The definition of the price-to-rent ratio is very important for real estate investors. This ratio is a measurement for the affordability of a particular rental property and tells investors whether it is better to buy or to rent in a certain geographic area.
As the definition says, one has to divide the price of the property (or the average price of the properties in a city or neighborhood) to the rent that property brings after 12 months. To make it more clear, here is an example. If an investor wants to know whether to invest in a house with a market value of $300,000 and an average rent of $1,900/month, he will divide 300,000 by 1,900x12(months)=22,800 so the final price-to-rent ratio is 13.15.
If the ratio is below or equal to 15, then it will be a smart decision to buy, since that property has a good ROI. In the example above, that house is a worthwhile investment. Obviously, the higher the rent, the lower the price-to-rent ratio. So it makes sense to invest in properties with lower price-to-rent ratios.
Real estate agents have an eye for this kind of properties and most of them can match any kind of property with the right buyer or investor. And if the deal is really good, they might purchase it themselves! It’s enough to tell your real estate agent that you are looking for properties with a price-to-rent ratio below 10, and you will receive offers that match this criterion.
You also have to compare the rent with your monthly installment. Most real estate investors are looking for properties that pay for themselves. In this case, the property’s revenue should cover the mortgage payments over the life of the loan. This is the ideal investment. However, the definition of the price-to-rent ratio says absolutely nothing about the vacancy periods. So this ratio is important, but not strong enough to make a real estate investor buy a property right away.
However, real estate investors should not run away from expensive cities! A high price-to-rent ratio doesn’t mean that there are no affordable properties on the market. For example, San Francisco and Honolulu have a price-to-rent ratio over 40. Cities with a price-to-rent ratio of 10 or lower are Detroit (MI), Cleveland (OH), and Buffalo (NY). Properties with a good price-to-rent ratio in the most expensive cities appear sporadically on the market, but watching online listings every day or week, or keeping in touch with a real estate agent who understands what you are looking for will pay off.