How to Use Price-to-Rent Ratio to Analyze a Location
One of the most popular numbers people like to consider when analyzing a location is the price-to-rent ratio. In other words, what is the average ratio of the median monthly rent divided by the median purchase price in the area?
Let’s Break It Down
If that confused you, let me break it down a little further. The median sales price of an area is the point at which half the properties are more expensive and half the properties are less expensive. You can find this data in a number of places, but I’ve found the most accurate figures at www.zillow.com/research/data/, where you can download a massive amount of data about
nearly every zip code in America. Scroll down to the Other Metrics section, and click on Data in the zip code column.
You’ll be able to download a CSV (comma separated values) file, which you can open with Excel or Google Docs, and see the current and historical median sale price data for almost every zip code in the country. Find your local median sale price by searching for your zip code and write that number down somewhere. Then head back to www.zillow.com/research/data/ and
under Zillow Rent Index, download the data in the row marked All Homes in the zip code column.
Then, simply find your zip code and look in the column representing the most current quarter (all the way to the right). There you will find the median rental price for your zip code. To find the price-to-rent ratio, simply divide the first number by the second.
Price-to-Rent Ratio = Median Monthly Rental Price / Median Sales Price
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In my area, according to the data from Zillow, I’ve found my median monthly rental price is $839 and my median sales price is $106,846.15; therefore, my price-to-rent ratio is .7%.
Related: 6 Deal-Breakers that Disqualify a Market for Real Estate Investment
Now that I’ve shown you how to calculate this number, let me explain why you might not want to use it! As with any calculation, everything comes down to the data you input. Garbage in, garbage out. In the case of my area, I know that this data might be technically correct, but I also know it doesn’t take into account numerous factors.
For example, it doesn’t separate out the properties in the lower-income areas of this zip code. It doesn’t look at the condition of the properties. It doesn’t distinguish between properties of different sizes or number of bedrooms. It doesn’t look at a lot of things. When I purchase a single-family house in my area, I typically will pay approximately $50,000 for the home, which will rent for around $750 a month. This is a price-to-rent ratio of 1.5%, double what the data showed.
So keep in mind that although this data does have some use, especially in comparing one area with another, you must take this information with a grain of salt and look at properties with specifics, not averages, or you might miss out on a great location simply because of bad data.
What pieces of data do you use to analyze locations for investment?
Let us know with a comment!