What is Price-to-Rent Ratio and how it can help?

 

What is Price-to-Rent Ratio?


Price-to-rent ratio is a very good tool if you are deciding on whether or not to invest in a specific market. Some markets are very expensive with rents that are not keeping up, and other markets can be inexpensive with a decent average rent.

You can come up with a price-to-rent ratio by taking the median home value and divide that by the average annual rent for the market. This will give you a whole number, this is the price-to-rent ratio. Generally, the lower that number is the more cash flow you will be able to receive. 

 

Formula:

Median Home Value/Average Annual Rent=Price-to-Rent Ratio
Example: $100,000/$12,000= 8.33

How can it help?


Price-to-Rent ratio should not be the only thing you use when determining where to invest, however it can help you narrow down markets that you have in mind. 

Typically the lower the ratio the cheaper it is to buy and more expensive to rent, and the higher the ratio the more expensive it is to buy while the cheaper it is to rent. This is not always the case, as every market has different values, but this is a good generalization of how to use it.

For example, Detroit has a Price-to-Rent ratio of 4.4, which is very low. This might be enticing for an investor because you can purchase cheap properties that will cash flow well, however you will not be creating much wealth because properties do not appreciate very well. Where somewhere like Los Angeles, with a Price-to-Rent ratio of 27.9 makes it more affordable to rent, but over the past 22 years Los Angeles has seen appreciation of 277% compared to 29% in Detroit.

 

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