Rent-to-Income Ratio: The Key to Financially Stable Tenants

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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 helpful when measuring a market’s health.

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.

What is rent-to-income ratio?

The RTI measures a very simple—but very important—concept for landlords: How much of your tenant’s income goes towards their rent? This can be a crucial calculation for estimating your renters’ financial stability.

Why is RTI Important?

RTI tells us two things:

Is rent affordable?

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.

I don’t want to be the type of landlord who squeezes tenants for more money than they can afford. Thus, any market or property with an RTI over 30 percent indicates to me that the tenant may be in an unsustainable financial situation. That’s not good for the tenant or the landlord.

For this reason, I typically look for markets and neighborhoods with a sub-30 percent RTI. But remember: 30 percent is just a guideline. You must examine the market holistically—the RTI is just one of several key data points.

Are rents sustainable?

A lot of the data we examine for BPInsights shows rent trends—which markets are seeing rents go up, and which aren’t. That data is super helpful, but past performance doesn’t guarantee future results. Just because rent has increased in the past does not mean it will continue to do so. That is why I use RTI to look at price sustainability.

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 climbed too high too fast and may fall in the future.

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

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.

That’s it! That is all the math you need to calculate RTI for any state, city, village, or neighborhood. If that wasn’t easy enough, BiggerPockets Pro and Premium members can download a spreadsheet for most of the country’s top 500 markets here. (Password: insights)

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 median income for the country or below. But high-income households can afford to put greater than 30 percent of their income towards rent.

Let’s use an extreme example: someone earning $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, Seattle and San Francisco.

To learn more about this, check out this great article on Earnest.

What weight do you place in RTI?

Let us know below.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.