Rent vs Buy the Price to Rent Ratio

For Sale and To Let signposts on a row of housesTo Rent vs Buy.

Deciding whether to rent or buy a property can be very confusing. You need to ask the right questions. Those questions are listed and explained here. 

You need a simple way to work out the best deal for you, and not for the Banks. 

With this simple price-to-rent ratio sum and a few penetrating questions. 
You can make an accurate, detailed and informed choice, based on the facts and not hype, or your emotions.
The formula is as follows: 

average price of a property, divided by the average monthly rent, times 12 months.

or 

the property's price / average monthly rent * 12. 

This simple calculation will give you the number of years it would take you to pay off just the asking price of the property. (without interest charges, taxes and fees) 

Your sum will produce a number between 1 and 20+. Any multiples above 20, are examples of distorted house prices and/or exorbitant rents.

If the number your sum produces is below 15, then it is cheaper to buy. 
If the number is between 16 and 20 and above, it is cheaper to rent. 


Property Market Distortion


Distortions in markets occur when governments interfere with the normal operation of the market. 

The UK government states that it believes in 'Free markets'. Yet it is distorting the property market by encouraging people to get into more debt than they can afford. 
Offering cheap loans to people who patently cannot afford to buy a property is storing up problems.  Selling properties to sub prime buyers can only end badly. As was seen in the Fannie May disaster in the US.     

Location Location Location 

The location of a property, is always portrayed as of paramount importance. Especially by TV shows and Realtors/Estate Agents. 
While it may be important for a few people. It is not as important for the vast majority of people. 

Research has shown that most people do not move more than a few miles away from where they were born. Even in a country with a highly mobile population like the USA, we find that most still live in the state where they were born. 
Most people in Britain live within 50 miles of where they were born.  

The vast majority of people are more interested in being: 

(1) Near family. 
(2) Distance to work and 
(3) Amenities such as Schools, Hospitals  

Location is not as important as we are led to believe.  

Another good question to ask yourself is. 'What position would you be in, if interest rates rose?' 

A comment from Ben Bernanke, of the US federal reserve; saw stock and bond prices tumble recently. With interest rates at historic lows, there is only one way for them to go. 

A return to higher interest rates is almost inevitable. People still want to earn some money from their savings accounts.  Eventually interest rates must rise. It has happened before and will happen again. These historically low interest rates are unprecedented and unsustainable.  As we can see from the Bank of England data below.



Ask yourself these questions. 
  • What are your current rental or mortgage costs.
  • How much would it cost to buy.
  • Can you sell your property.
  • Are there cheaper rental properties.
  • Could you manage a 2% rise in interest rates? 
  • Could you manage an interest rise of 17%?

You need to think about your decision in simple practical terms. This method can help you to decide whether to rent or buy. Using this price-to-rent ratio, can help you make better choices.

What is the price of a property divided by average monthly rent, multiplied by 12 months. On a per calender month basis.

There are many other costs associated with buying a property. 

Transfer and property taxes (UK stamp duty); mortgage fees, insurance and maintenance costs, surveyor, solicitor and realtor fees (UK estate agents) 

Most of these costs are paid up front, and will be a total loss. In a falling or flat-line housing market, you cannot pass on these costs to the next buyer.

Lets take a simple example based on averages from two property websites in the the US and UK. (see below)
You can change the figures and currency to suit your own prices and location. Use a calculator.

In this case a property is priced at $160,000.

Divide $160,000 by the average monthly rent $675.

You would pay $8,100 per year in rent.

Calculating these figures together we see that  $160,000 divided by $8,100 = 19.75 or 19 years and 9 months. Where the .75 is 75% of a full year (9 months)

In other words; you could live in this property for 19 years and 9 months (19.75) and still pay less than the $160,000 asking price. 

Remember that the interest on the average mortgage loan, over the life time of the loan, can in many cases double or treble the initial asking price.

Using the number from the calculator (19.75).

We can see it falls into the ratio between: 16-20. So it is cheaper to rent. 

This ratio is based a on variety property types, both in the rental sector and for sale. 

The averages are listed on trulia.com, a USA property search website. For a similar website in the UK, check out Zoopla.co.uk

Given a price-to-rent ratio of between 1 to 15 = it's cheaper to buy a property.

With a price-to-rent ratio of 16 to 20 = it's cheaper to rent a property.

In our example with a price-to-rent ratio of 19.75. It is typically cheaper to rent than to buy.

When house prices are unstable or distorted, as they are at the moment. It is cheaper and wiser to rent. Although rental costs can increase over time, they can also fall. When rents do rise they rise considerably slower over the long term. 

Being tied to a mortgaged property can restrict your mobility. Having the option to move quickly to a new area for work, is a big advantage of renting. Remember that selling a house can take months or even several years.

Now you have a simple method that you can follow to make a better choice.

Some commentators state that the housing market is recovering. The truth is; that in a few tiny pockets of the country, house prices have risen, (mostly in parts of London, New York and Califonia) but in other places, house prices ares still falling. 

You could be buying a depreciating mill stone, rather than an appreciating asset.

There have been many false dawns in recent years, but this housing market crash is systemic and will not be fixed anytime soon. 

You need sound judgement, and for that you need to know how to price a property correctly.

Hope this helps you make the right choice.