How Price To Rent Ratio Fools Investors

Q: I’m looking for the right local real estate market to invest in. What do you think about using price-to-rent ratio to decide? Devon, Palo Alto, CA

A: Price-to-rent ratio is the average ratio of the median purchase price divided by the median (average) annual rent in the area and is a measure that can be used to compare local real estate markets:

Price-to-Rent Ratio = Median Sales Price/Median Annual Rent

The usefulness of any calculation boils down to how accurate and representative the input data that goes into it is. One problem with using this ratio is that properties even within one local market are not uniform–there can be a huge variety of property types, property conditions and prices even within one local city or town.

While price-to-rent ratio is useful to an extent, it should be used as a data point among other factors, the more specific the better to determine whether an area is ideal for real estate investment and more importantly whether a specific property in that area would make a good investment.

Thanks for your question, Devon. For more real estate information and tips visit my blog at geraldlucas.com.