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. This ratio is used as a benchmark for estimating whether it’s cheaper to rent or own property. The price-to-rent ratio is used as an indicator for whether housing markets are fairly valued, or in a bubble.
Key Takeaways
- Price-to-rent is used as a benchmark for estimating whether it is cheaper to rent or own property.
- It compares the economics of buying versus renting but 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.
Formula and Calculation of Price-to-Rent Ratio
The price-to-rent ratio is calculated by dividing the median home price by the median yearly rent and the formula for the price-to-rent ratio is as follows:
Price-to-Rent Ratio=Median Annual RentMedian Home Price
What the Price-to-Rent Ratio Can 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.
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.
Special Considerations
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. This index is most often used as a gauge for qualifying for a mortgage.
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 Midwestern town where both homes and rents are relatively cheap.
Example of How to Use the Price-to-Rent Ratio
As of the second quarter of 2020, the median home value was $291,300. The median home rent was $1,463 for August 2020. The price-to-rent ratio, thus, was 16.6, or $291,300 / ($1,463 * 12). This is across the U.S., but the price-to-rent ratio can also be calculated based on figures for a specific city.
The total costs of renting factors in actual rent and renter’s insurance.
For Trulia’s version of the price-to-rent ratio, it currently sits at around 18, suggesting it’s better to rent than buy as of April 2020.
