The Complete Guide to Price to Rent Ratio in Real Estate Investing

The real estate investing business is full of terminology, and one of the most important terms – especially for investors in traditional rental properties – is the price to rent ratio. While this real estate concept is relatively easy to understand and calculate, it’s a crucial factor in determining rental demand, rental income, and return on investment for long term investment properties for sale. That’s why we’ve put together this complete guide which will answer all questions you have about the price to rent ratio and its use in real estate investments.

What Is Price to Rent Ratio?

The price to rent ratio is a real estate term which is useful for both real estate investors (landlords) and renters (tenants). In simple words, this metric calculates the ratio between the average property price in a given housing market and the average annual rental rate there.

From a common person’s point of view, this measure compares whether renting a property or buying a home costs more, relatively speaking. Thus, the ratio helps individuals make an informed decision on the old dilemma of “rent vs. buy”.

In the case of real estate investors, the situation is a bit more complicated. The price to rent ratio affects demand for long term rental properties in any US housing market. This means that it has a direct effect on the return on investment to be expected in a location, in terms of both traditional cash on cash return and traditional cap rate. We will come back to the issue of how investors and landlords can make the best use of this real estate concept in a bit.

How to Calculate Price to Rent Ratio?

To get a full understanding of this real estate investing concept, here’s the price to rent ratio formula:

Price to Rent Ratio = Average Property Price/Average Annual Rent

Or

Price to Rent Ratio = Average Property Price/Average Monthly Rent x 12

As most people learn best through a hands-on experience, let’s have a look at an example. According to real estate market analysis conducted by Mashvisor, here are the figures for the Houston real estate market:

Houston Housing Market Figures 2020

• Average Property Price: $395,169
• Average Monthly Rent: $1,825

Price to Rent Ratio in Houston = $395,169/$1,825 x 12 = 18

Related: Houston Housing Market Predictions 2020

While the formula for calculating the price to rent ratio is simple and straightforward, it requires a significant amount of real estate data. To help out beginner real estate investors buy their first rental property, Mashvisor has developed a tool providing the needed data to calculate this ratio in any US housing market at the neighborhood level.

Mashvisor’s investment property calculator conducts neighborhood analysis for any US city and town, no matter how big or small. Looking at the neighborhood-level price to rent ratio makes much more sense when analyzing rental properties for sale. This is particularly true in such large markets as the Chicago real estate market, the Los Angeles real estate market, the New York real estate market, and others where areas witness major differences from one another.

At the neighborhood pages on Mashvisor’s real estate investment software app, investors can see the median property price in the area (which is very similar to the average property price) as well as the average monthly traditional rental income. All calculations are based on the performance of actual real estate listings and long term rental listings on the MLS and Zillow. Once beginner real estate investors have these two numbers, calculating the price to rent ratio in any neighborhood becomes easy.

Mashvisor’s Neighborhood Analysis in the Austin Real Estate Market

How to Use Price to Rent Ratio in Real Estate Investing?

Now that you know what this metric is and how to calculate it on your own, you might be wondering of what use it is to real estate investors. In other words, “How can I use the price to rent ratio in my real estate investing decisions?”

Actually, the answer to this important question is not straightforward.

To begin with, the price to rent ratio is generally divided into three categories:

• High: 21 or above
• Moderate: 16-20
• Low: 15 or below

Let’s see what each of these ranges means for both renters and real estate investors:

High Price to Rent Ratio

In such a real estate market, homes are too expensive compared to monthly rents, so the vast majority of people decide to rent rather than buy. This should be good news for investors as it translates into strong demand for long term rental properties. However, there are two possible risks which they should take into consideration before deciding to invest in rental properties for sale in a location with a high price to rent ratio. First, property prices might be prohibitively elevated not only for homebuyers but also for real estate investors. Nationwide rental market analysis conducted by Mashvisor reveals that a few cities with a high ratio where investment properties for sale but also unaffordable home values include the New York real estate market, the San Francisco real estate market, the Boston real estate market, and the San Diego real estate market.

Second, even if beginner real estate investors can afford to buy a rental property in these markets, they are not always optimal for the traditional rental property investing strategy. Property prices are simply too high compared to rents to provide positive cash flow income properties with a high return on investment. For instance, the median property price in the Las Vegas real estate market (which has a high price to rent ratio) amounts to $444,100 – significantly below the locations mentioned above – but the cash on cash return for traditional rental properties reaches only 1.2%.

Moderate Price to Rent Ratio

Although generalizations should be avoided in the real estate investing business, markets with moderate price to rent ratios tend to be optimal for the traditional rental strategy. First of all, property prices are usually high enough to drive many people to choose to rent vs. buy. Simultaneously, the traditional rental income is not low enough to prevent landlords from achieving a high rate of return on a rental property. Of course, before deciding to buy an investment property in such a location, a smart investor needs to conduct diligent real estate market analysis as well as investment property analysis on traditional rental properties for sale within his/her budget. This is the only way to assure investing in positive cash flow properties with a good cash on cash return and a good cap rate each and every time. Using the right real estate investment software tools – such as Mashvisor’s Property Finder and rental property calculator – is vitally important for beating the competition and buying profitable traditional income properties before anyone else.

Low Price to Rent Ratio

The risk of focusing your real estate investing energy on a market with a price to rent ratio below 15 is that it will be relatively difficult to find tenants. People in such markets prefer to buy vs. rent because home values are low compared to rental rates. These markets offer excellent real estate investment opportunities for marketing experts who can create outstanding rental listings and attract tenants, even amid a low rental demand. On the plus side, many US housing markets with low price to rent ratios are generally affordable, so rental properties for sale there are within the budgets of even first-time investors. Furthermore, the fact that rental income is high relative to property prices translates into a high return on investment, whether looking at cash on cash return or cap rate. And that’s what all real estate investors are after.

In conclusion, while this ratio is definitely one indicator which investors in traditional rental properties should consider, it does not suffice to make an informed decision. Performing more detailed rental market analysis with the help of the right real estate investment tools is a must.

Related: Price to Rent Ratio by City – Where to Invest in 2020

What Price to Rent Ratio by City to Expect in the US Housing Market in 2020?

Even though calculating the price to rent ratio by city is absolutely doable for as many US housing markets as you’d wish to do it, it will be rather time-consuming and tedious. That’s why we’ve put together three lists of the major US real estate markets with high, moderate, and low price to rent ratios. We’ve also included Mashvisor’s real estate data on the average property price, the average traditional rental income, and the average traditional cash on cash return in each of these places. This should help beginner real estate investors focus their attention on the most appropriate location for them based on their budget and expectations:

Table 1: Top Cities with High Price to Rent Ratio in the US Housing Market in 2020

Table 2: Top Cities with Moderate Price to Rent Ratio in the US Housing Market in 2020

Table 3: Top Cities with Low Price to Rent Ratio in the US Housing Market in 2020

Related: 20 Most Profitable Locations for Traditional Rentals in 2020: Cash on Cash Return

The price to rent ratio is one of the metrics a real estate investor must look at when buying a traditional rental property. However, it’s not the only one. Investing in positive cash flow properties with a high profitability requires comprehensive real estate analysis at both the neighborhood and the property level. To start searching for profitable investment properties for sale – whether MLS listings or off market properties – in markets with high, moderate, or low price to rent ratio today, sign up for Mashvisor.