I read an article recently in the New York Times entitled “Home Prices Seem far From Bottom”; one part of the article struck me as particularly interesting. It described a way of determining the relative value of a home by calculating the property’s “price-to-rent ratio”. This ratio is determined by taking the asking price of a home and dividing it by the annualized rent of a similar property.
“Price-to-Rent Ratio” – Utilizing this “price-to-rent ratio”, I think we have a measure of value that all Buyers can use when starting a property search. As the article explains, “The ‘price-to-rent ratio’… provides one measure of how much of a premium home buyers place on owning rather than renting ….” The article goes on to state that historically and nationwide, “the usual ‘price to rent ratio’ is 15”. So if a Buyer can find high quality properties in pleasant communities that are priced at or below a calculated ratio of 15 or less, the properties should represent good value. Right?
I Used It and It Works! – So I tested the ratio to see where some of our local communities stand, particularly in places that I instinctively feel are priced well. I checked out two communities where I have a good handle on recent rental prices and sale prices. To no surprise, I found that presently they have a “price-to-rent ratio” of 12 and 11, respectively. Drawing a comparison to the peak price years of 2005/2006, these same communities in those peak years had ratios of over 20; this is evidence that current prices have come down to a level within historical norms, and, to my way of thinking, represent good value. I further calculated the ratio in one community that I feel is still comparatively expensive, and indeed, the present ratio is over 27 indicating, at least by this measure, that the list prices in this particular community have some room to move down, or that potential buyers would be willing to pay a large premium to live there.
So I now have a simple, easy to understand, Rule of Thumb to give potential investors as a first step in evaluating a specific community for investment, or to a buyer looking to buy a principal residence. Its use could save time and effort in the initial evaluation of the many properties available to Buyers today.