Definition of Price to Rent Ratio
Price to rent ratio is defined as the ratio between the original price of the house if anyone buys it to the annual rent of a similar house if the person instead of buying prefers for renting the specific property where if the ratio is between 1-15 it is typically better to buy the house and if the ratio is more than 21 it is preferable to rent the same property.
Price to Rent Ratio is defined as the ratio between the original cost of the house if anyone buys it to the annual rent of a similar house if the person instead of buying prefers for renting the specific property. When the ratio stands between 1-15 it is typically better to buy the property rather than taking it as rent, 16-20 becomes a bit risky to enter into a buy agreement and lastly anything above 21, it is always advisable to rent than buy the property.
Formula
The formula to calculate the debt to price to rent ratio is as follows:
How does it Work?
Price to Rent Ratio indicates us whether buying a house is a good option or renting it. While this is very handy when we are comparing buying to renting, it does not always depict the overall affording limit of buying a property or in the same way renting in a similar market. So in theory in both places when owning and renting are expensive and cheaper too could have the same price to rent ratio. The price to rent ratio will only give us an idea about owning the house and renting it and whichever is cheaper but it cannot help us to decide on the affordability of housing when compared to other cities or places.
This ratio is used by both real estate investors and homebuyers to determine which option is cheaper i.e. either renting the property or buying the property. It basically compares the available demand of the rental property in the market based on the cost of ownership. The ratio also finds its use about what a home price should be in the prevailing market and what the structure of rent should be in the same market.
Examples of Price to Rent Ratio
Let us, for example, consider a classic example of buying or renting homes in the US market. According to a 2019 real estate survey, an average home in the US cost anything around $230,000 when we think of purchasing it where the same home when it is available for rent the monthly rent stands to be $1,600. This means that annual rent of the house will be $1,600 * 12 = $19,200.
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The price to rent ratio thus can be calculated as $230,000/$19,200 = 11.9. When the ratio stands between 1-15 it is typically better to buy the property rather than taking it as rent, 16-20 becomes a bit risky to enter into a buy agreement and lastly anything above 21, it is always advisable to rent than buy the property. Thus we see in the US it is still in a better market to own a home-based on the price to rent ratio we have calculated above.
Classification of Price to Rent Ratio
The price to rent ratio is classified into three categories namely and these are Low, Moderate and High. Anything below 15 is considered to be in the low category where the option of buying the house is more preferable than renting it. 16 – 20 is considered to be a moderate ratio where the option of renting is better than buying the house but then it depends on person to person and also the affordability.
Anything which is 21 and above falls under the high category and this is definitely a situation where renting is the best option compared to buying the house because prices are exorbitantly high or overvalued. Investing in cities with low price to rent ratios is also a good move because property prices are low because the owner can buy property at cheaper prices in form of cash rather than taking a loan and secondly rental income goes high with every passing time. The house bought at a cheaper price can fetch a higher rental income with every passing time.
Moderate price to rent ratio is also a good option but then one needs to be careful before taking a call. As a real estate investor, this tells us that we can anticipate a good demand for rental properties in the future. A high number of the ratio above 21 is definitely a signal where one should always go for renting the property instead of buying it. In these markets, property prices are too much expensive compared to rents in the real estate market. These markets may be an attraction for real estate investors due to the fact that they have strong rental demand prevailing in such areas.
Advantages
The following can be considered as the several advantages for the same:
- This is a very good trigger which helps people to make a decision about buying or renting
- It comes useful to both real estate investors and prospective house owners to decide their course of action
- It also places a major role in deciding the value of the house in a specific market or the cost of renting in the same market.
- The classification of the ratio in the above mentioned three categories i.e. low, moderate and high helps both home buyers and real estate investors decide which market to invest in and get the ROI analysis.
Conclusion
Price to Rent Ratio indicates us whether buying a house is a good option or renting it. This ratio is used by both real estate investors and homebuyers to determine which option is cheaper i.e. either renting the property or buying the property. It basically compares the available demand of the rental property in the market based on the cost of ownership.
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This is a guide to Price to Rent Ratio. Here we discuss the introduction to Price Rent Ratio along with the example, classification, working and the advantages. You can also go through our other related articles to learn more –
