The price-to-rent ratio is a measurement of the relative affordability of buying vs. renting a real estate property in a particular housing market.
So, what exactly is the price-to-rent ratio, how can you use it in real estate, how to calculate it, and what are some of the highest and lowest price-to-rent ratios for housing markets in the US?
We will try to answer all these questions and more to help you better understand the metric and be able to use it when trying to decide whether to buy or to rent a residential real estate property and what real estate housing markets you should be looking at.
What Is the Price-to-Rent Ratio?
The price-to-rent ratio is a metric used in real estate investing to measure the relative affordability of buying vs. renting in a real estate housing market. The metric is calculated as the ratio of home prices to the annual rent rates.
As a quick example, let’s suppose that we have a real estate housing market where the average home is worth $300,000, and the average rent rate is $1,500. The price-to-rent ratio in this market would be 16.6.
The formula used to determine the price-to-rent ratio is as follows:
Price-to-Rent Ratio = Home Price/(Rent Rate x 12)
So, in the example, the price-to-rent ratio was calculated as: $300,000/($1,500 x 12)
What Is the Price-to-Rent Ratio Used for?
The price-to-rent ratio is a useful metric for determining whether a housing market is favorable for buying or for renting real estate properties by comparing the costs of buying and renting across different real estate housing markets. The metric can be particularly useful for real estate investors as well as homebuyers.
Real estate investors can use price-to-rent ratios to determine whether a particular real estate market is good for investing in a rental property, while homebuyers can use it to determine whether it is better to buy a home or to rent one in a particular real estate market.
Generally, a lower price-to-rent ratio indicates that a real estate market is more favorable to homebuyers, while a higher ratio indicates that a real estate market is better suited for renters.
Price-to-Rent Ratio in US Cities
In the US, price-to-rent ratios can be used as an indicator to see which cities are favorable for buying a home and which cities are favorable for renting a home. Different cities in the US have drastically different home prices and rental rates. Some cities can be used to easily distinguish the difference between a homebuyer’s market and a renter’s market due to the large gaps that exist between the different cities and housing markets.
Below is a table with some of the top 3 highest and the top 3 lowest price-to-rent ratios in cities in the US. For these examples, we will only take into consideration residential real estate properties that rent out for $1,000/month to see how the prices of these properties compare to other cities based on their price-to-rent ratio:
|City||$1,000 Rental Home Price||Price-to-Rent Ratio|
|San Francisco, CA||$550,560||45.88|
|Los Angeles, CA||$456,240||38.02|
As you can notice from these examples, there is a significant difference in the price-to-rent ratios among the different cities, especially when looking at the high end and the low end of the spectrum for housing markets based on their home prices.
Cities like San Francisco, Oakland, and LA all have high price-to-rent ratio due to them having some of the highest home prices nationwide, while Buffalo, Cleveland, and Detroit are known for their low home prices, resulting in them having some of the lowest price-to-rent ratios nationwide.
What this means is that the first three cities are not favorable for buying a real estate property, especially for real estate investors who are looking to buy an investment property to rent out. On the other hand, cities like Detroit, where home prices are very low, can be a good option for purchasing a real estate property, but does that mean that buying an investment property in Detroit to rent out is a good investment option? Not necessarily.
What Do Price-to-Rent Ratios Say About Affordability?
While in the examples above we can see that cities where homes are more affordable have much lower price-to-rent ratios, the ratio itself is not an indicator of the affordability of homes in a real estate housing market.
This is because price-to-rent ratios indicate whether buying or renting is more affordable, but they do not indicate that home prices or rental rates are high or low.
In a city like San Francisco, for example, where the price-to-rent ratio is very high, it is easy to assume that renting is more affordable than buying. This, however, isn’t absolute, and we all know that rental rates in San Francisco are very high. So, what the price-to-rent ratio indicates, in this case, is that buying is relatively more affordable than renting, but it does not mean that buying is affordable or cheap.
The Historical Performance of Price-to-Rent Ratio
The price-to-rent ratio is a not a static value, and it changes over time depending on the housing market’s performance and other events that can affect it. In the US, before the housing crisis, the national price-to-rent ratio was 22.73 in 2005, but as the market heated up, the price-to-rent ratio went up to 24.50 in 2007. As the real estate market turned back, home prices fell, and rent rates increased, causing the price-to-rent ratio to drop below 20 in 2011, and it got down to 19.21 by 2016.
The price-to-rent ratio is a good metric to use for homebuyers and real estate investors when researching a housing market to determine the choice between buying and renting a real estate property. Generally speaking, real estate markets where the price-to-rent ratio is low are great for buying a property, while a higher price-to-rent ratio indicates that home prices are high compared to rental rates.
To make the most out of this metric for determining whether to buy or to rent a real estate property, head over to Mashvisor and start analyzing the local US housing markets using the data that wet provide. With Mashvisor, you can obtain data related to the average home prices and rental rates for each property and for each housing market, which you can use to calculate the price-to-rent ratio and determine whether a housing market is a good choice for buying or for renting a property.