Conventional belief says that owning a home is financially smarter than renting. But that isn’t always true. Forbes suggests calculating your “rent-to-price” ratio to decide which is the better financial decision — renting or buying.
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Forbes contributor John Wasik makes a good case for renting. Many people decide to buy a home, but their home doesn’t see enough appreciation. He suggests a simple metric for deciding if you should consider buying:
Prospective home buyers should calculate their “rent-to-price” ratio, or the ratio of the annual rental costs of a home compared with its purchase price, to determine whether to buy a home or rent and invest.
Simply divide your annual rental costs by a home’s purchase price. Wasik says if your ratio is 5% or less, you’re probably better off renting and investing any savings. If your ratio is greater than that, you might consider buying.
Bankrate explains why this is used as a measure for gauging a home’s value:
The use of a price/rent ratio is analogous to employing a price/earnings ratio for stocks. When a stock price is high, and its earnings per share relatively low, the P/E is high. A high P/E often indicates that the stock is too expensive, and the share price is headed for a drop. What someone is willing to pay to rent a place is that home’s “earnings.” And, just as in the stock market, a high home price related to the rental earnings mean homes values will probably drop.
From a renter’s perspective, this also helps you see if you’re getting a good “deal” on rent in your area, versus owning a home. For more detail on when renting might beat buying, check out the rest of Wasik’s article.