⚠️ DANGER: Some Math Ahead
If you don’t understand it, don’t invest in it. Whether it’s stocks, real estate, or anything else — if you can’t analyze it properly, you’re gambling, not investing. Learn the math first, then put your money to work.
I have three sets of friends: those who invest in real estate, those who invest in stocks, and those who throw their chips on the table with Bitcoin. Bitcoin is another story entirely, so let’s leave that dragon sleeping for now.
Between stocks and real estate, one of the most useful ways to compare them is the P/E ratio — price-to-earnings. Think of it as a score for how many dollars of price you pay for each dollar of profit. The lower the P/E, the quicker you get your money back.
P/E in Stocks
On Wall Street, the price-to-earnings ratio (P/E) is the ruler everyone uses. If a company trades at a P/E of 10, it means the price you pay equals ten years of current earnings. A P/E of 20 means twenty years.
- Low P/E → the stock “pays you back” faster, but may be cheap for a reason.
- High P/E → you’re betting on growth, and sometimes betting against gravity.
It’s not complicated: P/E = Price ÷ Earnings per share.
P/E in Real Estate
Real estate has the same logic, just different words. A rental property has a price and it generates earnings (rent minus expenses).
- Property price = $300,000
- Rent = $3,000/month = $36,000/year
- Expenses (taxes, insurance, upkeep, vacancies) ≈ 30% = $10,800
- Net Operating Income (NOI) ≈ $25,200
Now do the math:
- Gross P/E = 300,000 ÷ 36,000 ≈ 8.3 (like Gross Rent Multiplier).
- Net P/E = 300,000 ÷ 25,200 ≈ 11.9.
- Cap Rate = NOI ÷ Price = 25,200 ÷ 300,000 = 8.4% (the real estate way of saying earnings yield).
So this $300,000 rental is like owning a stock with a P/E of ~12. This property follows the 1% rule, see below for an explanation of this very important concepts.
Option 1: All Cash – The Steady Play
Buy the property outright. No banks, no leverage, no worries.
- You earn about 8.4% per year on your money.
- Equivalent to owning a solid stock at P/E 12.
- Safe, steady, but it ties up $300,000 in cash.
Option 2: With a Mortgage – The Leverage Game
Now let’s stir in some debt. Put down $50,000, borrow $250,000. Suddenly, your return doesn’t just depend on the property, but on the gap between rent and mortgage.
| Mortgage ($/mo) | Cash Flow After Debt | Property P/E | Equity P/E | Equity Yield |
|---|---|---|---|---|
| $1,500 | $7,200 profit | 11.9 | ~7 | 14.4% |
| $2,000 | $1,200 profit | 11.9 | ~42 | 2.4% |
| $2,500 | –$4,800 loss | 11.9 | Negative | Negative |
- At $1,500/mo, leverage makes you a winner: 14% return on just $50k down.
- At $2,000/mo, leverage squeezes your gain to almost nothing.
- At $2,500/mo, leverage flips you upside down: you’re losing money every month.
This is the heart of leverage: it magnifies the good, and it magnifies the bad.
Option 3: Skip the House – Buy the Stock
Now imagine you take that same $50,000 and buy a boring stock with the same valuation — P/E of 12 (earnings yield 8.4%).
- Annual return = $50,000 × 8.4% = $4,200/year.
- No tenants, no repairs, no mortgage man.
- You earn exactly what the property itself earns, without the roller coaster of leverage.
The Bottom Line
- Option 1 (all-cash property): 8.4% yield, P/E ~12. Safe, steady, but capital-heavy.
- Option 2 (mortgaged property): With leverage, you can turn that into a 14% winner — or a bleeding loss — depending on the mortgage.
- Option 3 (stock investment): Same P/E, same yield, but no leverage and no headaches.
Leverage is the dividing line. It’s the difference between a calm walk in the park and running with a rocket strapped to your back. You’ll go farther, faster, but the crash can be just as spectacular.
Whether you’re talking about stocks or real estate, the truth is the same: your P/E is the clock ticking on your investment, but leverage is the wind that decides whether that clock runs fast, slow, or shatters in your hands.
One final comment, if your Investment has a PE of 0 or negative run. You can’t count on growth to bail you out of what is coming, you are going to drown without some positive cash flow. Cash flow going forward is were it is at.
No one can afford losers right now or promises in the dark, just remember Pat Benatar every time you want to buy some junk or overpriced stock or real estate, Listen to the song it is quite good.
EXTRA CREDIT: The 1% Rule in Real Estate
The 1% rule is a quick-and-dirty test investors use to screen rental properties. It says:
👉 The monthly rent should be at least 1% of the property’s purchase price.
Example 1: Property that meets the 1% rule
- Property price = $200,000
- 1% of $200,000 = $2,000
- If the property rents for $2,000/month (or more), it passes the 1% rule.
Example 2: Property that fails the 1% rule
- Property price = $300,000
- 1% of $300,000 = $3,000
- If the rent is only $2,000/month, it fails the 1% test.
Why it matters
The 1% rule isn’t a guarantee of profitability — it’s a screening shortcut. If rent is less than 1% of the purchase price, chances are expenses, taxes, insurance, and financing costs will eat away too much of the return.
- Passes 1% rule → Worth a deeper look, may cash flow even with expenses and a mortgage.
- Fails 1% rule → Likely won’t cash flow, unless rents rise or you buy at a discount.
Relation to P/E and Cap Rate
The 1% rule is basically another way to think about P/E in real estate:
- If a $300,000 property rents for $3,000/month ($36,000/year), the Gross Rent Multiplier is 8.3 (like a P/E of 8.3). That’s usually healthy.
- If it rents for only $2,000/month ($24,000/year), the Gross Rent Multiplier jumps to 12.5 — closer to a P/E of 12.5 before expenses, which means thinner margins.
So the 1% rule is just a shortcut to spot whether the P/E (or cap rate) is in the ballpark for a solid investment.
The Rule of 72
The Rule of 72 is a simple formula to estimate how long it takes for an investment to double given a fixed annual rate of return.
Example 1: Stock Market Average (≈ 8%)
- Return = 8% per year
- Years to double = 72 ÷ 8 = 9 years
So if you earn 8% annually, your money doubles in about 9 years.
Example 2: High-Yield Investment (12%)
- Return = 12% per year
- Years to double = 72 ÷ 12 = 6 years
Example 3: Savings Account (2%)
- Return = 2% per year
- Years to double = 72 ÷ 2 = 36 years
That’s why parking cash in low-interest accounts barely grows.
Why It Works
It’s an approximation derived from compound interest math. The exact formula involves logarithms, but 72 is close enough for most practical uses, especially between 6%–10% returns.
- At higher or lower rates, it drifts a little, but it’s still good for back-of-the-envelope estimates.
How It Relates to Real Estate & P/E
- If your rental property earns an 8.4% cap rate, the Rule of 72 says your money doubles in about 8.5 years.
- If you have a stock with an earnings yield of 5% (P/E of 20), your money doubles in about 14 years.
So the Rule of 72 is really the time version of P/E and yield thinking.
⚠️ Takeaway: The Rule of 72 is a quick way to ask: “If I just sit here, how long until my money doubles?” If the answer is longer than you’re willing to wait, you either need higher returns, or you’re in the wrong investment. None of us will outlive Warren Buffet so plan accordingly.
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