An Investor’s Guide To The Price-To-Rent Ratio
By Than Merrill
Traditional price-to-rent ratio calculations are an incredibly valuable tool for comparing the affordability of buying to renting in a single location. As a result, uncovering the price-to-rent ratio by city may help investors choose which locations suit their investing needs the best. Understanding where it’s more affordable to buy and rent is an invaluable metric investors can use to formulate a sound exit strategy. That said, it may literally pay to learn how to calculate a city’s price-to-rent ratio. If you are interested in learning how to calculate the price-to-rent ratio of a city, or simply need a refresher, place reference the following guide.
How To Calculate Price-To-Rent Ratio
The price-to-rent ratio is a calculation used to determine whether it is cheaper to buy or rent in a respective city; it estimates the relative affordability of renting and buying. In its simplest form, however, the price-to-rent ratio is nothing more than a calculation involving no more than two variables. By dividing the average property sales price by the average annual rent price, prospective buyers and renters will be given a number that fits within one of three distinct ranges:
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If the resulting number is equal to or below 15, it’s better to buy a house than rent one.
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If the resulting number is somewhere between 16 and 20, it’s most likely better to rent than buy.
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If the resulting number is equal to or above 21, it’s definitely better to rent a house than to buy one.
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Price-To-Rent Ratio Formula
The formula used to calculate the price-to-rent ratio only needs two variables: the average property sales price and the average annual rent price. Once each variable has been accounted for, simply put them in their corresponding positions in the following equation:
Price-To-Rent Ratio = Average Property Sales Price/Average Annual Rent Price
Remember, the resulting number is meaningless unless it is placed in the appropriate context. Therefore, you’ll need to take the answer you get and apply it to the previously discussed ranges.
Price-To-Rent Ratio By City
The price-to-rent ratio is traditionally used by people who aren’t quite sure of which option makes the most financial sense: renting or buying. If for nothing else, the price-to-rent ratio is the easiest way to choose the most affordable option awarded at the time. However, the price-to-rent ratio isn’t relegated to traditional buyers and renters alone. Investors may use the price-to-rent ratio before adding another asset to their passive income portfolios. Doing so will help them make a more informed decision on impending acquisitions. As a result, it may be in the best interest of today’s investors to familiarize themselves with the cities on each end of the price-to-rent ratio spectrum.
Some Of The Cities With The Highest Price-To-Rent Ratios
Anything on the price-to-rent ratio scale that is 21 or higher suggests it is more affordable to rent in a respective city than to buy. Not surprisingly, cities with high price-to-rent ratios coincide with a rental market in high demand. Homes are simply too expensive for the majority of tenants, which forces many to consider renting. As a result, cities with higher price-to-rent ratios are generally better for real estate investors who want to build a passive income portfolio. Here’s a list of cities with high price-to-rent ratios that may favor rental property investors:
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San Diego, CA: According to Zillow’s Home Value Index, the median home value in San Diego is $679,658. The annual median rent price in San Diego is $33,000. The price-to-rent ratio in San Diego is, therefore, 20.5 ($679,658/$33,000). At just over 20, the price-to-rent ratio in San Diego suggests it is usually more affordable to rent than buy a house.
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New York, NY: According to Zillow’s Home Value Index, the median home value in New York is $652,307. The annual median rent price in New York is $34,800. The price-to-rent ratio in New York is, therefore, 18.74 ($652,307/$34,800). At just under 20, the price-to-rent ratio in New York suggests it is usually more affordable to rent than buy a house.
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Seattle, WA: According to Zillow’s Home Value Index, the median home value in Seattle is $767,906. The annual median rent price in Seattle is $31,200. The price-to-rent ratio in Seattle is, therefore, 24.61 ($767,906/$31,200). At more than 20, the price-to-rent ratio in Seattle suggests it is definitely better to rent than buy a house.
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San Francisco, CA: According to Zillow’s Home Value Index, the median home value in San Francisco is $1,447,191. The annual median rent price in San Francisco is $54,000. The price-to-rent ratio in San Francisco is, therefore, 26.79 ($1,447,191/$54,000). Well over 20, the price-to-rent ratio in San Francisco suggests it is definitely better to rent than buy a house.
Some Of The Cities With The Lowest Price-To-Rent Ratios
Anything less than a 15 on the traditional home price-to-rent ratio scale suggests it is more affordable to buy in a respective city than to rent. Consequently, a low housing price-to-rent ratio may hint at a rental market lacking in demand. In the event it is more affordable to purchase a home, it only makes sense that more people will lean in favor of buying than renting, effectively limiting rental demand. As a result, passive income investors may have a hard time filling vacancies in the following cities with low price-to-rent ratios:
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Baltimore, MD: According to Zillow’s Home Value Index, the median home value in Baltimore is $152,180. The annual median rent price in Baltimore is $16,200. The price-to-rent ratio in Baltimore is, therefore, 9.39 ($152,180/$16,200). At just over nine, the price-to-rent ratio in Baltimore suggests it is considerably more affordable to buy a home than rent one.
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Jacksonville, FL According to Zillow’s Home Value Index, the median home value in Jacksonville is $195,692. The annual median rent price in Jacksonville is $16,140. The price-to-rent ratio in Jacksonville is, therefore, 12.12 $195,692/$16,140). Slightly over 12, the price-to-rent ratio in Jacksonville suggests it is considerably more affordable to buy a home than rent one.
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San Antonio, TX According to Zillow’s Home Value Index, the median home value in San Antonio is $187,718. The annual median rent price in San Antonio is $15,600. The price-to-rent ratio in San Antonio is, therefore, 12.03 ($187,718/$15,600). At just over 12, the price-to-rent ratio in San Antonio suggests it is considerably more affordable to buy a home than rent one.
It is worth noting, however, that while cities with lower price-to-rent ratios may be harder to build and sustain a passive income portfolio, they are inherently cheaper to buy in. Since these cities coincide with lower home values, they are great places to consider for those looking to “flip” investment properties.
Summary
A properly calculated price-to-rent ratio may help investors decide which markets they can invest in. However, it’s important to note that the price-to-rent ratio doesn’t reflect the overall affordability of a given market relative to other markets; it simply suggests which strategy is more affordable in the context of the subject market. As a result, it’s important for investors to realize the limitations of this valuable metric. While it certainly has its uses, the price-to-rent ratio is not the only metric investors should use to make an investment decision; it’s simply one of many variables to account for in an impending real estate transaction. Nonetheless, today’s investors need to learn how to calculate the price-to-rent ratio, at least if they want to increase their odds of realizing success in a specific market.
Key Takeaways
- The rent-to-price ratio is a metric used to determine which option is more affordable: buying or renting.
- Determining the price-to-rent ratio by city won’t allow investors to compare markets, but it will give them an idea of whether it’s more affordable to buy or rent in a single market.
- Implementing the price-to-rent ratio by zip code allows investors to conduct a more localized search.
