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 property.
The Formula for the Price-to-Rent Ratio Is
Price-to-Rent Ratio=Median Annual RentMedian Home Price
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.
What Does the Price-to-Rent Ratio Tell You?
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.
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. The total cost of homeownership factors in mortgage principal and interest, property taxes, insurance, closing costs, homeowners association (HOA), mortgage insurance, and tax advantages such as the mortgage interest deduction. The total costs of renting factors in actual rent and renter's insurance.
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.
- Used as a benchmark for estimating whether it is cheaper to rent or own property.
- Compares the economics of buying versus renting, it says nothing about the affordability of either.
- Trulia’s own price-to-rent ratio is called the Rent vs. Buy Index, comparing the total costs of homeownership with the total cost of renting a similar property.
Example of How to Use the Price-to-Rent Ratio
As of the third quarter of 2018, the median home value was $330,000. The median home rent was $1,500 for the quarter. The price-to-rent ratio, thus, was 18.3, or $330,000 / ($1,500 x 12). This is across the US, but the price-to-rent ratio can also be calculated based on the city. As of Feb. 28, 2018, San Francisco had the highest price-to-rent ratio at over 50. Compare that to the price-to-rent ratio of Detroit, which comes in at just over 5.
For Trulia’s version of the price-to-rent ratio, before the housing bubble and subprime meltdown, its average 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 24.5 in 2007, before falling and bottoming out in 2012. As of July 2018, the ratio was 26.3. This is the lowest since 2012, suggesting that the benefit of buying relative to renting continues to shrink.
The Difference Between the Price-to-Rent Ratio and Housing Affordability Index
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 lays out whether an average family can afford the property based on home prices and income levels. The housing affordability is most often used as a gauge for qualifying for a mortgage.
Limitations of Using the Price-to-Rent Ratio
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.