Answering the question “Where to buy investment property?” is not a simple task because it takes time and thorough research to hone in on the right rental property aligned with your business vision and financial resources.
It is no secret that location and the neighborhood of choice are major criteria to maximize your returns and rental income in the long run. But, the trick is to be the first to tap into these real estate investment opportunities before your competition. The way to capitalize on the right real estate strategy in the right locations is dependent on how real estate investors go about conducting their real estate market analysis and overall due diligence.
One of the key metrics to deduce and differentiate good real estate investments from the bad is by calculating the price to rent ratio. This formula gives real estate investors a clear answer of whether or not a specific location is feasible for real estate investing.
Related: Our Bulletproof Formula for Success in Real Estate Investing
Price to Rent Ratio Formula
Where to buy investment property can be partially answered using the price to rent ratio formula. This metric is an easy calculation to use in the initial stages of your real estate market analysis to decipher and hone in on prime locations for real estate investing.
Price to Rent Ratio (P/R) = Average list price / (Average rent * 12)
*Average list price and average rental income can be found on Mashvisor.com
Key Notes on the Price to Rent Ratio:
- A ratio between 1-15 means it is better to buy.
- A ratio between 16-20 means it is better to rent.
- A ratio of 21 or more means it is better to rent.
In City V, the average real estate value is around $300,000 with an average rental income of $1,000 per month. What is the price to rent ratio? And what does it mean? Is it better to buy or rent in City V?
P/R = $300,000/ (1000 *12) = 25
This means that in City V it makes more sense to rent rather than to buy as the city is expensive for buying real estate. When the list price is high and the rental income per month is relatively low, the price to rent ratio is high.
A high price to rent ratio indicates real estate is too expensive to buy relative to its rental income and in turn, the value of the home will likely drop. In previous and current years, cities with high price to rent ratio have been San Francisco, New York, Los Angeles, Washington D.C., Seattle, and Anaheim.
It is important to mention that the price to rent ratio is only one of the key metrics to take into account when considering where to buy an investment property. To aggregate sufficient data for your analysis, do not discount the cap rate, NOI, cash on cash return, and overall ROI for your prospective real estate investments.
Related: How Real Estate Investing Is Your Money Maker
Where to Buy Investment Property in the US: Price to Rent Ratio in 2018
Where to buy investment property can be measured by the price to rent ratio. Below are the top highest and lowest price to rent ratios across the country. The sample below is based on residential real estate properties with an average rental income of $1,000/month.
|City||Rental Home Price||Price-to-Rent Ratio|
|San Francisco, CA||$550,560||45.88|
|Los Angeles, CA||$456,240||38.02|
Based on the data provided, cities which score a high price to rent ratio (i.e. San Francisco, Oakland and Los Angeles) are too expensive to buy and have a low ROI on rental income. If you are wondering where to buy investment property based on price to rent ratio, you would avoid these cities altogether. On the flip side, the bottom three cities on the list have a low price to rent ratio, below 15. This means, Buffalo, Cleveland, and Detroit are favorable cities to buy investment property for high rental income.
So long story short, it makes more sense to invest in real estate markets in Cleveland than San Francisco, based on the price to rent ratio metric.
6 Factors That Affect The Price to Rent Ratio
Where to buy investment property is highly correlated to the overall economic conditions; as income levels increase so does the demand for housing. Positive economic indicators increase overall income and enable people to spend more on houses, which increases demand and pushes up prices.
Where to buy investment property depends on the unemployment rate in the city in mind. If unemployment is on the rise, fewer people will be able to afford housing. Demand plummets; so does pricing.
Where to buy investment property is also highly correlated to the interest rate. As the cost of interest rates goes up, so does the cost of your monthly mortgage payments and in turn, this causes a lower demand for buying a house.
Where to buy investment property is influenced by consumer confidence and demand. If people fear prices will drop, be rest assured they become risk-averse and defer from buying rental property.
The more lenient the credit requirements, the more people will jump at taking out a mortgage loan and buying investment property. On the flip side, the stricter the requirements, the less mortgages are given out, and demand falls.
A shortage of supply pushes up prices, while excess supply will cause prices to fall.
Related: Top 10 Cities for Safe Investments in the US Housing Market 2018
To sum it up, real estate investors must take into account the price to rent ratio for deciphering where to buy investment property for the highest returns and long-term financial rewards. But, this does not discount the other metrics and calculations you must consider to make smarter decisions for your real estate investments. If you want to streamline your research and real estate market analysis, Mashvisor helps you find the best cash flow properties in the fastest time.
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