In real estate, the price to rent ratio is a tool to determine how
the total cost of home ownership compares to the annual rent for homes
in an area. The average list price typically is used to determine
whether it is preferable to buy or to rent in an area.
Usually, if the price to rent is 15 or less, then it is much better
to buy than it is to rent. If the price to rent is between 16 and 20, it
is typically more favourable to rent, and if it is over 20 then
generally it will be significantly better to rent than to buy.
The price to rent ratio can help predict how market prices might
change and what properties will ultimately prove a strong investment.
The main force behind this is in areas where the price to rent ratio is
different than the average; it gradually tends to move in a way that
will realign it with the average.
This means that if the price to rent ratio is higher than the
overall average, property prices will either decline or at least not
increase while prices in areas around it rise, and is thus considered to
be a weaker investment.
However, if the price to rent ratio is at a value that is lower than
the average, then the chances are good that property values will
increase over time, making it a strong investment.
Calculating the Price to Rent Ratio
Calculating the price to rent ratio follows a very simple formula –
you take the real estate price and divide it by the annual rent.
Real Estate Price/Annual Rent = Price to Rent Ratio
So, if a home costs $500,000, and the annual rent was $50,000, it
would have a price to rent ratio of 10. This home would be better to buy
than to rent, and a sound investment opportunity as well.