Rent to Purchase Price Ratio

The New York Times has a well-regard rent vs buy tool: http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html?#

Thanks for the interesting calculator, fakestate.

You bring up a worthwhile point, sideline_searcher. That said, I believe that the typical buy/rent ratios have typically not included this significant refinement.

My understanding of the historical range of New York buy/rent ratios is about 10 to 25 which does not adjust for maintenance fees.

Most properties that I've liked have been in the low-20s up until recently which is pretty expensive by historical standards. A ratio of 12 was fairly common in the early nineties and many studios were well into the single-digits.

NYTimes tool is awful, because it ignores the tax deduction on the interest. http://housemath.us gives an incredibly detailed analysis, with about 20 customizable numbers for your particular situation.

The buy/rent ratio depends hugely on interest rates. Anyone giving you a historical number (or any number that doesn't depend on interest rates) is just flat out wrong, even before they say what the number is.

That said, with today's interest rates, 18x is about breakeven (assuming zero price changes in the future). That includes "average" maintenance for the unit in question - if your unit has substantially higher or lower maintenance than is typical, you clearly need to factor that into the ratio.

Historically a 10-14 Price to earnings is a fair barometer to purchasing - maybe not in Manhattan but generally for the rest of the country.

So lets say the home you want to purchase is 500k

You would probably like to see it being able to rent (look at comp rents for the unit) at around something like this.

500,000/14 = 35714 a year
35714/12 (months) = $2976 a month (roughly $3000)

Thats for a higher P/E - a lower pe of 10 would be less.

Anyway there is no magic formula but I typically feel safe with something like this (aside from doing your own research and validation in the neighborhood demographics - changes etc.

I have owned over 6 rental units so its based on some experience.

"I have owned over 6 rental units"

The cost/benefit analysis is different for owning a rental vs. owning an owner-occupied piece of real estate. For the former, you pay tax on the rent you receive. For the latter, you don't pay tax on the rent you don't have to pay yourself.

I use a valuation based on 15x what you could rent the place out for, to come up with a sensible price. So if you think a place could be rented out for $2,500/month, then it's price should be $450,000. I would NOT increase this multiple to 18x due to historically-low interest rates, because once interest rates rise, then the re-sale value will correspondingly drop. So I think it's a non-factor in the valuation -- unless you are certain you will be holding on to the property for 20+ years.

As for mike_s55's suggestion, I agree the lower PE ratio is appropriate if you are looking at the property as income-producing asset. But a 10x would not necessarily apply if you are looking to live in it for several years.

Regarding maintenance, one way to look at this is to view maintenance as already incorporated into any normal formula. In a condo, you pay a monthly fee. In a separate house in the burbs, you have to replace the roof, the hot water heater, repair the driveway, etc (comes out to the same thing - cost to maintain the property). Of course, if the maintenance is unusually high - (the analogy would be if you were buying a house in the suburbs and you know it will need a new roof immediately), then you lower the price accordingly, but I don't know that there is a specific formula for that.

Thanks for the input. I was thinking specifically about this property http://www.streeteasy.com/nyc/building/245-west-104-street-manhattan

Here the rent to buy ratio is 18.4. And this would include taking into account the maint. Also, if they are willing to rent for this price doesn't it mean that they bought if for significantly less than the listing price.

This one is available for $549,000 to buy or $2,200 to rent. The purchase price is 20.7 times the annual rent or 41.6 times the $1,100 the landlord would net each month after paying maintenance of $1,100. I'm fasicnated the rent has increased maybe 40% over the last 12 years yet the price has about tripled. The apartment is probably worth no more than $300,000. It's a big, big bubble. You can measure the value of any apartment by either the rent it generates or the rent you could save by purchasing. The numbers in Manhattan make no sense.

http://www.streeteasy.com/nyc/sale/216354-coop-126-riverside-drive-upper-west-side-new-york

These days, streeteasy has hundreds of listings where the purchase price is 25X or more the annual rent - in Harlem, LIC, and Wburg, even 30x. The ratio is all out of whack. You DEFINITELY should not rent if its just 18X. Negotiate the rent down.

Just ran a simple scenario on housemath:

Buy a home costing: $1,000,000
Come up with: $272,312 to buy the place.
Take out a mortgage for $750,000

Assumptions:
Home will appreciate at 4.5% a year
Sell it in 10.0 years

Payment of $6,745 monthly...
...but, your home will be appreciating, you will be getting income tax deductions, though you will also owe capital gains taxes on any appreciation and have to pay the closing costs when the home finally sells.

