What is the rule of 69?

realized1031.com - What Is the Rule of 69 Percent In Real Estate Investing? - Realized 1031

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Investors love to employ rules to help them predict outcomes. For example, there is a one percent rule (a one percent increase in interest rates equates to ten percent less you can borrow to keep the same payment) and a two percent rule (the percentage of a home’s cost that you should be asking for in monthly rent) and more. Some of these rules can help estimate potential results, but others are outdated or possibly never really held much value.

What Is the 69 Percent Rule?

The Rule of 69 is a simple calculation to estimate the time needed for an investment to double if you know the interest rate and if the interest is compound. For example, if a real estate investor can earn twenty percent on an investment, they divide 69 by the 20 percent return and add 0.35 to the result. In this example, the double in value would require 3.8 years. For simplicity’s sake, many investors use the 72 rule instead because you can leave off the .35. Instead, you divide 72 by the rate of return. For example, if the return is ten percent, the Rule of 72 would suggest that the value of the investment will double in 7.2 years.

Do These Rules Make Sense?

These calculations provide a simple back-of-the-envelope formula to forecast doubling time if you invest in something with a fixed return. However, real life doesn't always follow simple recipes. For example, since the Rule of 69 percent relies on compounding, it may not be accurate. That’s because a lower appreciation early in the forecast period will continue to hold down the total gains by reducing the denominator. Here’s an example: Suppose that Joe buys a property and expects a 20 percent return. The Rule of 69 states that the investment would double in 3.8 years. However, if values drop initially, the investment needs to catch up before the compounding can start to increase the value, which will lengthen the timeline.

Appreciation Isn’t Guaranteed

Whether a real estate investment grows in value quickly, slowly, or not at all depends on factors not within the investor's control. Overall economic conditions like inflation and unemployment are significant, as are supply and demand. As with any investment, there is a risk that value will drop rather than increase. Investors should examine their risk tolerance and appetite when deciding whether to purchase a specific property. "Rules" can help as shortcuts for estimating possible growth but can't substitute for due diligence or guarantee outcomes.

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Does the rule of 72 always work?

The Rule of 72 works best in the range of 5 to 12 percent, but it's still an approximation. To calculate based on a lower interest rate, like 2 percent, drop the 72 to 71; to calculate based on a higher interest rate, add one to 72 for every three percentage point increase.

bankrate.com - Rule Of 72: What It Is And How To Use it | Bankrate

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