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SHOW NOTES FOR EPISODE 402: VIRUS UPDATE – PRICE-TO-RENT RATIO AND WHY IT’S IMPORTANT
We have more virus updates and new financial strategy information. Also, in the midst of a pandemic, it’s hard to think of real estate investing but, nonetheless, many are poised to take advantage of the great deals possibly ahead. In this podcast episode, Bill shares important data on a key analysis ratio that will be very helpful in finding good deals and good markets in the new economy.
Introduction
As we are learning to cope with a new life in the midst of the coronavirus pandemic, things such as social distancing, face masks, obsessively washing our hands and learning to work from home are our new reality! But then there are us real estate investors who also dealing with a host of other challenging issues – unemployed tenants, eviction bans, covering our mortgage payments, property taxes and insurance, and a host of other regular operational expenses such as maintenance and repairs, utilities, lawn care.. .
And then, there is the inevitable deal flow pipeline that we worked so hard to set up so we can still keep acquiring the deals that meet our criteria. And with that, we still need to stay on top of our key markets to see if there are shifts occurring as a result of the new economic challenges. That’s why our due diligence needs to refined and optimized to not buy in areas that were once hot and now and in trouble.
Our analysis and underwriting needs to include factors that
The real estate investing business is full of terminology, and one of the most important terms – especially for investors in traditional rental properties – is the price-to-rent ratio. While this real estate concept is relatively easy to understand and calculate, it’s a crucial factor in determining rental demand, rental income, and return on investment for long term investment properties for sale. That’s why we’ve put together this complete guide which will answer all questions you have about the price to rent ratio and its use in real estate investments.
What Is Price to Rent Ratio?
The price to rent ratio is a real estate term which is useful for both real estate investors (landlords) and renters (tenants). In simple words, this metric calculates the ratio between the average property price in a given housing market and the average annual rental rate there.
From a common person’s point of view, this measure compares whether renting a property or buying a home costs more, relatively speaking. Thus, the ratio helps individuals make an informed decision on the old dilemma of “rent vs. buy”.
In the case of real estate investors, the situation is a bit more complicated. The price to rent ratio affects demand for long term rental properties in any US housing market. This means that it has a direct effect on the return on investment to be expected in a location, in terms of both traditional cash on cash return and traditional cap rate. We will come back to the issue of how investors and landlords can make the best use of this real estate concept in a bit.
How to Calculate Price to Rent Ratio?
To get a full understanding of this real estate investing concept, here’s the price to rent ratio formula:
Price to Rent Ratio = Average Property Price/Average Annual Rent
Or
Price to Rent Ratio = Average Property Price/Average Monthly Rent x 12
As most people learn best through a hands-on experience, let’s have a look at an example. Here are the figures for the Houston real estate market:
Houston Housing Market Figures 2020
Average Property Price: $395,169
Average Monthly Rent: $1,825
Price to Rent Ratio in Houston = $395,169/$1,825 x 12 = 18
While the formula for calculating the price to rent ratio is simple and straightforward, it requires a significant amount of real estate data. To help out beginner real estate investors buy their first rental property, Mashvisor has developed a tool providing the needed data to calculate this ratio in any US housing market at the neighborhood level.
Mashvisor’s investment property calculator conducts neighborhood analysis for any US city and town, no matter how big or small. Looking at the neighborhood-level price to rent ratio makes much more sense when analyzing rental properties for sale. This is particularly true in such large markets as the Chicago real estate market, the Los Angeles real estate market, the New York real estate market, and others where areas witness major differences from one another.
At the neighborhood pages on Mashvisor’s real estate investment software app, investors can see the median property price in the area (which is very similar to the average property price) as well as the average monthly traditional rental income. All calculations are based on the performance of actual real estate listings and long term rental listings on the MLS and Zillow. Once beginner real estate investors have these two numbers, calculating the price to rent ratio in any neighborhood becomes easy.
How to Use Price to Rent Ratio in Real Estate Investing?
Now that you know what this metric is and how to calculate it on your own, you might be wondering of what use it is to real estate investors. In other words, “How can I use the price to rent ratio in my real estate investing decisions?” Actually, the answer to this important question is not straightforward. To begin with, the price to rent ratio is generally divided into three categories:
High: 21 or above
Moderate: 16-20
Low: 15 or below
Let’s see what each of these ranges means for both renters and real estate investors:
High Price to Rent Ratio
In such a real estate market, homes are too expensive compared to monthly rents, so the vast majority of people decide to rent rather than buy. This should be good news for investors as it translates into strong demand for long term rental properties. However, there are two possible risks which they should take into consideration before deciding to invest in rental properties for sale in a location with a high price to rent ratio. First, property prices might be prohibitively elevated not only for home buyers but also for real estate investors. Nationwide rental market analysis reveals that a few cities with a high ratio where investment properties for sale but also affordable home values include the New York real estate market, the San Francisco real estate market, the Boston real estate market, and the San Diego real estate market.