Assuming rent increases with inflation at 4.0%, you could pay an equivalent rent of $3,000.38 a month starting today, live there, and be in exactly the same financial situation when you sell.

tech_guy, i 100% agree with you on the whole tax issue.... though i can't help but feel a fight with stevehjx is brewing here

Don't count on 4% inflation.

10-Year breakeven inflation on Treasury Inflation Protected Securities is now 1.16%. "Deflation" is the expectation for this year.

Personally, I think a figure closer to 2% is reaonable.

Should read, "reasonable."

Instead of thinking in terms of price-to-rent ratios, consider inverting this to rent/price "yields." If you were to buy an apartment for cash, what would be your "net" yield after paying the maintenance/taxes?

I've typically come up with numbers in the high 3s which doesn't sound real attractive to me when I can get 7.5% from investment grade bonds. That said, that yield may well rise over time largely in line with inflation. So, perhaps add 2% inflation to your 3%+ net yield and you get a 5% return over time.

Not real exciting to me. But each property has different characteristics and many people expect much higher inflation than me. "That's what makes a market." Caveat emptor.

If you can break even by renting the unit out to an unrelated third party on a cash-flow basis (that is, deducting everything but the principal), then that is the appropriate price to pay. Miraculously, under normal circumstances, it comes out to be about 12x annual rent. At today's interest rates, that ratio will be somewhat higher, but not much.

Home prices won't appreciate 4% a year. That's ludicrouse. Manhattan real estate will have to wait a decade for another uptick. It's a massive bubble. Prices need to drop 50%.

I agree with both steve and Topper...if buying as an investment you should compare the yield to other investments of similar riskiness. Investment grade corporate bonds are less risky in my eyes so I would want a yield in excess of 7%. If you are buying as "consumption" not "investment" then why bother doing analysis - pay whatever you feel like.

"I've typically come up with numbers in the high 3s which doesn't sound real attractive to me when I can get 7.5% from investment grade bonds."

Topper, I don't disagree as long as you are comparing investment grade bonds to an investment property. Comparing investment grade bonds to owner occupied real estate is an exercise in futility.

"10-Year breakeven inflation on Treasury Inflation Protected Securities is now 1.16%. "Deflation" is the expectation for this year."

Expected by you. Others expect hyperinflation. In another thread, MMAfia lead a group believing that fiat currency will basically fail, and money won't be worth the paper its printed on.

"Instead of thinking in terms of price-to-rent ratios, consider inverting this to rent/price "yields.""

If you give up the *huge* benefits of having a mortgage, the math will look awful. Owning a home outright is a terrible financial choice. Back in the real world, people have mortgages, these are incredibly advantageous terms to the borrower, and they greatly affect the rent vs. buy math.

Although I'd prefer to own rather than rent in principle, when things are way out of kilter I'm quite content to rent. You may not feel that way, JuiceMan, that's your "utility function." (Hope I didn't sound too nerdy there!)

Things will return to equilibrium again and I'll buy. (Alas, my best guess is that won't happen until late 2011.) The slow-motion train wreck is proceeding according to plan...

"Although I'd prefer to own rather than rent in principle, when things are way out of kilter I'm quite content to rent."

That's cool Topper, there is nothing wrong with renting. I think you missed my point. What I meant was, from an "investment" perspective you cannot compare owning and living in real estate to investments in stocks, bonds, or alpacas because you gain a benefit (a place to live) that you don’t have in traditional investment vehicles. The only accurate way to look at owner occupied real estate to from an investment perspective is to compare it to renting.

"The only accurate way to look at owner occupied real estate to from an investment perspective is to compare it to renting."

On this JuiceMan and I are in agreement. Owner-occupied residential real estate is capitalized rent. Ergo it should cost no more to own than to rent, or else you're overpaying. Which is why if you look at owner-occupied real estate the way economists do - renting to yourself - you would have to rent the apartment to yourself at the same price that you would rent it to an unrelated third party. Which is why, to break even, you cannot spend more out-of-pocket to rent than to own. Yes there are tax benefits for having a mortgage, but there are similar (actually better) tax benefits to investment real estate: the entire mortgage is deductible. Which is the fundamental flaw of tech_guy = LICComment's argument which they fail to comprehend.

"Which is why if you look at owner-occupied real estate the way economists do - renting to yourself - you would have to rent the apartment to yourself at the same price that you would rent it to an unrelated third party"

Unlike you, economists understand taxation. When you rent to a third party, you pay tax on income received. When you rent to yourself, you don't. To ignore this very real benefit is just plain stupid.

"Which is why, to break even, you cannot spend more out-of-pocket to rent than to own."

Agreed, as long as you look at it over the lifetime of the loan and factor all of the appropriate variables (tax benefit, equity at the end of the loan term, apreciation (or depreciation), etc. Looking at things such as 15x ratios as general guidelines are fine, but I don't feel it is very helpful in painting an accurtae picture for the long term.

"Yes there are tax benefits for having a mortgage, but there are similar (actually better) tax benefits to investment real estate: the entire mortgage is deductible."

steve, I hear what you are saying, but you are actually contradicting your own point above. You can’t compare owner occupied real estate to investment real estate. It doesn’t work.

"Agreed, as long as you look at it over the lifetime of the loan"

housemath.us has some very good graphs. Under "normal" real estate circumstances (forget the current market, use historical nation-wide values and pretend everything is slow and steady), its only beneficial to own if you keep the place more than 5 years, and *less* than about 20 years. It could be substantially better to hold for 15 years, and then a mild loss to hold for 25 years.

How? Simple: opportunity cost of equity makes owning real estate a terrible choice. The stock market does much better, period. That's what Topper and others demonstrate when they compare buying outright to corporate bonds.

Insisting that the mortgage either not exist (Topper), or be paid off entirely, is an incredibly fixed comparison. 1, it doesn't reflect reality. 2, it discounts ownership's primary advantage.

"Ergo it should cost no more to own than to rent, or else you're overpaying."

Agreed, though I would be more specific and say it should cost no more to own than to rent, on average, over the duration of your expected stay.

"When you rent to a third party, you pay tax on income received. When you rent to yourself, you don't."

Steve, tech_guy has a solid point here. I would not say investment real estate tax benefits are really better.

How do you factor into the equation that most co-ops only allow you to rent for 2/5 years (or sometimes 2/10!!)? Also, the co-ops often take an increasing percentage each year. How does that affect the calculation?

Shit man why does everyone take a simple discussion and turn it into some quantitative analysis paralysis throwing in inflationary and deflationary pressures as it relates to the bell curve against investment grade bonds with a utility function.

Rational people buy investment properties to rent out because:
1. They can carry the property with little or no cost to themselves i.e. it runs on its own.
2. They are relatively confident they can rent the place out consistently.
3. They may think the area is on an upswing and that after a few years there will continue to be positives happening to the area vs. negatives.
4. In return after 30 years they have an asset that they own out right - it will generate income free and clear or in many cases act as a tool for retirement.

Throw all this additional analysis out the window. 99.99% of landlords in this country are not evaluating the returns of their capital against investment grade corporate bonds that is just foolish analysis.
Commercial real estate with teams sure but that just is all crazy talk.

"I would not say investment real estate tax benefits are really better."

I don't read tech_guy, but they are, in fact, better. First, mortgage interest is fully deductible, not limited to a $1 million mortgage. Second, property tax is fully deductible, not subject to AMT. Third, the property can be depreciated (though not the land). Fourth, all maintenance expenses are fully deductible. Fifth, capital gains can be put off indefinitely as long as you reinvest the principal.

JuiceMan is not correct that you have to take the property over the life of the property to do the comparison. Rental is a short-term proposition. The analysis is break-even in the first year. If you want to be very technical about it, you can only count 11 months' rental income as the unit will sometimes lie fallow.

"JuiceMan is not correct that you have to take the property over the life of the property to do the comparison. Rental is a short-term proposition. The analysis is break-even in the first year."

This doesn't even justify a response.

Here's another wrinkle in the analysis. Assuming that you buy a place, should you deduct the costs saved from not renting your current place. I am only doing this analysis because I want to live in the place not for investment purposes. Although I realize RE is a massive investment, and don't want to lose money when there could be a better wait and see alternative. Also, the time horizon is about 5 years.

"This doesn't even justify a response."

Because there isn't one. Why would you buy a rental property if you knew you were going to lose money in the first year? Because you thought you were going to make money in the second...?

This is why I no longer argue with stevejhx over details. I'll say my big point, and ignore his attempts to overly complicate it with incredibly incorrect analysis. 1, he'll never learn. 2, what he says is so absurd that nobody objective would trust anything he has to say. Sure, other incredibly bearish people champion him, but that just demonstrates their own intelligence (or lack thereof).

s-p-i-n

One bit of advice sideline searcher - do not follow anything stevejhx says about this. We have all gone through this with him in the past and his analysis is fundamentally wrong. He is very stubborn and refuses to admit when he is wrong, even when it is clearly shown to him. His main errors are in not accounting for the mortgage tax benefit, not looking at current market situations, and cherrypicking bad examples when determining comparable apartments.

