What Is the Price-to-Rent Ratio?
Let me explain the price-to-rent ratio directly: it's the ratio of home prices to annualized rent in a specific location. You can use this as a benchmark to figure out if it's cheaper for you to rent or own property. It also acts as an indicator of whether housing markets are fairly valued or potentially in a bubble.
Key Takeaways
- Price-to-rent serves as a benchmark for estimating if it's cheaper to rent or own property.
- It compares the economics of buying versus renting but doesn't touch on the affordability of either option.
- Trulia’s price-to-rent ratio, known as the Rent vs. Buy Index, compares the total costs of homeownership with the total cost of renting a similar property.
Formula and Calculation of Price-to-Rent Ratio
You calculate the price-to-rent ratio by dividing the median home price by the median yearly rent. The formula is straightforward: Price-to-Rent Ratio = Median Home Price / Median Annual Rent.
What the Price-to-Rent Ratio Can Tell You
This ratio tells you if housing markets are fairly valued or heading toward a bubble. Looking back, the sharp rise in the ratio before the 2008-2009 housing crash was a clear warning sign of the bubble. Trulia's version, the Rent Versus Buy Index, looks at the total costs of homeownership compared to renting a similar property.
Those total homeownership costs include mortgage principal and interest, property taxes, insurance, closing costs, HOA fees, mortgage insurance, and tax benefits like the mortgage interest deduction.
Trulia sets these thresholds: a ratio of 1 to 15 means it's much better to buy than rent; 16 to 20 suggests it's typically better to rent; and 21 or higher indicates it's much better to rent.
Special Considerations
The price-to-rent ratio shows you whether buying or renting is best for a specific property in a given market. In contrast, the housing affordability index checks if an average family can afford the property based on home prices and income levels—it's often used to qualify for mortgages.
Remember, while this ratio compares the economics of buying versus renting, it doesn't say anything about the overall affordability in that market. For instance, cities like San Francisco or New York, where both renting and buying are expensive, might have the same ratio as a small Midwestern town where both are relatively cheap.
Example of How to Use the Price-to-Rent Ratio
Take the second quarter of 2020 as an example: the median home value was $291,300, and the median monthly rent was $1,463 in August 2020. So the price-to-rent ratio comes out to 16.6, calculated as $291,300 divided by ($1,463 times 12). You can apply this to the whole U.S. or just a specific city.
Keep in mind that the total costs of renting include actual rent and renter's insurance. For Trulia’s version, it was around 18 as of April 2020, suggesting it's better to rent than buy.
