The best places to buy rental property are those with high rental demand, affordable real estate properties, and high rental income. A good starting point to assess the profitability of a given location is to look at its price to rent ratio (P/R). This ratio, along with other real estate metrics, can help real estate investors make investment decisions for a given location. So, what is the best price to rent ratio when buying a rental property?
Definition of Price to Rent Ratio and How to Calculate It
Price to rent ratio is a real estate metric that measures the affordability of buying a real estate property in comparison to renting one in a certain location. For homebuyers, the best price to rent ratio is a low one, which means that buying a property is cheaper than renting a property. For real estate investors, on the other hand, the best price to rent ratio is a high one. A high price to rent ratio corresponds to high rental property demand and therefore, more favorable investment conditions. But that is not always the case- continue reading to see how low price to rent ratio markets can be good investment locations.
Before we talk about the best ratio, let us take a look at how it is calculated. As the name implies, the price to rent ratio is calculated by dividing the value of the real estate property by its annual rent. For a real estate market, this metric is calculated by dividing the average price of all real estate properties by the average annual rent.
For example, the average price of a real estate property in a given location is $300,000 and the average monthly rent there is $1500.
P/R Ratio = $300,000 / ($1500 x 12) = 16.67
There is no rule of thumb when it comes to the best price to rent ratio when looking for a location to buy a rental property. There are pros and cons to investing in a real estate market with high or low price to rent ratio. We will discuss these after explaining how to interpret this value in general.
What Does This Value Mean?
The price to rent ratio is generally divided into 3 categories:
1- P/R ratio below 15: A ratio below 15 is a good indication for homebuyers. However, depending on the real estate investing strategy, such markets may not offer good investing conditions.
2- P/R ratio between 16-20: This neutral zone indicates that it is probably better for homebuyers to buy a home than rent one. For real estate investors, investing in rental properties in these locations can still be a good option.
3- P/R ratio of 21 and above: The best real estate markets to invest in are those with a high price to rent ratio. The main reason behind that logic is that homebuyers find it more feasible to rent a property over buying one.
The Best P/R Ratio: Pros and Cons
When looking at where to invest in rental properties, basing your decision on price to rent ratio is certainly powerful as an initial assessment for the property market. However, the ratio falls short on including other important factors like the affordability of investment properties and the return on investment. For that reason, we will explore the pros and cons of investing in both low and high price to rent ratio markets.
Investing in a High Price to Rent Ratio Market
The Pros
A ratio between 16-21 and above is considered to be in the high category. Real estate investors are encouraged to buy investment property in such locations due to the high demand for rental property. The best price to rent ratio might seem to be a high one, but other factors should be taken into consideration as well.
The Cons
Rental demand does not tell everything about a real estate market. In high P/R markets, investment properties tend to be expensive and unaffordable for many real estate investors. Moreover, the ratio does not tell anything about the rental expenses, which can greatly affect the net rental income.
Investing in a Low Price to Rent Ratio Market
The Pros
The main advantages of investing in low P/R markets is the lower price of investment properties and the high rental income that some cities with low P/R have.
The Cons
The main disadvantage of buying a rental property in a low price to rent ratio market is the low demand for rental properties. However, this classification targets homebuyers who are looking for buy vs rent options. This means that other real estate investment strategies like short term rentals can still have a high demand.
So, Which Is the Best?
When it comes to investing in a real estate market with low or high P/R ratio, the decision depends on the real estate investor’s goals. If you want to follow a short term rental strategy and invest in Airbnb rentals, then it does not matter whether the market has a high or low ratio. On the other hand, if you are looking for affordable rental properties then you will mostly find those in low price to rent ratio markets, due to the high supply of real estate properties in these locations.
Depending on your real estate investing goals, both rental property markets have something to offer. The best price to rent ratio can, therefore, be a low one or a high one, depending on your goals and investment strategies. Real estate investors should carry out a complete market analysis and neighborhood analysis before investing in a given location to find whether it is good to buy an investment property there. Furthermore, an investment property analysis will ensure that a property will generate positive cash flow and will give the real estate investor a detailed return on investment analysis. Check out Mashvisor to get access to all the tools you need to perform real estate analysis.