Rent to Buy Ratio

In early 2011, the price-to-rent ratio suggests that it's better to buy than rent in most U.S. cities.

If you're looking for housing and are wondering whether to rent or buy, there are many tools that can help you decide. One of these is the rent-to-buy ratio, more commonly called the price-to-rent ratio, which compares the median costs of renting versus the median costs of owning. Both the rental market and the real estate market offer a similar product---housing---and the price-to-rent ratio tells you which of them is presently more favorable to the consumer.

A Comparison of Markets

As a market gauge, the price-to-rent ratio doesn't say anything about whether you personally would save more money renting or buying. It also doesn't tell you anything about an individual apartment or house. It sticks strictly to median market values, a degree of generalization necessary to preserve the ratio's accuracy. Thus, the price-to-rent ratio is only one tool out of several that you can utilize to make a fully informed decision whether to rent or buy.

The Equation

The price-to-rent ratio is the quotient of the median price of buying a home in a given city or town, and the median price of one year's rent there. So, if the median price of a home is $240,000 and the median price of a year's rent is $19,000, simply divide those two numbers and you'll see that the price-to-rent ratio is about 12.6. In other words, after 12.6 years of renting you would have spent more money than the purchase price of the $240,000 home, not accounting for inflation. Also, you can resell a home, recouping part or all of your original purchase cost, whereas rent money never comes back to you.

Conventional Wisdom

The conventional wisdom says that if the price-to-rent ratio is less than 20, the real estate market is more lucrative and consumers are likelier to get ahead by buying, while if the ratio is more than 20 then the rental market is more lucrative and consumers are likelier to get ahead by renting. The "20" figure isn't a rule of nature. Economists derived it from looking at past data, and it varies from city to city.

Present Outlook

According to Moody's Analytics, in 2010 the price-to-rent ratio for the metropolitan United States was 14.9, suggesting that many people would be better off buying than renting. This meshes well with the real economic picture. Housing prices declined steeply when the housing bubble burst in 2008. Many people were forced to rent after losing their homes, and others chose to rent because the decline in housing prices continued for years and made real estate investments look risky. Banks tightened their home loan rules, further cooling home purchases.

Most U.S. cities had ratios between 14.0 and 18.0 in 2010, but some outliers included Seattle with a rating of 27.0 and Charlotte with 26.0, suggesting a better market for renting in those cities, and, on the other extreme, Detroit at 12.3 and Atlanta at 12.9.

A Word of Caution

The price-to-rent ratio doesn't predict the future. It analyzes the present. If the economy goes in a starkly unexpected direction, either locally or nationally, the usefulness of the ratio goes out the window. In 2011 the national economy is still in a fragile recovery from the Great Recession, and conditions are tenuous. Do not use the price-to-rent ratio as your only method for deciding whether to rent or buy.

References

• CNN Money: Rent vs. Own Ratio to Flip in 2011?
• New York Times: Breaking Down the Rent-Buy Equation