How Does the 80-20 Rule Apply to Real Estate Investing?

A graph shows the 80-20 rule.

The 80-20 rule is also known as Pareto’s Rule, Pareto’s Principle, the law of the vital few or the principle of factor sparsity. The rule, applicable in many financial, commercial, and social contexts, states that 80% of consequences come from 20% of causes.

For example, many researchers have found that:

  • 80% of real estate deals are closed by 20% of the real estate teams.
  • 80% of the world’s wealth was controlled by 20% of the population.
  • 80% of a typical business’s revenue comes from 20% of its clients.

The 80-20 rule reflects the unequal distribution of outputs and can be used to determine the best way to focus efforts. However, it’s important to note that the rule is not a mathematical concept and doesn’t apply in every situation.

The Origins of the 80-20 Rule

In the early 20th century, Italian economist Vilfredo Pareto was the first to describe the 80-20 rule. During this time, the distribution of wealth in Italy was a cause for concern. Pareto noticed that 20% of the Italian citizens owned 80% of Italian real estate. As he examined real estate ownership in other countries, he discovered a similar pattern.

Later, Dr. Joseph Juran, an operation management expert, examined the law and found that it applied to various business and productivity contexts. Applying the rule to business production, he demonstrated that 20% of the problems in production methods were responsible for 80% of the defects in products. He then postulated that if 20% of the problems identified were addressed, the overall production could be increased.

A Closer Look at Pareto’s Principle

Although often misinterpreted and misrepresented, the 80-20 rule has nothing to do with mathematics. Some people have tried to make mathematical arguments about the rule — especially after considering that 80% + 20% equals 100% — but inputs and outputs are two different values. The cumulative value of input and output doesn’t need to equal 100.

Also, the 80-20 rule doesn’t apply in every case. Sometimes, the ratio may be 95/5, 70/30 or something else entirely. The main point is to know such disparities exist and to think of how to use that information wisely.

However, the 80-20 rule is an invitation to examine where the highest profits or losses, productivity or lack of it and resources are being deployed.

When the 80-20 rule is used in businesses, it is easy to identify what works and what doesn’t. For example, if 80% of your profits come from 20% of your real estate investments, then you should focus on that investment type.

The 80-20 rule in real estate investments can help you identify your most valuable clients or partners. It can help you determine where you should concentrate efforts and where divesting might be the best plan.

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