Investing in Real Estate, Rule of 72

If real estate prices increase at the same pace as inflation (aprox 3%), then leveraging a property is sure to make you money in the long run.

Rule of 72: A rule stating that in order to find the number of years required to double your money at a given interest rate, you divide the compound return into 72. The result is the approximate number of years that it will take for your investment to double.

Rule of 72 (Investopedia.com)

So, if we divide 72 by the rate of inflation (3%), we get 24 or (72 ÷ 3 = 24).

Formula: 72 ÷ % = Years
72 (the rule) divided by x% (rate of return) = the number of years for value to double

This means that a house will double in value in (aprox) 24 years due to inflation alone. I know this doesn't sound too enticing but when we leverage, it changes everything.

If you buy a house for $100,000 and put down 25% with a 75% mortgage (leveraging) our rate of return changes drastically. In 24 years your house will be worth $200,000 but the return on the investment will be 4 times your initial investment of $25,000 (or $100,000).

Since the return will be 4 times greater, we then divide the 24 years by 4 to see that our investment will actually double in just 6 years (24 ÷ 4 = 6). Going back to Rule 72, we divide 72 by the number of years and you'll see that our rate of return will be 12% (72 ÷ 6 = 12).

By leveraging, at inflation levels alone, we get 12% returns.

If you're not impressed with a 12% return, think about the rate of return you get from your bank (much lower I'm sure).

What if real estate increases at a higher rate than inflation? Let's take a conservative number like 7.2% (it works well with Rule 72 and I beleive it is fairly close to historical rates). This will cause real estate to double in 10 years which will give you a rate of return (based on same percentages as above) of 400% (or 25% annually) on your intitial investment.

Use Rule of 72 to calculate returns on potential investment property. Keep in mind that when a property doubles in value (aprox 10 years), it is the entire property that has doubled (not just your cash investment). So if your down payment is only 10% with a 7.2% annual increase in real estate? Your return would be 100% per year on your initial investment.

You think this can't happen? What would you think if I told you that I bought an investment property at the height of the real estate market (November of 2005) and my returns have been 100% annually on my inititial investment for the first 2 years (with a 25% down)?