Understanding the Price-to-Rent Ratio: Is Buying or Renting Better?

What Is the Price-to-Rent Ratio?

The price-to-rent ratio compares home prices to annual rent, helping to determine if it's cheaper to rent or buy. This ratio is used as a benchmark for estimating whether it's cheaper to rent or own property. The price-to-rent ratio indicates if housing markets are fairly valued or in a bubble.

How to Calculate the Price-to-Rent Ratio

The price-to-rent ratio is calculated by dividing the median home price by the median yearly rent and the formula for the price-to-rent ratio is as follows:

 $\begin{aligned} &\text{Price-to-Rent Ratio} = \frac{ \text{Median Home Price} }{ \text{Median Annual Rent} } \\ \end{aligned}$​Price-to-Rent Ratio=Median Annual RentMedian Home Price​​

Understanding the Insights from the Price-to-Rent Ratio

The price-to-rent ratio is used as an indicator for whether housing markets are fairly valued, or in a bubble. The rising ratio before the 2008-2009 housing market crash was a warning sign of the bubble. Trulia produces a price-to-rent ratio called the Trulia Rent Versus Buy Index, which compares the total costs of homeownership with the total cost of renting a similar property.

Homeownership costs include mortgage, taxes, insurance, homeowners association (HOA) fees, and tax benefits like the mortgage interest deduction.

Trulia's thresholds suggest that a ratio of 1-15 favors buying, 16-20 leans toward renting, and 21 or higher strongly favors renting.

Additional Considerations When Using the Price-to-Rent Ratio

The price-to-rent ratio shows whether buying or renting would be best for a particular property in a given market. The housing affordability index shows if an average family can afford a home based on prices and income. This index is most often used as a gauge for qualifying for a mortgage.

While the price-to-rent ratio compares the economics of buying versus renting, it says nothing about the overall affordability of buying or renting in a given market. Cities where both renting and buying are very expensive, such as San Francisco or New York, could have the same price-to-rent ratio as a small Midwestern town where both homes and rents are relatively cheap.

Practical Example: Applying the Price-to-Rent Ratio

As of the second quarter of 2020, the median home value was $291,300. The median home rent was $1,463 for August 2020. The price-to-rent ratio, thus, was 16.6, or $291,300 / ($1,463 * 12). This is across the U.S., but the price-to-rent ratio can also be calculated based on figures for a specific city.

For Trulia’s version of the price-to-rent ratio, it currently sits at around 18, suggesting it's better to rent than buy as of April 2020.