A price-to-rent ratio gives homebuyers a metric to determine whether it’s cheaper to buy or rent a property in a given location. This, in turn, affects the vacancy rates and the resale housing market as the renter-owner ratio fluctuates. 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), IRR, and the list goes on. 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.
Calculating a price-to-rent ratio
Calculating a price-to-rent ratio is straightforward. You take the median 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 at $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, versus renting. A higher ratio indicates that property prices are high compared to rents and that renting may be a better option.
By way of comparison, in 2019 Alabama had an overall price-to-rent ratio of 11, whereas Delaware for the same time period sat at 46.6. This means that in Alabama it was much more financially savvy to buy a home (because they’re cheaper) than to rent. Whereas in Delaware, because rents were low in 2019 (average: $1,225) and house prices were high (average: $684,892), it made much more sense to rent than to buy. But more on this later.
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 versus rent.
- Price-to-rent ratio of 16-20: Leans towards renting as a better option over buying.
- Price-to-rent ratio of over 21: By renting you are making a much better personal finance choice.
Now, go calculate the price-to-rent ratio for your portfolio, what did you find? What would be to the same ratio of units in another jurisdiction nearby you?
Recent data from the National Association of Realtors (NAR) sheds some light on the current state of price-to-rent ratios across the U.S. Now that you understand what price-to-rent ratios mean, here is a state-by-state breakdown of the data: