Buy or Rent? Look at the Price-Rent Ratio

Kiplinger recently ran an article that shed some really great light on whether it makes more sense to buy a home or rent an apartment. I’ve never addressed this topic on 20somethingfinance, because quite frankly in the housing market that we’ve had over the last two years, it’s hard to make a strong case for buying a home. That’s coming from someone who’s last two dwellings have been purchased homes.

Buying Versus Renting: First Look at the Price-Rent Ratio

Kiplinger suggests looking at the median price of a home versus the median annual price of rent, otherwise known as the price-rent ratio, when deciding whether to buy or rent.

At the housing market’s peak (in 2005), the national median home price had inflated to 21 times the median annual rent. However, in the second half of 2009, that ratio dropped back down to 15, which is the historical norm. That indicates a national housing bubble.

Price to Rent at the Local Level

price-rent ratioThat’s all fine and dandy, but how does that affect you at the local level?

Kiplinger claims that if the price-rent ratio where you’re looking to buy is 18 or higher, your market might still be over-priced, and the odds are that prices could fall further after you buy. If it’s fallen below 15, odds are pretty good that they won’t fall further.

Home Prices Versus Apartment Rental in 20 Metro Areas

The following chart looks at the price-rent ratio in some of the nation’s largest metro areas. The monthly mortgage payment shown is based on a 30-year fixed rate mortgage with a 10% down payment and 5.3% interest rate). The apartment rent price is the median rent price.

rent or buy a house

Looking at the chart, it might make a whole lot of sense to buy a home if you live in Cleveland, but probably no sense at all if you live in, well…. just about anywhere in California.

How Do you Determine Rent or Buy Even More Precisely in your Area?

What you can do is get an average list price of homes that satisfy what you would be looking for and then divide that by the average annual rent of similar apartments in the area. Pretty simple stuff, right?

Why I love this Home Buying Advice

Determining when to buy a home based on your speculation of whether the home price will go up or down is much like trying to time the stock market. Everyone has their guess on where prices are heading, but nobody truly knows. Home pricing, however, has a large component of material value, making it much more concrete than stocks.

Using the price-rent ratio is brilliant in that it takes the guessing out of the equation. Just look at the cold hard numbers and let them make the decision for you. You could also use this when determining when to sell a home (if the price-rent ratio gets outrageously high).

Buy or Rent Discussion:

  • Have you ever looked at the price-rent ratio when deciding whether to buy a home or rent an apartment?
  • Do you live in one of the 20 metro areas highlighted? Which one? Do you think prices will go up or down in your area?
  • What is the current price-rent ratio in your area?

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