The price-to-earnings (PE) ratio for investment real estate varies depending upon the class and type of property being evaluated. Real estate investors typically capture the relationship between net income and value by determining a cap rate, which is calculated as net income over value.
A cap rate can be easily converted to a PE ratio. If investors know the appropriate cap rate for a property, they can convert it into a PE ratio by taking the following steps:
Step 1: Multiple the Cap Rate by 100
Step 2: Divide 100 by the result from Step 1.
The result from Step 2 equals the PE ratio for the property.
Let’s take a simple example. Suppose the net income for a property, typically referred to as the net operating income (NOI), is $80,000 per year and the value is $1,000,000. The cap rate in this example would be 8 percent. Multiplying 8 percent by 100 equals 8, and 100 divided by 8 equals 12.5, which is the PE ratio.
The steps above can also be expressed as:
PE Ratio = 100 / (Cap Rate * 100)
By converting cap rates into PE ratios, investors can more easily compare stock and real estate investments. On average, the PE ratio for stocks has been somewhere around 14 to 16.
It takes just four minutes