Price-to-Rent Ratio – What is it and how can it be used?

The price-to-rent ratio is a simple calculation that one can make to get an idea of whether it makes sense to rent or buy in a particular area. For the real estate investor, it can be used as another tool in your arsenal to determine what areas you should invest in.

How to Calculate Price-to-Rent Ratio

Price-to-rent ratio = price of the house / annual rent

That is, you simply take the price you would have to pay for a property and divide that by the annual rent you would receive for the same property.

Should I rent or buy?

This ratio is often used in discussions about whether it makes sense to rent or buy in your particular area of the country. The thresholds for the ratios are:

Price-to-rent ratio of 1 to 15 would mean it makes more sense to purchase than to rent.
Price-to-rent ratio of 16 to 20 would mean its typically better to rent than to buy, but this is the grey area where a lot would depend on the particular market and situation.
Price-to-rent ratio of 21 or higher means its much better to rent than to buy.

What Price-to-Rent Ratio means to the investor

As a property investor, you can use this ratio as an indicator on what your return on investment (ROI) is going to be for a particular area. The lower the price-to-rent ratio the higher your ROI is going to be.

Unfortunately, if you’re doing these calculations from a major Canadian city at the time of this writing you’re going to find extremely high ratios. According to the International Monetary Fund (IMF) the average ratios for Montreal, Toronto, Calgary, and Vancouver are concerning (full report is here):

Montreal: 35
Toronto: 35
Calgary: 32
Vancouver: 58

That isn’t to say it would be impossible to find individual properties in those markets with considerably lower ratios, but it would be very tough. As an investor living in any of these major cities this would be an indication, when combined with other analysis like cash flow and cap rate, that it is time to look outside your immediate area for investment opportunities.

As a comparison, the property we recently purchased in London, Ontario has a ratio of 7.66 (175000 / [1905 * 12]).

Significantly more appealing.

This entry was posted on January 19, 2012, 8:30 am and is filed under Calculations, Investment Real Estate. You can follow any responses to this entry through RSS 2.0. You can leave a response, or trackback from your own site.

Emerson Cho

Another great blog ! People have been telling me it’s a lot more expensive to buy in Vancouver but almost the same to rent – it’s nice to see there are numbers to back that up.

Speaking of buying property, do you have any tips on what the optimal down payment is for some particular interest rate ?

http://www.ryanprice.ca Ryan Price

Hey Emerson,

Yeah Vancouver is one area I won’t be buying real estate anytime soon. That market is due for a (possibly large) correction!

For down payment there is really no magical guideline. It really depends on your situation. Right now the minimums for Canada are 5% for your own home and 20% for an investment property.

If you’re putting down enough to have 20% of your mortgage paid off now or in the near future, I’d recommend getting a readvancable mortgage which simply means you can borrow equity from your house to invest elsewhere (even in other real estate!). It’s called The Smith Manoeuvre and you can read about it here: http://www.milliondollarjourney.com/the-smith-manoeuvre-a-wealth-strategy-part-1.htm

The more you’re able to put down the better as you’ll pay less interest over time, and if you use the Smith Manoeuvre that money can still be accessed for other investments. That said, some people would rather pay more interest over time and use the extra money they’ve saved to travel. Whatever lifestyle works for you.

If you’re debating “do I buy now, or save up more and buy later?” my answer would also be “it depends”:

1. If its for a long-term investment property I would recommend buying as soon as you can afford quality properties that will cash flow.

2. If you’re buying for yourself it would depend on the market. In a place like Toronto, especially the Condo market, I would use the price-to-rent ratios and ask myself if my money is best spent on purchasing property right now.

There are two ways for properties to come back down to a price-to-rent ratio that is more inline with historical values. The first is that rents could move up and the second is that prices could come down.

Historically, it has been far more likely that prices come down.

Dmitrii Filatov

what about comparing two different properties? how do you calculate whether it makes more sense to rent in one area vs. buying in another?

http://www.ryanprice.ca Ryan Price

When you’re personally making
a decision like buying in Durham region vs renting a downtown condo the
price-to-rent ratio isn’t really relevant. What it takes into consideration is the average yearly cost of owning vs renting the same house, so
it doesn’t factor in things like travel time or lifestyle choices. It
is meant to be more of a guide for when you’re looking to live in a
particular city or neighbourhood. You can run this calculation and see
if it makes sense to buy or rent there. For income properties, you’re more likely to have stronger cash flow with a lower price-to-rent ratio.

Ryan Price