Second, even if beginner real estate investors can afford to buy a rental property in these markets, they are not always optimal for the traditional rental property investing strategy. Property prices are simply too high compared to rents to provide positive cash flow income properties with a high return on investment. For instance, the median property price in the Las Vegas real estate market (which has a high price to rent ratio) amounts to $444,100 – significantly below the locations mentioned above – but the cash on cash return for traditional rental properties reaches only 1.2%.
Moderate Price to Rent Ratio
Although generalizations should be avoided in the real estate investing business, markets with moderate price to rent ratios tend to be optimal for the traditional rental strategy. First of all, property prices are usually high enough to drive many people to choose to rent vs. buy. Simultaneously, the traditional rental income is not low enough to prevent landlords from achieving a high rate of return on a rental property. Of course, before deciding to buy an investment property in such a location, a smart investor needs to conduct diligent real estate market analysis as well as investment property analysis on traditional rental properties for sale within his/her budget. This is the only way to assure investing in positive cash flow properties with a good cash on cash return and a good cap rate each and every time.
Low Price to Rent Ratio
The risk of focusing your real estate investing energy on a market with a price to rent ratio below 15 is that it will be relatively difficult to find tenants. People in such markets prefer to buy vs. rent because home values are low compared to rental rates. These markets offer excellent real estate investment opportunities for marketing experts who can create outstanding rental listings and attract tenants, even amid a low rental demand. On the plus side, many US housing markets with low price to rent ratios are generally affordable, so rental properties for sale there are within the budgets of even first-time investors. Furthermore, the fact that rental income is high relative to property prices translates into a high return on investment, whether looking at cash on cash return or cap rate. And that’s what all real estate investors are after.
In conclusion, while this ratio is definitely one indicator which investors in traditional rental properties should consider, it does not suffice to make an informed decision. Performing more detailed rental market analysis with the help of the right real estate investment tools is a must.
What Price to Rent Ratio by City to Expect in the US Housing Market in 2020?
Even though calculating the price to rent ratio by city is absolutely doable for as many US housing markets as you’d wish to do it, it will be rather time-consuming and tedious. That’s why I’ve put together a list of U.S. Markets that have the more desirable Moderate Price-to-Rent Ratio cities.
Top Cities with Moderate Price to Rent Ratio in the US Housing Market in 2020
| CITY | PRICE TO RENT RATIO | AVERAGE PROPERTY PRICE | AVERAGE MONTHLY RENT | AVERAGE CASH ON CASH RETURN |
| Tampa, Fl | 20 | $ 419,300.00 | $ 1,720.00 | 1.5% |
| Chicago, IL | 19 | $ 450,100.00 | $ 1,970.00 | 0.7% |
| Dallas, TX | 19 | $ 416,300.00 | $ 1,810.00 | 0.5% |
| Atlanta, GA | 19 | $ 446,800.00 | $ 1,960.00 | 1.6% |
| Indianapolis, IN | 19 | $ 260,400.00 | $ 1,140.00 | 1.7% |
| Minneapolis, MN | 19 | $ 434,000.00 | $ 1,900.00 | 1.1% |
| Louiseville, KY | 19 | $ 264,900.00 | $ 1,140.00 | 1.3% |
| Pittsburgh, PA | 19 | $ 295,200.00 | $ 1,280.00 | 1.7% |
| Houston, TX | 18 | $ 395,200.00 | $ 1,830.00 | 1.5% |
| Orlando, FL | 18 | $ 347,600.00 | $ 1,640.00 | 1.5% |
| Philadelphia, PA | 18 | $ 324,200.00 | $ 1,470.00 | 2.1% |
| Palm Springs, CA | 17 | $ 615,000.00 | $ 3,010.00 | 2.2% |
| Columbus, OH | 17 | $ 241,700.00 | $ 1,190.00 | 1.3% |
| San Antonio, TX | 16 | $ 336,100.00 | $ 1,740.00 | 1.8% |
The price to rent ratio is one of the metrics a real estate investor must look at when buying a traditional rental property. However, it’s not the only one. Investing in positive cash flow properties with a high profitability requires comprehensive real estate analysis at both the neighborhood and the property level. To start searching for profitable investment properties for sale – whether MLS listings or off market properties – in markets with high, moderate, or low price to rent ratio today, sign up for Mashvisor.
DISCLAIMER: Many of the above strategies take knowledge and have a higher degree of risk. You need to do your research and/or work with someone who is experienced to reduce your risk.
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