Rule of Thirds
There are various different “rules of thirds” in business. If you google “rule of thirds”, you will see numerous answers, which are different for each type of business. Let’s discuss the “rule of thirds” in regards to business profitably. If you are a law firm, the thirds are wages, overheads, and partner profit. We aren’t discussing law firms, though. If you are running a self-storage facility, those thirds are expenses, debt, and profit.
Let’s define the calculation and each of its parts.
GPR
First, we start with Gross Potential Rent (GPR). This is the amount of money you would receive annually if all of your units were rented at the full rate. We all know that is not reality- all of the units are not rented at the full rate 100% of the time. This is why it’s called Gross Potential Rent.
Expenses and Vacancy
Now we look at the expenses and vacancy. The combination of these two should be about one third of GPR. This includes any money you spend on advertising and marketing, repairs and maintenance, utilities, office supplies, payroll, management fees, taxes, insurance, water/sewer, and any other miscellaneous expenses. This also includes vacancy, which can be calculated as a percentage, based on the occupancy rates for that property in years past. Since we are subtracting this from the GPR as an annualized figure, the expenses and vacancy should also be annualized amounts.
Debt
Next, we look at debt service. This is the amount you pay to the bank that services your loan, including principal and interest. Similar to the expenses above, this should also be an annual figure for accurate comparison. This number should also be about one third of GPR.
Profit
That leaves the final third, which would be your profit. In short, one third of your revenues should result in profit. Starting with this guideline, you can make adjustments as needed to reduce one of the thirds to increase the other. If you reduce expenses by 6% and keep debt service steady, then your net cash flow should increase by 6%. It also works within each category/third. If you increase advertising and marketing by 10%, then you need to reduce vacancy or another expense by 10% to keep the balance.
In Conclusion
Obviously, this is a quick and dirty calculation, but it’s a good rule of thumb to use to evaluate your business. Keeping the rule of thirds in mind and following this guideline will certainly keep the business profitable.