It can be hard to decide whether to buy or rent a rental property in a certain area. Many factors such as personal preference, investment goals, and much more come into play. Still, we can almost all agree that the biggest factor to impact this decision is affordability. Luckily, there’s a metric that is used to determine if a real estate investor should buy or rent based on affordability, introducing the price to rent ratio!
What Is the Price to Rent Ratio (P/R)?
As the name implies, the price to rent ratio is a ratio of property price to rental income. Specifically, it is the average property price in an area divided by the average annual rental income of the area.
Price to Rent Ratio = Average Property Price/Average Annual Rental Income
How does the P/R tell a real estate investor whether it’s more affordable to buy or rent an investment property? Depending on the range of values of the P/R, a real estate investor can learn whether buying or renting a rental property is financially more sound:
- If the price to rent ratio is from 1 to 15, it is better to buy a rental property than to rent one.
- When the P/R is from 16 to 20, it is more affordable to rent an investment property than to purchase.
- If the P/R is above 21, it is much better to rent than to purchase rental properties.
A Price to Rent Ratio Example
Like most things in real estate investing, an example will help clarify the P/R concept.
P/R = ($1,364,844/12 × $4,469) = 25.4
The P/R of this location is more than 21, meaning that it is much better to rent than to buy in this city.
The city used in the example is not an imaginary one. No, it is San Francisco, based on data obtained by Mashvisor’s investment property calculator at the time of this writing. So, what other cities have high price to rent ratios, and are thus better places to rent than to buy investment properties?
Cities with the Highest Price to Rent Ratios
Here are the cities with the highest price to rent ratios calculated by SmartAsset using US Census data. These ratios are as of early 2017 and use home values of rental properties that rent for $1,000.
Although the average property prices of these cities are expensive, a real estate investor would likely find success renting out investment properties, since it is more affordable for tenants to rent instead of buy. Still, there’s hope. Use Mashvisor’s investment property calculator and investment property analysis to locate inexpensive deals in these expensive cities.
1. San Francisco, CA: 45.9
2. Honolulu, HI: 40.1
3. Oakland, CA: 38.5
4. Los Angeles, CA: 38.0
5. New York, NY: 35.7
6. Seattle, WA: 35.1
7. San Jose, CA: 34.7
8. Long Beach, CA: 34.6
9. Washington, D.C.: 32.0
10. Anaheim, CA: 31.3
Cities with the Lowest Price to Rent Ratios
Renting out investment properties is more affordable in the previous ten cities. The next ten cities represent the opposite, as buying real estate property investments is more affordable.
1. Detroit, MI: 6.3
2. Cleveland, OH: 10.5
3. Buffalo, NY: 10.7
4. Pittsburgh, PN: 12.0
5. Memphis, TN: 12.3
6. Corpus Christi, TX: 13.1
7. Toledo, OH: 13.3
8. San Antonio, TX: 13.7
9. Milwaukee, WI: 14.2
10. Jacksonville, FL: 14.3
Caveats of the Price to Rent Ratio
The price to rent ratio is a valuable metric in real estate investing, but there are some caveats when using it.
- The price to rent ratio is a useful metric when deciding to buy or rent a property, but it should not be the only metric used.
If you were to only be guided by the P/R in real estate investing, you would most certainly be lost. As mentioned earlier, the ratio only tells you whether renting or buying real estate property investments is more affordable. The ratio is definitely helpful in the affordability aspect, but more pieces of information, including mortgage payments, interest rates, and more should help determine affordability.
- The price to rent ratio says nothing about market conditions.
The price to rent ratio scales the relative affordability of buying versus renting real estate property investments in a certain market. It does not say anything about how affordable the market actually is. San Francisco, for instance, has a P/R of more than 21. This means that renting is the more affordable option. However, San Francisco is still a very expensive city for renting, and the P/R says nothing about that. The P/R determines whether buying or renting in a city is more affordable, but it doesn’t determine whether the option is actually affordable.
- The price to rent rate can be used to analyze broad macroeconomic trends.
While the previous point illustrates that the ratio cannot assess specific markets, it can be used to analyze broad real estate trends. As the housing bubble began, for instance, the national P/R rose from 22.7 to 24.5. The ratio has since decreased to about 19 as property prices have slowed down.
- The price to rent ratio is not as important as return on investment.
The return on investment, or ROI, is the more important metric for a real estate investor. Return on investment, in its different forms such as cap rate and cash on cash return, tells the investor if the property will make money. The P/R is useful when buying or renting, especially for potential investors or tenants. But when an investor has rental properties operating, ROI will be the more important metric to have, which can be obtained through Mashvisor’s investment property analysis.
The Bottom Line
The price to rent ratio is a valuable metric when deciding which is more affordable: renting or buying investment properties. The higher the P/R in an area, the bigger the potential tenant pool, since renting is more affordable in this case. Still, the ratio does not indicate whether the market in question is actually affordable, and other data should be included in the investment property analysis. As a real estate investor concerned with properties to make money, however, ROI should be your more important focus. To learn all about a location or investment property, use Mashvisor’s investment property calculator to find the best properties to make money!