A price-to-rent ratio gives homebuyers a metric to determine whether buying or renting a property in a given location is cheaper. As the renter-owner ratio fluctuates, this affects the vacancy rates and the resale housing market. As such, it's critical for real estate investors to understand this metric.
As real estate investors, we need to be well acquainted with various metrics, including cap rates, net operating income (NOI), internal rates of return (IRR), and so forth. Here's an overview of price-to-rent ratios, how to calculate them, and what recent data is telling us about the renter-owner differences across the U.S.
How to calculate
Calculating a price-to-rent ratio
Calculating a price-to-rent ratio is straightforward. You take the median real estate sales price in your area and divide by the median annual rent amount, giving you the price-to-rent ratio.
For example, if home sales average $250,000, and the average median rent is $1,200/month, you would do the calculation like this:
Median house price ($250,000) / Median annual rent ($1,200 x 12 = $24,000) = 10.4
Easy, right? But how do we know what 10.4 means, and how does this compare to other areas across the country?
Key takeaway: The lower the price-to-rent ratio, the more favorable the environment is for buying a home vs. renting. A higher ratio indicates that property prices are high compared to rents and that renting may be a better option.
Keeping all this in mind, here are some general guidelines for understanding price-to-rent ratios in your specific area:
- Price-to-rent ratio of less than 15: It's cheaper and more affordable to buy than rent.
- Price-to-rent ratio of 16-20: Leans towards renting as a better option over buying.
- Price-to-rent ratio of more than 21: You are making a much better personal finance choice by renting.
Now, go calculate the price-to-rent ratio for your real estate portfolio. What did you find? What would be the same ratio of units in another jurisdiction nearby?
The data
The data
SoFi Technologies (SOFI -0.61%) recently looked at 52 large cities in the U.S. and compared their price-to-rent ratios. Not surprisingly, cities like San Jose and San Francisco came in near the top, with price-to-rent ratios of 40 and 38, respectively.
On the flip side, though, Detroit (6), Baltimore (13), Chicago (14), and Philadelphia (14) came in with the lowest price-to-rent ratios.
Impact of low interest rates
The impact of low rates and flat rents
One drawback of the price-to-rent ratio is that it doesn’t account for lower interest rates, which can make owning a home more affordable. A typical monthly mortgage payment can change dramatically based on the interest rate, which isn't accounted for in the price-to-rent ratio.
The price-to-rent ratio also doesn't account for living affordability across various markets. For instance, the cost of living in Missouri vs. New York City or San Francisco will be dramatically different.
Unfortunately, living in America in 2024 is very expensive almost everywhere. The cost of purchasing a house is up, interest rates are up, and rents are way up.
Where to find P/R ratios
Where to find price-to-rent ratios
There are a number of platforms that will give you a better idea of the different price-to-rent ratios in your real estate market. The easiest way is to calculate it yourself by using Census Bureau median home prices, and your own rental data in your portfolio. Otherwise, you can draw that data from platforms like Zumper, or Apartment List (or Rentals.ca for my Canadian peers).
You need your average price, which can be at the state or neighborhood level. Ideally, you would get as granular as possible to get the most accurate number. Prices in one location vs. another can change dramatically. The same goes for rents -- try to get as local as possible in your data.
Here are a few other websites that can help you find the data needed to make your calculation:
- Zillow: Its research center can give you data on average prices as well as rents across various markets in the U.S.
- Redfin: Similarly, Redfin has a data center that gives you the data required to make a price-to-rent calculation.
- NAR: You can subscribe to or keep an eye on the National Association of Realtors' Economists' Outlook, which regularly publishes data related to prices and rents.
Related investing topics
Bottom line
Understanding the economics of buying and renting real estate is critical for a real estate investor. If your real estate market favors homebuying more than renting, it might be time to explore what other markets around you are doing. Would you have a larger renter pool if you looked at a market with a higher price-to-rent ratio?
This calculation is simply one of the many investing metrics you need to consider as you explore different investment opportunities. Learn and practice how to calculate the price-to-rent ratio and apply the logic and analysis of this ratio to your investment due diligence.
