The question of ‘rent vs buy’ is a common one. After all, there are many factors, such as location, that dictate the answer. Arguably the most important factor is affordability. Fortunately, there is a metric that is used to answer the ‘rent vs buy’ question with a focus on home prices and rent prices. Not only is the metric useful for homebuyers who are wondering if they should make the leap into homeownership or continue renting, but it also reveals something very important to real estate investors looking to buy an investment property. In today’s blog post, we’ll talk about this metric – the price to rent ratio – and why it is important in real estate.
What Is Price to Rent Ratio?
The price to rent ratio (also known as P/R) is a metric used by real estate investors and tenants. As the name implies, P/R is a ratio of the average property price in a rental market to its average rental rate. By using P/R, a person can find out whether it is cheaper to buy a home or rent a property. For real estate investors, however, there is another layer to its importance. The price to rent ratio represents the demand for long-term rentals. In other words, P/R can reveal something about the potential return on investment in a housing market.
How to Calculate Price to Rent Ratio
Here is how to calculate price to rent ratio:
Price to Rent Ratio = Average Property Price ÷ Average Rental Income
Like with other real estate metrics, the P/R concept becomes clearer with an example. Here’s one: The median property price in a rental market is $1,685,668. The average monthly rental income in the market is $4,300. What is the P/R of the rental market?
P/R = $1,685,668 ÷ ($4,300 x 12 months) = 32.67
So, what does this home price to rent ratio mean? Depending on the range of values of P/R, one can find out whether buying or renting a property is more affordable:
- A P/R from 1 to 15 means it is better to buy a home than to rent
- A 16 to 20 price to rent ratio of a real estate market means it is typically more affordable to rent than to buy
- A P/R of 21 and above indicates that it is much better to rent than to purchase
This, of course, is how a renter or potential homebuyer would use the price to rent ratio. So why does it matter to real estate investors?
Why Does Price to Rent Ratio Still Matter in Real Estate?
With the mentioned ranges in mind, what is a good price to rent ratio for a real estate investment? Is any P/R range inherently better than others? The answer is quite nuanced, but it explains why P/R still matters in real estate.
High (21 and above)
In real estate markets with a P/R of 21 and above, home prices are significantly more than rent prices. As a result, renting makes more sense financially for the average resident. The domino effect, as you would expect, is a strong demand for long-term rental properties.
However, there are two caveats to this principle. Firstly, the rental market might be too pricey, on average, for both tenants and real estate investors. The P/R in the previous example, in fact, follows this mold. It is the P/R of the San Francisco housing market, based on Mashvisor’s real estate market analysis data. Some other cities with the highest price to rent ratio in the US housing market 2020, according to Mashvisor, include:
The second caveat is that even if real estate investors can afford to buy an investment property in these markets, they are not always best suited for traditional investing. The median property prices are too expensive, relative to rent prices, to generate a high return on investment (ROI). Once again, this is seen with San Francisco. Although its annual average rental income of $51,600 is quite high, its average traditional ROI of 1.05% is not.
Moderate (16 to 20)
As a general rule, rental markets with moderate price to rent ratios tend to be the best for investing in traditional long-term rentals. The reasons why are simple reversals of why high P/R markets may not be optimal. For starters, while home prices can be high, they are typically not high enough to be a barrier to investing. Traditional rental income will, therefore, be higher relative to home prices. As a result, investors can expect good rental returns. Here are some locations with a moderate price to rent ratio by city,
Low (1 to 15)
In real estate markets with low P/R, investors may find a shortage of tenants. Due to low prices in these markets, many residents, even first-timer buyers, can manage to purchase a home. Still, when investors rent out to tenants in these areas, they are likely to receive a high return on investment. This, once again, is due to the high rent prices compared to low home prices. Some large US cities with the lowest price to rent ratio include:
If you do go for one of these real estate markets, be sure to check occupancy rates as well as renter vs homeowner populations. This will help you pinpoint a location with a large pool of tenants.
How Mashvisor Is Here to Help
Clearly, the price to rent ratio is among the most important property metrics. Nonetheless, there is more to purchasing an investment property than a good price to rent ratio. While a P/R of 16 to 20 is generally considered optimal, much more needs to be included in a definitive real estate market analysis. Return on investment, while influenced by P/R, should take precedence for investment decisions, for instance. Therefore, you will need the proper real estate investment software to analyze a rental market and properties for sale. Where can you find such tools? Look no further! You can find them right here, with Mashvisor.
Mashvisor’s investment tools provide all the data needed to calculate the P/R and ROI in the US housing market at the neighborhood level. Mashvisor’s data is also the most up-to-date you will find, basing data and calculations on real estate comps and listings from the MLS, Zillow, and other sources. Above all, Mashvisor will help you conduct a full-scale real estate market analysis in a matter of minutes. With Mashvisor, learn where to invest in real estate and begin researching real estate markets. To start your 7-day FREE trial with Mashvisor, CLICK HERE!