Price-To-Rent Ratio: An Investor’s Guide

Key Takeaways:


The price-to-rent ratio (PTR ratio) is a simple metric with several valuable applications. In its simplest form, the PTR can help identify affordable living arrangements. However, at its pinnacle, the PTR can become an invaluable investor tool used to identify numerous opportunities in a given marketplace. How you decide to use it is up to you, but this simple ratio isn’t without its own shortcomings. To truly benefit from using the PTR ratio, you must not only know how to calculate it yourself, but you must familiarize yourself with what it can and can’t do. The following will provide you with everything you need to know about using the PTR and how to maximize its efficiency.

What Is The Price-To-Rent Ratio?

The price-to-rent ratio is a metric that identifies the more affordable option between owning a home and renting in a respective community over the course of a year. The aptly named PTR ratio allows prospective buyers and renters to evaluate two different variables with a single equation. In comparing an area’s median home value with its average annual rental rate, buyers and renters are rewarded with a single metric which may suggest the most affordable living arrangements (relatively speaking). As a result, the PTR ratio is one of the most common tools people use to determine whether to buy or rent in a given neighborhood.

It is worth noting, however, that the price-to-rent ratio serves more than a single purpose. In particular, the metric may be reverse engineered to identify the best places for investors to buy rental properties. Lower-priced neighborhoods tend to see more rental demand than their higher-priced counterparts. In determining the most objectively affordable areas to rent a home, investors may narrow in on a subject property with inherent demand.

Conversely, price-to-rent ratios which suggest it is more affordable to own a home, may reveal valuable opportunities for opportunistic investors. If for nothing else, the competitive nature of today’s market will relegate many potential buyers to the renter pool. Buyers who cannot make a purchase (based solely on the volume of competition in today’s market) will be forced to rent, despite having the financial means to close on a property. That means more renters are more likely to enter the rental market with increased savings. Investors with rental properties in higher-priced neighborhoods may simultaneously benefit from increased demand and cash flow.

When all is said and done, the price-to-rent ratio is a valuation tool. The variables the metric accounts for are only as valuable as the due diligence buyers, renters, and investors back them up with.


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Rent-to-price ratio

How To Calculate Price-To-Rent Ratio

Calculating the price-to-rent ratio isn’t nearly as complicated as many people make it out to be. In fact, the equation is relatively simple. All inquiring minds need to make their price-to-rent ratio calculation are two variables: the median home value in a given area and the average amount it costs to rent a comparable home in the same neighborhood for one year. Nest, apply each variable to the following equation:

Median Home Value/Annual Rental Rate

Calculating the price-to-rent ratio is that simple. Dividing the median home value by the amount it costs to rent a comparable home for 12 months will result in the price-to-rent ratio in a given neighborhood.

What The Price-To-Rent Ratio Can Tell You

Every price-to-rent ratio calculation will result in a decimal which can be translated in one of three ways:

  • 15 & Under: A price-to-rent ratio of 15 or less suggests it is more affordable to buy than rent.

  • 16-20: A price-to-rent ratio between 16 and 20 suggests it may be better to rent than buy.

  • 21 & Higher: A price-to-rent ratio of 21 or more suggests it’s better to rent than buy.

It is important to note that the PTR ratio has its limitations. Not only is it intended to compare renting and owning over the course of a single year, but it also doesn’t account for several important variables, not the least of which are outlined below.

Low Rate & Flat Rents

One of the single greatest deficiencies of the price-to-rent ratio is its failure to account for current interest rates. At the very least, interest rates are one of the most expensive variables to account for in homeownership, and the PTR ratio ignores them. Not only can monthly mortgage obligations vary dramatically based on their specific amortization, but the rate itself won’t factor into the comparison. As a result, the price-to-rent ratio fails to take one of the largest payment indicators into consideration, which can skew the answer one way or another.

Buyers, renters, and investors also need to be aware of the differences between the microeconomic and macroeconomics of rental properties. Over short periods of time, rental rates may fluctuate dramatically. However, when you take a step back and look at the macroeconomic picture, the last decade will reveal rental prices have remained relatively stagnant. In comparison, home values have risen exponentially. Therefore, the price-to-rent ratio will ultimately depend on what time of the year it is calculated, as rents tend to increase in the spring and summer months. Even the difference of a few months could throw off an entire calculation over the course of a year.

Last but certainly not least is the absence of “the cost of living” variable. The price-to-rent ratio is supposed to unveil the most affordable option between buying and renting. Still, the cost of living in a respective area can greatly influence whether or not owning or renting is more affordable. Both owning and renting come with additional costs, none of which are accounted for in the price-to-rent ratio.

Example Of The Price-To-Rent Ratio

Let’s say, for example, someone is trying to determine whether it’s more affordable to rent or own in San Diego. The median home value in San Diego is currently about $741,195, and the median rent price is somewhere in the neighborhood of $2,750/month.

Since the price-to-rent ratio accounts for annual rental rates, the first thing to do is multiply the monthly rental rate by 12 months. In doing so, the annual rent rate comes out to $33,000 ($2,750 x 12 months). Next, divide the median home value by the annual rental rate ($741,195 / $33,000). The answer will reveal a price-to-rent ratio of 22.46. With the PTR ratio in hand, all that’s left to do is translate the answer. At 22.46, San Diego’s price-to-rent ratio suggests it is more affordable to rent than buy.

Where To Find Price-To-Rent Ratios

Price-to-rent ratios are in constant flux, as home values and rents are subject to daily volatility. As a result, a comprehensive collection of price-to-rent ratios doesn’t exist. Instead, it is better to attempt the calculation yourself; that way, you are assured a more accurate answer.

While you may not be able to find the exact price-to-rent ratio you are looking for, it is entirely possible to locate the individual variables required to run the calculation. To do so, simply visit any of the online real estate valuation sites made available to the public. Zillow, RedFin and Opendoor all provide searchable databases for locating home values in a given area. Take note of the median home value, and begin looking for the same area’s median rent price. Sometimes the previously mentioned sites will have the information you are looking for, but more digging may be necessary to find rental prices. Popular sites which provide rental data include Apartment List and Zumper.

Summary

Whether you refer to it as the rent-to-price ratio or the price-to-rent ratio, there’s no denying this particular metric’s validity. Within minutes, a simple calculation can reveal if it is more affordable to own or rent a home in a given area. The applications are invaluable to everyone: renters, owners, and investors can benefit from learning how to calculate the price-to-rent ratio. That said, any resulting ratio is only as strong as the due diligence you are willing to put into the corresponding research. While the price-to-rent ratio is telling, it isn’t without its own flaws. For the price-to-rent ratio to work correctly, you will need to know how to complement its findings and identify its own shortcomings; hopefully, this article will be able to help you do both.

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