Know Your 'Rent-To-Price' Ratio When Deciding If You Should Buy A Home

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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.

When Homebuying Is A Waste of Money: Five Smart Moves [Forbes]


    Another story derived from US sources... :/

    The links are also to US sites, they do however point out that there are other factors than just the house PE ratio to consider. Tax considerations, in Australia the primary residence is capital gains tax free, a massive concession. House price inflation. And the biggest consideration of all, the mortgage rate.

    The main point is that if you are paying less in rent than the mortgage (and other costs) for a particular household, the savings could be invested, you might come out in front. Tax is payable on some or all of these earnings and they must be above house price inflation for you to come out in front. If there is house price deflation you definitely will.

    To take a point in time and say that your savings can be invested and conclude that in the fullness of time (whatever timeframe?) you will be better off is a big leap, which is why the article only says you might be better off. A study of how you would be better off if you bought in a certain year and realised the sale of a house in another, by suburb, taking into account floating mortgage rates would be very illuminating.

    To surmise that if your rent is less than your ownership costs you may be better off renting than buying is about as useful as using a PE ratio as the sole basis of buying stocks. Note Forbes magazine does not say this, one of their contributors did, and other contributors disagree, neither side providing a useful analysis of the numbers to support either case.

    Last edited 19/11/14 11:05 am

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