What is Price-to-Rent Ratio?
The Price-to-Rent Ratio compares the purchase price of a property to its rental income to estimate the potential return on a rental investment.
How to Calculate Price-to-Rent Ratio
In real estate investing, the price-to-rent ratio is a metric used to determine whether purchasing a property or renting it is more economically viable.
The price-to-rent ratio is most often used to analyze houses available for rent (or to potentially purchase if the seller is offered the right price).
The price-to-rent ratio is calculated by dividing the purchase price of the property by the gross rental income it can generate on an annual basis.
By comparing the property price to the rental income of the property, real estate investors can retrieve practical insights into the potential return on investment (ROI).
- Low Price-to-Rent Ratio → Potential to Generate Long-Term Profitable Returns
- High Price-to-Rent Ratio → Risk of Generating Poor Returns
The ratio also serves as an indicator of how appealing a particular location is for rentals and indicates the current level of demand from new buyers and investors.
Generally, a market with a high price-to-rent ratio is implied to be a compelling opportunity for rental investments.
Conversely, a market with a low price-to-rent ratio is likely better suited for property ownership rather than renting the property (or units) to tenants.
Broadly put, a price-to-rent ratio of 15.0x to 20.0x is the “sweet spot” for real estate investors to maximize profits and returns.
- Price-to-Rent Ratio < 15.0x → A sub-15.0x ratio is unlikely to generate enough cash flow for the investor to achieve their target return
- Price-to-Rent Ratio = 15.0x to 20.0x → From a profitability standpoint, the decision the rent rather than purchase becomes far more compelling around here
- Price-to-Rent Ratio > 20.0x → A ratio that exceeds 20.0x is certain to be more profitable than outright purchasing the property (and is worth the risk)
Price-to-Rent Ratio Formula
The formula to calculate the price-to-rent ratio is as follows.
The equation is relatively straightforward since the median home price in the selected area is divided by the approximate annual rent pricing in the market, which can be estimated using online data sources.
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We’ll now move on to a modeling exercise, which you can access by filling out the form below.
Price-to-Rent Ratio Calculation Example
Suppose we’re tasked with calculating the price-to-rent ratio for the Manhattan real estate market as of July 2023.
Upon compiling the relevant market data, we determined our two formula inputs as the following:
- Median Home Value = $1,344,000
- Median Annual Rent = $61,200 ($5,100 × 12)
By dividing the median home value by the median annual rent, the implied price-to-rent ratio in Manhattan is 22.0x.
- Price-to-Rent Ratio = $1,344,000 ÷ $61,200 = 22.0x
Historically, New York City (NYC) has been a city where the majority of householders are renters.
In fact, approximately two-thirds of households in NYC are renter households.
The median gross rent in NYC has risen by 16.2% across the past decade, with Manhattan ranked at the top for the highest median gross rent.
The borough in New York that incurred the steepest decline in the share of rental households was Manhattan, as expected, given the market rate rent and the highest price-to-rent ratio of the five boroughs.