The ratio is dependent on interest rates and tax rates. The lower the interest rate, or the higher the tax rates, the higher the ratio. A good starting point in NYC for a fair comparison to rents is the 18x-20x range. You can always run your projected monthly ownership costs on an apartment based on your specific situation and look at comparable rents to see if it makes sense.

Way too many wrinkles for a general ratio - maintenance, deductibility of mortgage for taxes, jumbo vs. conforming, etc. As others have said, you should do an analysis of costs of renting vs. owning, or do the yield calculation (factoring in that it's a tax-free yield).

Also, if your time horizon is only 5 years, I would think very carefully about buying right now. Transaction costs on the way in and out will probably be well north of 10%, and I think it's far from clear whether prices in 5 years will be higher than today. I would say unless you get an amazing deal, and/or have a non-financial reason to own, you should rent.

Spin?

JuiceMan, JuiceMan, JuiceMan! When you purchase a property to rent out, there are no economies of scale. If you are starting a service company or a manufacturing company, you rely on economies of scale to grow the business (and I hate the word "grow" as a transitive verb!) by increasing turnover; therefore, you can confidently draw down your working capital until you reach breakeven, which in any case can't take the 30 years that you seem to think you have when buying a property.

There are no economies of scale, no decreasing marginal costs of production when you buy a property to rent out. Therefore, you must break even at the start, or you risk draining your capital with no chance of replenishing it.

mike_s55, if you assume (probably correctly) that many investment purchases are made via simple rules-of-thumb and largely driven by sentiment on the housing market then that would most likely lead to periods of dramatic over and undervaluation...which is exactly what the housing market has experienced over the years. I would argue we are much more likely for an overshoot on the downside than another overshoot to the upside in the next decade. Therefore, I expect abnormally low price-to-rent ratios in the coming years.

Another of the fundamental flaws in steve's analysis is his failure to account for increases in rental costs over time.

mbz - agreed.

Lets face if you ever rented from a person that was not a major property management organization - yes there are tons of 1-4 unit landlords out there myself included - did you get the sense that these people are watching the futures market on commodity prices measuring it against the S&P 500 ? No they really arent that sophisticated. Most are just acquiring a place here and there over a number of years cause they think its a good way to build wealth over time. Yes we deviated from this dramatically in the last 4 years as people entered the real estate investment market place with a completely different rationale.

People on this board crack me up because i would guess since its a nyc blog alot are astute with finance and some financial analysis - myself included i work in the field - but when i go out to other regions of the country - I have a few places in the hartford area - along with talking with my father a small buisness owner and his social circles - you really have to realize 99.99% of americans are really just trying to figure out a way to make a little income. They see a property they like think its good ask around a few lenders about a mortgage and what it would cost and then give it a shot. Really thats it no magic formula.

steve, where in my posts was did I mention investment properties? We were discussing owner occupied real estate and the comparison to other investments. Pay attention!

JuiceMan - news flash - no one except maybe 100 people in nyc buy an owner occupied home measured against the opportunity cost of entering other investments. They just dont. People need a damn home. They look at what it costs for a similar type of home in rent. See if they have enough of a down payment for a mortgage of a similar home and that the cost of the mortgage isnt a huge disparity to that and what it would cost to rent. And then they purchase the damn home if it makes sense. the last 4 years people didnt care they bought on price appreciation but we are past that phase, and we are back to a rational marketplace. THATs IT. People's first investment is always their home PERIOD. And if it makes sense like i listed above they buy - in a normal marketplace.

mike_s55, I don't disagree. My initial response was if you choose to look at your home as an "investment" the only thing you can compare it to is the cost of renting. Comparing "the opportunity cost of entering other investments" is a completely irrelevant exercise because you can't live in a bond. So the "news flash" for you is that you are barking up the wrong tree.

stevejhx blatantly ignored the topic at hand, created a new topic, and argued that instead? Unbelievable. He never, ever does that.

Ok sorry to impose on your/tech_guy and stevejhx worthless discussion.

People really need to get a life on these boards.

"Ok sorry to impose on your/tech_guy and stevejhx worthless discussion"

You are not imposing at all but if you plan to be snarky, at least know what the hell you are talking about

"People really need to get a life on these boards."

Yawn. If the discussion is so worthless and lame, what are you doing here?

"where in my posts was did I mention investment properties?"

I said that the proper price to pay for a property is when you could rent it out to an unrelated third party and cover your costs.

Sorry your fragile little ego was shattered to bits... you really don't see the irony in you giving a nitty-gritty mathematical ratio 5th post in, then spending the rest of the thread insulting others who do the same thing, only better than you?