What Investors Should Know About Rent to Income Ratio (+5 Great RTI Markets)
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When analyzing potential investment markets and neighborhoods, pay careful attention to the rent-to-income ratio (RTI). While this calculation isn't as popular or well known as the rent-to-price ratio or return metrics like return on investment and compound annual growth rate, I find it a good rule of thumb to measure a market's health. It's a quick way to assess housing costs on a large scale: Can tenants afford their rent payment? Do rents have room to grow?
Here’s a deeper look into the rent-to-income ratio—and why every real estate investor should know when and how to use it.
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What Is Rent-to-Income Ratio?
The RTI measures a very simple—but very important—concept for landlords: How much of your tenant’s gross income goes towards their monthly rent? This can be a crucial calculation for estimating your renters’ financial stability and ensuring your rental property reaps its maximum cash flow.
For decades, personal finance experts have recommended that tenants spend no more than 30 percent of their income on rent. This rough guideline means that a tenant making $30,000 per year can afford $750 per month in rent ($30,000 * 0.3 / 12) and still, in theory, afford other key expenses and savings.
If rent has grown for years and the RTI is still around or under 30 percent, the rent growth is likely sustainable. In fact, there might even be more room to grow. If rents are growing rapidly and the RTI has shot up to 35 or 40 percent—or even higher—that could spell trouble. Tenants may be at high risk of not making rent. Alternatively, it could indicate that rent climbed too high, too fast and may fall in the future.
Rent to income ratio and investors
For investors, calculating a market’s overall RTI can identify locations with solid investment potential. Here’s why:
- Budgeting experts recommend tenants spend around 30 percent of their income on housing, at most. Therefore, an RTI over 30 percent could indicate that renters are stretching their budgets to afford housing.
- RTI helps investors understand if rent growth is sustainable. Many markets have seen rapid rent growth over the last few years—but past performance doesn’t indicate future success. If rents have shot up but the current RTI is 45 percent, that gives me pause. Perhaps rents grew too fast and could soon fall.
How to Calculate RTI
The great thing about RTI? It’s extremely easy to calculate. You need only two metrics: median annual income and median rent. You can gather these metrics for an entire state, city, or neighborhood. No matter how granular your data is, the formula remains the same:
RTI = Median Rent / Median Income
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Let’s look at San Antonio. The city’s median income hovers around $49,000 per year, and the median rent price is about $1,200 per month, or $14,400 per year.
Just divide $14,400 by $49,000, and you’ll see that San Antonio’s RTI is 29.3 percent.
If you’re calculating a rent to income ratio for a prospective tenant, the calculation remains the same. Divide their monthly income by their rent (or use gross annual income and annual rent). That tells you how much rent they can really afford.
That’s it! That is all the math you need to calculate RTI for any state, city, village, or neighborhood.
Exceptions to the 30 Percent Rule
Just like with every real estate rule, there are exceptions to my above guidelines. With RTI, the most notable exception is for high earners.
The 30 percent guideline works best for households earning close to the median income for the country or below. But high-income households can afford to put greater than 30 percent of their income toward rent.
Let’s use an extreme example: someone with an annual salary of $200,000 per year, post-tax. Using the 30 percent guideline, this individual could afford to spend $60,000 on housing. If this individual wanted to spend $80,000 on housing, not $60,000, they would still likely be able to afford their other expenses and save money.
Therefore, in neighborhoods and properties geared toward high-income tenants, an RTI greater than 30 percent isn’t a huge concern. You see this dynamic in large metropolitan areas like New York City, Seattle, and San Francisco.
When calculating individual RTI for potential tenants, this is important to keep in mind, as well. But there are also exceptions for tenants in less-favorable unique situations, such as large student loan debt or credit card debt. Although on paper, their rent to income ratio looks reasonable, their financial situation isn't as great as the numbers might indicate. Ask for all of their income data—and make sure you know about their debts, too.
5 Great RTI Markets
Ready to start investing? Over at BPInsights, we’ve identified five markets with promising rent to income ratios. I calculated RTI across the largest 500 markets in the U.S. It came out to 28.6 percent, just under that 30 percent marker. For the five markets I identified—ranging from Alabama to Iowa—I found RTI ratios of 20 percent or less.
For savvy investors, there are fantastic deals to be found in these five cities. Want to learn more? Check out my September Markets of the Month at BPInsights—available as a free add-on for Pro members. (Not a Pro member? Upgrade your account today.)
How do you use RTI?
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