K
  • Rent Price Ratio

    By Heather Luea, Academic Department Chair, Kaplan University

    One of the factors impacting the decision to buy is the relative price of renting versus owning. This relative price is measured using the rent/price ratio. This ratio is calculated by dividing the average annual imputed rent by the average house price. 

    Since 2012, this ratio has trended downward. The ratio can fall either because home prices increase, annual rent falls, or the percentage change in annual rent is relatively smaller than the percentage change in home prices. Prospective buyers likely do not calculate this ratio before they go looking for homes, but they certainly compare their proposed mortgage payment with their current rent.

    Fluctuations in this index may impact the decision to buy. As this ratio falls, the relative price of renting to owning falls. As this ratio rises, the relative price of renting to owning rises. Since 2012, home prices have both risen and fallen on a quarter-to-quarter basis while annual rents have steadily increased. However, the net gain for home prices has been substantially larger than the increase in annual rent. This movement translates into a decreasing rent/price ratio, implying that from a relative perspective, renting is becoming less expensive.

    If renting is truly becoming less expensive, why do people continue to buy homes? Although people are still buying, the composition of buyers has changed. In fact, the percentage of buyers who are first-time homebuyers is at its lowest in over three decades (www.kiplinger.com/article/real-estate/T010-C000-S002-housing-outlook-2015.html). This can be partially explained by other factors such as student loan debt and credit scores, but the relative price of renting versus owning is also likely a cause. As these first-time buyers see home price deals from the housing crash erode, they become less enthusiastic about buying. Renting may seem like a relatively less expensive option, and that is exactly what the data implies.

    The remainder of homebuyers must then find other benefits of owning, and these benefits must clearly outweigh the relative costs of buying. These benefits might include tax advantages or simply the personal gratification of owning. After all, the ratio only reflects the accounting costs of renting and owning, not the implicit costs and benefits associated with tenure status. The evidence suggests that although some prospective buyers may be discouraged by a rising rent/price ratio, a substantial group of buyers persist in the market and buy regardless of the fluctuation.

     

    Heather Luea is a professor and academic department chair at Kaplan University. The views expressed in this article are solely those of the author and do not represent the view of Kaplan University.

     

    References

    “Rent-Price Ratio.” Lincoln Institute of Land Policy. http://www.lincolninst.edu/subcenters/land-values/rent-price-ratio.asp(Accessed 12/10/14).

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