The price to rent ratio indicates whether a market is overpriced and the potential demand for rental property based on house prices.
When expanding your property portfolio, deciding on where to invest next can come with a lot of challenges. Should you invest in a single-family or a multi-family property? Where should it be located? What about short-term rentals? Will it be worth the financial investment? Thankfully, there are many metrics that can help you make this decision. The price to rent ratio is one such calculation.
This ratio can be used by both real estate investors and prospective homebuyers. It sheds light on whether it makes more sense to rent or own a property in a particular market and also indicates the potential demand for rental property based on house prices.
To calculate the price to rent ratio, you should take the median home price of a particular area or market and divide it by the median annual rent.
Price to rent ratio = median home price/median annual rent
For example, if the median home price in a city is $95,000 and the median annual rent is $7,800, the price to rent ratio will be 12.17.
$95,000 / $7,800 = 12.17
A high price to rent ratio suggests that housing in a particular market is currently overpriced and that it would make more sense to rent instead. If it makes more sense to rent, then there is likely high demand for rental housing. This can be good news for rental property investors and landlords.
A low ratio suggests that it is better to buy than rent. This is great for homeowners but not so favorable for landlords, as there is lower demand for rentals.
Generally speaking, a ratio of under 15 is indicative of a good market to buy in and a ratio of over 21 suggests that it would be better to rent than buy. Anything between 15 and 21 generally means that it’s better to buy than rent.
Once you’ve calculated the price to rent ratio of a specific market, you can use the same calculation on individual properties to see whether or not they will be a good investment. If you find a property that has a lower price to rent ratio than the general market, it can either mean that the property is underpriced (meaning a good deal for you) or that the rent is above market.
Regarding affordability, for example, SmartAsset has determined that San Francisco has one of the highest price to rent ratios in the country at 51.79. However, because the median home value is already high ($1,217,500), the high ratio does not necessarily mean that it is affordable to rent there either. It might be relatively less expensive than buying a house but is still more pricey than renting in other cities that have a lower price-to-rent ratio.
As mentioned at the beginning of this article, the price to rent ratio is just one calculation that can be used by rental property investors to help them analyze potential investments. Some other metrics and calculations that should be considered by landlords are as follows:
Landlord Studio has developed a number of free calculators for landlords that can help you determine your monthly mortgage payments, net worth, rental yield and more.
In isolation, the price to rent ratio is an evaluation tool that only sheds a small amount of light on potential investments. For maximum benefit, it should be used in conjunction with other metrics, calculations, and research to determine when and where you should be investing next. Generally speaking though, rental property investors should look to invest in areas with a high price to rent ratio, as there is demand for rentals due to relatively high house prices.