple to understand.
How the rule works
First of all, the Rule of 72 allows you to calculate the number of years needed to get a 100% return on your investment. Let’s start with the basis for this rule. Supposing the rate of return is pegged at 24%, it will take only 3 years to double the amount of your investment. If we are to express this into an equation, it would look like this:
24% rate of return X 3 years = 72
From this, we now have the number 72 to serve as our base. We can use this number to determine the number of years it would take to double your investment. Since 24% is a less realistic number, to begin with, let’s use an actual number for real estate investing.
Let’s say you’ve invested in a multifamily property with a rate of return of 8%. Using the number 72 as our base, we simply divide 72 by 8, as expressed by this equation:
72 / 8% rate of return = 9 years
The equation yields the number 9, which is the number of years it would take for your investment to double. That simple!
Of course, if the rate of return is higher, the Rule of 72 will produce a time period that’s shorter. Eventually, we can assume that the best way to double an investment faster is to focus on the rate of return on a property.
What’s a more accurate process?
For me, one of the best ways to determine the rate of return is through the capitalization rate or cap rate. This metric gives us a good glimpse of the profitability of a multifamily property. The cap rate takes the net operating income (NOI) of the property and divides it by the purchase price. The higher the NOI, the lower the cap rate will be.
In this sense, if you want your cap rate to decrease and double your investment faster, it’s important to increase the income you can generate from your property. For this, you can use value plays that work towards increasing the value of the property through renovation projects. Moreover, you can set value-adding components such as parking fees and an automated laundry service, which can also help you increase the property’s income.
Once you have enhanced your cash flow through these strategies, the Rule of 72 will give you an improved time frame for getting a good return on your investment.