Real Estate P/R originally published March 6, 2006. The ratio was extremely high at the time. Was this the harbinger of the dark days ahead?
In the February issue of Best Life Magazine, Chris Taylor says the simple price-to-rent ratio may be a useful tool in helping you decide whether it’s better to rent or buy a particular property. It’s also a simple indicator of an overpriced housing market, according to Gleb Nechayev, Senior Economist with Torto Wheaton Research, part of CB Richard Ellis. Mr. Nechayev is responsible for all residential real estate research for the company.
The price/rent ratio is used like a stock’s price earnings ratio. It is calculated over time and charted to determine predictable patterns.
To determine the ratio, you divide the price of the property by the comparable annual rental cost. In his example, if a $200,000 house can be rented for $920 a month, or $11,040 annually, the price/rent ratio is about 18:1. Chris says that’s extremely high, historically speaking. And it just so happens to be the current national average. He points out that when the real estate market nose dived between 1979 and 1989, the ratio was 14:1.
If you rely on stock charts to make stock decisions, you may want to calculate the real estate P/R in your market. If you find the P/R ratios rich, Chris advises you to rent rather than buy. Then take the money you save by renting versus making the monthly mortgage/tax payment and invest it somewhere else. When the market adjusts (read sales prices fall), swoop in and buy. Then brag to your friends what a genius you really are.
The author cautions against blind faith in the ratio. He says it’s not a perfect predictor because the national average takes into account apartments in large cities and not houses in the suburbs. In other words, don’t use it like Kelley Blue Book.
Best Life Magazine offers smart tips, advice and cutting edge information on topics, it says, matter to men. If it matters to men it should also matter to women. Decide for youself. Go to the Best Life website and sign up for a free trial issue.
I’ve never heard of the price/rent ratio before. I think there’s a lot more to it than just that, though. By renting the place even for just a year, you’ve wasted $11,040 that could have been used to build equity, so that’s an opportunity cost. Depending on what your mortgage might be, that might be the wise decision assuming you have a very small down payment and high monthly payment.
It is certainly very interesting, but one of the basic fluctuations is going to be the cost of money… If the interest rate to buy the home is 5%, and the payment to purchase is $1000/mo. that $920 looks entirely different that if the interest rate is 13% and the home costs $2100/mo. to buy.
Aside from that, it is quite an interesting ratio to track. I guess if I were doing it, it wouldn’t be price/rent, but payment/rent.
Many people are saying that now is clearly the time to buy. Whether it is for investment sake or a place to live, there are many bargains out there and if you have the stomach for it, try a short sale ~ you can save even more.