What is the Price-to-Rent Ratio
The price-to-rent ratio is the ratio of home prices to annualized rent in a given location, and is used as a benchmark for estimating whether it is cheaper to rent or own a property.
BREAKING DOWN 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 dramatic increase in the ratio leading up to the 2008-2009 housing market crash was, with hindsight, a red flag for the housing bubble.
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 Mid-Western town where both homes and rents are relatively cheap.
Price-to-Rent Ratio in Practice
In the United States, online residential real estate website Trulia used to produce a 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 factors in mortgage principal and interest, property taxes, insurance, closing costs, homeowners association (HOA) dues where appropriate, mortgage insurance where appropriate, and tax advantages such as the mortgage interest deduction. The total costs of renting factors in actual rent and renter's insurance.
Trulia’s 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 established 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.
Historical Price-to-Rent Ratios
Before the housing bubble and subprime meltdown, the average Trulia price-to-rent ratio was around 15. This indicates that prices are currently still more favorable to renters than buyers, from a historical perspective. The ratio rose to 24.50 in 2007, before falling and bottoming out in 2012.
As can be seen in the chart below, which is calculated using S&P/Case-Shiller home price indices and the owners equivalent rent index published by the Bureau of Labor Statistics, price-to-rent ratios have recovered nationally, but in 2018 are still modest compared to the peak of the housing bubble in 2006. However, there are still many cities in the U.S. which have extreme price-to-rent ratios, such as San Francisco, Los Angeles and New York City – where renting is clearly more affordable than buying.