“He who understands it, earns it. He who doesn’t, Pays it!”
Understanding the Rule of 72 and 2 can be invaluable in property investment. The Rule of 72 is a quick calculation to estimate how long it takes for an investment to double in value based on a fixed annual growth rate. Divide 72 by the annual growth rate to get an approximate doubling time.
The Rule of 72 works best in the 5 to 12 % range, but it’s still an approximation and doesn’t consider inflation, market change and other variables.
A real property example is a $345,000 unit purchase price with 2% annual growth. 72/2 = 36 years to double. Too long.
Property sales consultants, strategists or property specialists use this Rule with an imaginary annual growth rate. Most books, brochures and sale pitches are calculated based on 5% growth, which can work on powerful properties but not on a high-risk product sale, off-the-plan units or other average products in an oversupplied area and the wrong asset class or property configuration!
This property, for instance, was bought almost 12 years ago for $345,000 with 5% growth on average on the marketing materials 72/5 = 14.4 years.
This property, around 2025-2026, will double in value.
In this specific case, in one of the oversupplied suburbs in Brisbane, 5% growth was a fiction. The property didn’t grow an inch. It decreased in value and is now around $250,000-$280,000. I doubt it will double soon.
Interest rates can replace the growth rate in the formula, but it’s the same.
72/ 6% interest rate = 12 years to double the $345,000 investment
If we calculate based on the interest rate and, in this example, only on the money invested:
e.g. 345,000 x 20% (Deposit) = $69,000 invested capital (exclude stamp duty, lawyers fee, reno miscellaneous etc.)
12 years so far…
Interest rates: 6%
72 / 6 = 12
12 years to double – $69,000 to $138,000.
As mentioned above, if the property is worth 280k sale price or even 300k by the Bank valuer, we are already in a loss of $45,000.
Even if we say that the interest rate was at 4% on average – 72/4 = 18 (although it started in the 7%~ and went down gradually and met the 7% again this year)
It means that in the next six years, up to 18, the property should grow at a fast pace to $138,000 + $45,000 (current loss) and, in total, $183,000.
If we exaggerate and we project that this unit will be worth $500,000 in 5 years, we will still be at a loss of a few 10’s of thousands.
The Rule of 72 works well with low-risk properties, second-hand with a land component on a good socio-economic location!
Beside the Rule, make sure you buy well!
“Hewhounderstands it, earns it. He who doesn’t, Pays it”
In real estate rental assessment, the “Rule of 2” refers to a simple guideline for evaluating the profitability of a potential rental property. According to this Rule, the property’s gross monthly rental income should ideally be at least 2% of the property’s purchase price. For instance, if a property costs $200,000 to buy, the monthly rental income should be around $4,000 (2% of $200,000) to meet this guideline. This Rule helps investors quickly assess whether a property has the potential to generate sufficient rental income compared to its cost.
This prudent approach ensures that the investment remains financially viable over the long term and safeguards against potential downturns in the rental market.
Marketers and investment firms generally use an annual 4-5% rental yield as a sale pitch.
For instance, based on actual numbers in major city locations:
$18,000 annual rent divided by $345,000 purchase price = 5.2% rental yield. (The past two years with significant interest rate increases and COVID rent discount, adding to that rental increase is insignificant.)
Bear in mind that this is gross rent!
The NI (Net income) is $1000 a year, approximately $1000/$345,000 = 0.2%.
0.2% is a meagre yield, and usually, it has negative cash flow. In this case (loss of 5k) -$5000/345,000 = -1.4%
This Rule is suitable for assessment, but sales ads work with gross rental yield usually 4-5% and recently even 6-7%, But consider that it’s gross only.
Operation profit-wise is relatively poor but still positive cash.
$8,000 operation profit / $345,000 = 2.3% (Still work), but with mortgage cost, all the profit became negative and the Rule of 2 doesn’t work!
Negative gearing, which many marketers and consultants pitch these days to become positive after Tax, is not a solution either and doesn’t offset enough after half of the property cycle (around five years).
The tax element is essential but isn’t significant unless we invest well!
Those rules play well in a sale pitch, ads and marketing brochures,please be very cautious about which real estate product you add to yourportfolio and if potential growth or rental income is most likely to occur.
“Hewhounderstands it, earns it. He who doesn’t, Pays it”
