The price-to-rent ratio is an insightful metric that compares home prices to annualized rent within a specific area. It is pivotal for assessing whether it’s more economical to rent or own property, serving as a valuable barometer for gauging market valuation and identifying potential bubbles in housing markets.
Key Takeaways
- Benchmark Criterion: The price-to-rent ratio is a benchmark for determining the cheaper option between renting or owning a property.
- Comparative Analysis: It compares buying versus renting costs, though it doesn’t address the affordability of either option.
- Practical Indexes: The advanced Trulia Rent vs. Buy Index offers a comparative analysis of the total costs associated with homeownership versus renting a comparable property.
Formula and Calculation of Price-to-Rent Ratio
To calculate the price-to-rent ratio, you need to divide the median home price by the median yearly rent. Here’s the formula expressed mathematically:
Price-to-Rent Ratio = Median Home Price / Median Annual Rent
Example Calculation
Consider the scenario where the median home price is $300,000 and the median annual rent is $18,000. The price-to-rent ratio would be calculated as follows:
Price-to-Rent Ratio = $300,000 / $18,000 = 16.67
What the Price-to-Rent Ratio Reveals
The price-to-rent ratio helps highlight the valuation of housing markets. For example, an increasing ratio may signal impending market bubbles. Specific thresholds can guide renting or buying decisions as follows:
- A ratio of 1 to 15 suggests it might be significantly cheaper to buy than rent.
- A ratio of 16 to 20 typically indicates a lean towards renting being more cost-effective.
- A ratio of 21 or higher generally suggests that renting might be a much preferable option.
Practical Implications on Home Buying and Renting
Besides the ratio itself, total cost layers contributing to homeownership include mortgage payments (principal and interest), property taxes, insurance, and various associated fees (e.g., homeowners association fees). Benefits like mortgage interest deductions are factored in as well.
Conversely, renting costs are straightforward, usually encompassing monthly rent and renter’s insurance.
Special Considerations Affecting Housing Decisions
While the price-to-rent ratio offers an economic equivalence between buying and renting, it is context-sensitive. High-rent cities like San Francisco and New York might show the same ratios as more modest towns, while markedly differing in absolute housing costs. Hence, additional considerations like the Housing Affordability Index, reflecting whether the average family qualifies to buy a home, should also be factored into decision-making.
Example of Using the Price-to-Rent Ratio
Consider data from the second quarter of 2020 when the median home value stood at $291,300, and the median rent was $1,463 per month. The price-to-rent ratio was derived as follows:
Price-to-Rent Ratio = $291,300 / ($1,463 * 12) ≈ 16.6
This calculation reflects the wider U.S. market. However, the specific ratio may differ significantly by city. Notably, the Trulia price-to-rent ratio hovered around 18 at that time, indicating a tilt towards renting as a more advantageous option in the prevailing conditions.
Related Terms: homeownership, mortgage, renting, housing affordability index
References
- Trulia. “Trulia’s Rent vs. Buy Index Reveals Top 10 Cities for Renting, Owning Homes”.
- National Association of REALTORS. “Median Sales Price of Existing Single-Family Homes for Metropolitan Areas”.
- Yardi Matrix. “Matrix Monthy - Aug. 2020”.
- SmartAsset. “Price-to-Rent Ratio in the 50 Largest U.S. Cities – 2020 Edition”.
