How to Use Price-to-Rent Ratio to Analyze a Location

by | BiggerPockets.com

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

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

The Drawbacks

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!

About Author

Brandon Turner

Brandon Turner (G+ | Twitter) spends a lot of time on BiggerPockets.com. Like… seriously… a lot. Oh, and he is also an active real estate investor, entrepreneur, traveler, third-person speaker, husband, and author of “The Book on Investing in Real Estate with No (and Low) Money Down“, and “The Book on Rental Property Investing” which you should probably read if you want to do more deals.

12 Comments

  1. Scott Sklare

    Brandon, excellent article as usual. Very helpful. For those that are interested, I am fortunate to find, buy, sell, 2% rent to purchase price deals on a regular basis. These are located in a very nice blue collar, solid metro market called Janesville-Beloit, Wisconsin. Feel free to contact me if you are interested. Amazing ROI, amazing cash flow.

    • Michael P. Lindekugel

      not sure how that measures risk. risk is typically identified and measured as the delta between IRR or capitalization rate and the treasury rates. that is pretty much for all asset classes. i have seen markets with high and low price/rent ratios and neither changed investor behavior.

      seems to me the affordability index would be a better measure. when it becomes more unaffordable to own there is a strong rental market pushing up demand and rents absent an increase in the supply. when renters get priced out of the core market that pushes demand out into secondary markets.

    • Vaughn K.

      I think you’re correct that it is the way “the market” views risk. AKA the combined group “wisdom” of all people… But is it the way an INTELLIGENT person would view the risk? Often times the answer is no, because the wisdom of the crowd is often not very wise.

      I believe VERY strongly in fundamentals. At the end of the day if the math doesn’t jive, then there will be a correction that makes the math jive sooner or later. PERIOD. However, human irrationality drives the market as much or more than fundamentals for periods of time. Irrational booms and busts are all emotion, and no logic/math.

      Anybody with a head on their shoulders should have seen the market in 07/08 and realized it was in a bubble. I did. Lots of others did. Likewise when the stock market was at its lows, and some people were terrified of investing in stocks while it was in the toilet, anybody with a brain could look at P/E ratios and other metrics and see it was an AMAZING time to buy. Just as one can look at stocks today and see they’re overvalued again. It’s not hard. You just turn off the emotions, and look at the math.

      So the TRICK is to be smarter than the collective wisdom of all people in a market, which isn’t hard since most people are idiots. If you see high rent/purchase ratios, BUT the fundamentals for the area look good (job growth, wage growth, unemployment, the area is staying comparably nice or getting nicer, etc), then that is a buy right there!

      Markets are dumb. Smart investors see where the markets SHOULD BE, and invest according to that, because eventually they will come around that direction. Irrationality CAN sustain distortions in the market for long periods of time, which needs to be taken into account by investors, but it will eventually go where the math says it should be.

      Right now trendy coastal city real estate is in a mild to massive bubble, depending on the market in question. Most of the rest of the country is just about right where it should be though. Stocks are mostly over priced. Precious metals, especially silver, are under priced. It is what it is. Invest in what you know, but always heed the fundamentals, mixed with a little common sense.

  2. Martin Stocker

    Hi Brandon! I was working through your Ultimate Beginners Guide and just was checking BP posts to air my brain.
    That’s when I ran into this post. Now I feel real dense. Everything was just fine until I read Scott’s comment which did not make sense to me judged by your written definition, stating median rent divided by median purchase price.
    Went over to Investopedia and Mashvisor. There they state that it is the Average Listing Price divided by the Average Rent Price PER YEAR!
    Using average vs median by itself makes a big difference and then month vs year adds to that. Also price/rent sounds more like the name of the Ration (Price-To-Rent Ratio).
    Scott’s Comment about being a measure for risk I assume means that a high ratio indicates it is more expensive to buy vs to rent. That should then also mean, yes there are more renters lining up but your return on investment is reduced and also before the last bubble the index rose sharply, so in hindsight a high index can be seen as a warning sign of a bubble. Could someone please enlighten me!! I am currently I am currently trying to wrap my mind around lingo and metrics and here I right away am running into a roadblock.
    Thanks in advance.

  3. John Murray

    I have used the formula $Medium home value/$12K. This output represents the ability for the average person to either purchase or rent. Outputs below 25 usually favor entry level borrowers /owner and above 30 represents renting makes it more desirable. I live in Portland Oregon, my numbers are $425K/$12K= about 35. The 35 output means the entry level person would more than likely rent than purchase. This makes sense statistically. 66% of residents rent and 33% own. Punch the numbers for San Francisco, Seattle or the monster NYC and get a very different ratio. The outputs can be interpreted as a starting point and other factors add in such as median age, median income and desirability of a local neighborhood. Right now it makes more sense for me to liquidate my portfolio than to renovate and rent again since my profit margin is higher and the Feds give me a large capital gains break. I just wait until a tenant moves out and renovate to sell.

  4. Scott Sklare

    I find the rent to purchase price ratio a great tool, a great starting point to determine if a deal is worth looking at and pursuing.

    We are fortunate that in south-central Wisconsin we put together many deals that are consistently 2% rent to purchase price. These properties are in excellent, blue-collar neighborhoods where the median household income is right around $50K, which is right smack 2.5 to 3.0 our $1200/month rent. If anyone is interested or curious I would love to visit with you.

  5. Amir Ajami

    The way Zillow defines price to rent is reverse of what you described here. Zillow’s data include a price to rent data file but their definition are as following:

    Price to Rent Ratio: This ratio is first calculated at the individual home level, where the estimated home value is divided by 12 times its estimated monthly rent price. The the median of all home-level price-to-rent ratios for a given region is then calculated.

    Given this above definition I guess the lower the price to rent the better deal you can find as you get more rental income for a given dollar of home value.

    • Vaughn K.

      You’re still mathematically coming to the same conclusion, it’s just how you’re displaying it. Dividing it by the annual number versus monthly doesn’t change the math, just how it is “displayed” to you.

      So if comparing 2 houses, both ways of doing that math will show you the exact same gaps, it’s just if you want to think about it in monthly or annual terms.

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