What is 'Price-to-Rent Ratio'
The price-to-rent ratio is a well-established economic principle used for real estate valuation. It is typically calculated as the ratio of home prices to annualized rent in a given location. At its most basic level, the price-to-rent ratio is a benchmark for understanding whether is it better to rent or buy a property.
BREAKING DOWN 'Price-to-Rent Ratio'
The price-to-rent ratio can also be used to understand broader macroeconomic trends. For example, the ratio increased dramatically leading up to the 2008-2009 housing market crash. In retrospect, this was a red flag of a housing bubble. While the ratio compares the economics of buying versus renting, it does not provide information about the overall affordability of a market or individual property. For example, Manhattan (where homes are very expensive) could have the same price-to-rent ratio as a small town where homes are relatively cheap.
Price-to-Rent Ratio in Practice
The online residential real estate website Trulia produces a proprietary version of the price-to-rent ratio called the "Trulia Rent Vs. Buy Index" that compares the totals costs of homeownership with the total cost of renting a similar property. The total cost of homeownership considered by the ratio factors in mortgage principal and interest, property taxes, insurance, closing costs, HOA dues where appropriate, mortgage insurance where appropriate, tax advantages for owning — such as the mortgage interest deduction. The total costs of renting factors in actual rent and renter's insurance.
The price-to-rent ratio provides a comparison between owning and renting properties in certain cities. The ratio uses the average list price with average yearly rent on two-bedroom apartments, condos and townhomes that are listed on www.trulia.com, a real estate search website. The price-to-rent ratio is calculated by dividing the average list price by the average yearly rent price, as follows: Average list price / (Average Rent * 12). Trulia establishes thresholds for the ratios as follows: a price-to-rent ratio of 1 to 15 indicates it is much better to buy than rent; a price-to-rent ratio of 16 to 20 indicates it is typically better to rent than buy; and a price-to-rent ratio of 21 or more indicates it is much better to rent than buy.
Price-to-Rent Ratio City Rankings
U.S. Census data shows there are 33 cities in the U.S. with price-to-rent ratios above the 21 threshold. The top 10 cities in terms of price-to-rent ratios are San Francisco, Honolulu, Oakland, Los Angeles, New York City, Seattle, San Jose, Long Beach, Washington, D.C. and Anaheim. The average price-to-rent ratio of these 10 cities is 36.6, suggesting that renting is a more economically rational decision.