The price to rent ratio is a simple measurement that compares the price of buying property to the annual price of renting in a geographic location to estimate what’s cheaper (renting vs owning), if it’s a good time to buy, and where the best place to buy might be.
Anyone who’s interested in real estate must know that the secret to succeeding in this business lies behind the numbers. You can find multiple real estate deals in your housing market but end up choosing to buy the wrong one for investment if you don’t know how to run the numbers.
One of the first and most important metrics for real estate investors to calculate before making an investment decision is the price to rent ratio. This metric helps you analyze the given housing market and assess its profitability before making a purchase – and we all know how important it is to pick the best locations for investing in real estate. Along with other metrics, this ratio can help you make smart investment decisions when buying a rental property.
If you’re not yet familiar with the price to rent ratio, keep reading to learn:
- What does the price to rent ratio tell investors?
- How to calculate the price to rent ratio
- How to use price to rent ratio as a real estate investor
- What’s a good price to rent ratio?
- The price to rent ratio by city 2020
What Does the Price to Rent Ratio Tell Investors?
From just reading the price to rent ratio definition above, you can already tell how beneficial this metric is for real estate investors. Essentially, it answers three important questions: 1) Can I afford a rental property investment in this market? 2) Is this a good location to invest in? And 3) is now a good time to make the purchase? Those who have been in the industry for a while know that location and timing are key factors for any successful real estate deal. And of course, you don’t want to buy a property that you can’t afford and end up losing your investment and potential profits. Hence, calculating the price to rent ratio is crucial to make sound investment decisions based on numbers and real estate data. So, what is the formula for this real estate metric?
How to Calculate Price to Rent Ratio
From reading the definition, you probably already know the formula for calculating this ratio. It’s actually pretty straightforward and wouldn’t take too much time or energy from an investor looking to buy property in the best places to invest in real estate.
Here’s a breakdown of how to calculate price to rent ratio:
- Gather Data
The data you need is the average property price and the average annual rent price. You can get this type of information by simply doing an online search of your local housing market.
- Divide Numbers
Simply take the average property price in the housing market and divide by the average annual rent price.
Let’s demonstrate how to calculate price to rent ratio and take the city of Los Angeles, CA as an example. According to Mashvisor’s real estate data and predictive analytics, the property price in the Los Angeles real estate market is $812,571 and the average monthly rent is $3,324 (meaning, the annual average rent price = $39,888). Following the above formula, the house price to rent ratio in Los Angeles is 20. But what exactly does this number say about the real estate market in Los Angeles, CA? Is this ratio good enough for investors to consider buying an investment property here?
How to Use Price to Rent Ratio in Real Estate
Let’s answer the first question. The number you get after doing the price to rent ratio calculation can be used as quantitative data as well as comparative data to help you analyze the real estate market. How? Basically, this number will fall into one of these 3 categories:
- 15 and below – Low
- From 16 to 20 – Moderate
- 21 and above – High
Each category will tell you something about the real estate market. A low price to rent ratio indicates that average property prices are relatively cheap compared to annual rent prices in the city, meaning it’s better to buy a home than to rent one. A moderate ratio suggests the average property price is rather high compared to rents, so it’s probably better to rent a property instead of buying one. And finally, a high ratio tells you the average property price is too expensive compared to average rents in the real estate market, so you should definitely choose to rent a property and not buy one.
However, have you noticed an issue here? If not, here it is – the advice above is tailored to help renters and homebuyers make sound financial decisions, not real estate investors. A first-time investor might read the above and think that the best places to buy rental properties are cities with the lowest price to rent ratio as prices would be more affordable there. That, however, is not always the case.
You see, while affordability is an important factor to investors, you shouldn’t take it as the determining factor for where to invest in rentals. Instead, other factors should be taken into account, most importantly is the rental demand. So, a sound investment decision would be to invest in real estate in a market where the average person can’t afford to buy a house. This will drive the demand for your rental properties. So, here’s how the house price to rent ratio should drive your investment decision:
- Below 15: suggests that rental demand is not as strong as other markets since the average homebuyer finds property prices affordable relative to rent prices.
- 16 to 20: suggests that you might find good rental demand since prices are rather high so not everyone in this market can afford to buy and own a home.
- Above 21: suggests that the rental demand in the real estate market could be strong since renters find annual rent prices more affordable than average property prices.
Another thing investors can do is find the historical price to rent ratio data for their real estate market of choice and compare it to the current data to study some market trends. Doing so will give you an even better idea of whether or not it’s a good time/location to buy a house for investment. For example, let’s say that after comparing historical and current data, you’ve found that the home price to rent ratio in your market has been in the moderate category but is now in the high category. This means renting became the more affordable option as property prices increased in this market. In turn, this suggests the rental demand might be stronger than it used to be.
However, keep in mind that the price to rent ratio is a good starting point to a real estate market analysis, but it doesn’t tell you everything. For example, it doesn’t say anything about economic growth, crime rate, whether it’s a seller’s market or buyer’s market, and other factors that make for good places to invest in real estate. So, real estate investors should always mind due diligence and do their own research to find such information before selecting their investment location.
What Is a Good Price to Rent Ratio?
Like many other frequently-asked real estate questions, there really isn’t a direct answer to what is a good price to rent ratio. The answer is: it depends on certain factors, most importantly is the investor’s personal criteria when searching for investment opportunities.
It’s common for beginners to ask “what is a good…?” when starting their real estate business. This question applies to almost all metrics that investors use to estimate the profitability of investing in a given housing market or rental property for sale. For example, investors often ask: what is a good cash on cash return? What is a good cap rate? What is a good return on real estate investment? As you’re learning about the price to rent ratio, you must be wondering the same thing for this metric. However, while experts generally agree on what’s a good cash on cash return, cap rate, and ROI, there isn’t really a straightforward answer to what is a good price to rent ratio.
As the house price to rent ratio is divided into three categories, we can’t really say that a specific number represents a “good” or “the best” ratio that real estate investors can base their decisions on. Instead, a good ratio depends on a number of factors including what you’re personally looking for in an investment location, your budget, as well as your real estate investment strategies. For example, if you’re searching for a rental property in a market with strong demand and can afford to buy, anything over 21 can be a good ratio and your property search should be in cities with highest price to rent ratio.
On the other hand, say your investment strategy is to flip homes. That is, to buy cheap investment properties for sale, increase their market value by renovating them, and then sell them for a higher price. In this case, a good ratio would be below 15 because homes for sale in cities with lowest price to rent ratio are affordable and there’ll be a large pool of buyers to choose from when it’s time to sell. Hence, some investors might say a lower ratio is best while others would disagree in favor of a higher ratio. At the end of the day, a good ratio is based on what you are looking for.
Price to Rent Ratio by City 2020
So now you have an idea of everything you need to know about the home price to rent ratio and what to keep in mind before using it to make real estate investment decisions. Calculating this real estate metric is quite simple. Finding the data to make the calculation, however, is not that easy for a first-time investor. You can search for average property price and annual rent price data on your own, or you can use a real estate analysis software like Mashvisor to get readily calculated ratios. Here’s a list of current price to rent ratio data for 20 major cities in the US housing market provided by Mashvisor – from highest to lowest:
- New York: 33
- San Francisco: 31
- Boston: 27
- Seattle: 24
- Phoenix: 22
- Washington D.C: 22
- Austin: 22
- Nashville: 21
- Los Angeles: 20
- Miami: 19
- Denver: 19
- Chicago: 18
- Houston: 18
- Philadelphia: 18
- Tampa: 18
- Atlanta: 17
- Dallas: 16
- Orlando: 16
- Charlotte: 15
- Portland: 12
You can start looking for and analyzing the best investment properties in your city and neighborhood of choice using Mashvisor now!
The Bottom Line
The price to rent ratio is a good metric in real estate investing that you should calculate before making a decision. But is it the ultimate metric? No such thing exists. It’s a good metric to narrow down real estate markets and pick one where you’ll find investment properties. However, if you want true success with your investment, you need to look at all of the remaining numbers and metrics as there are limitations to the price to rent ratio. For example, it doesn’t show you the expected profitability of a rental property which is what you’re most concerned about as an investor.
Hence, you should always run a thorough real estate market analysis as well as a neighborhood analysis on a given location to find if it’s a good place to invest. Furthermore, an investment property analysis should also be carried out before buying a house for real estate investing to make sure it will actually yield a good return on investment. These analyses will include all the necessary metrics you need to make educated investment decisions including cap rate, cash on cash return, occupancy rate, and more!
To make the most out of the housing price to rent ratio along with other metrics, head over to Mashvisor to start analyzing your city/neighborhood of choice using the data that we provide including home prices and rental rates. When you sign up, you’ll also get access to all the tools you need to perform real estate market and investment property analyses in no time.
To learn more about how we will help you make faster and smarter real estate investment decisions, click here.