There are a number of factors to consider while analyzing a neighbor or location and check if the properties in that area are good enough for you to invest. Among them, the Price-to-Rent ratio bears a great significance in determining the real value and market condition of an area.
But what is Price-To-Rent?
Price-To-Rent
Before you get confused, allow me to explain it.
To put it simply, the price-to-rent ratio is the average ratio of the monthly median or median monthly rent that is divided by the median purchase price of properties in that area.
Now, what that means?
Firstly, you’ll have to understand what median is. Median sales price of properties in an area is a point that splits the prices of properties into two parts.
Finding the Price-To-Rent ratio
In order to find the ratio, you need to gather the necessary data.
Where to find the data?
There are a number of places online where you can these data. However, I prefer www.zillow.com/research/data/because they offer the most accurate data compared to other sources.
Also, they let you download a bulk data of an area. All you’ll need is the zip code of the area to find the data.
Simply scroll down towards the Other Metrics options and then click on the data from the column of all the zip codes.
You can download the data in a .csv format (Comma Separated Value format). The file can be viewed in Microsoft Excel or Google Docs.
It’ll show you the historical and the most recent median sale price data for almost all zip codes.
You’ll just need to find your local median sales price with your zip code.
Once you gather the data, you need to go back to:
Under the Zillow Rent Index, you need to download the data from the row marked “All Homes in the Zip Code” column.
Then locate your zip code from the column that is representing the most recent quarter. Also, you’ll find the median rental price there.
Now you have 2 numbers. To find your Price-To-Rent ratio, you’ll need to divide the 1st number by the 2nd one.
So, the basic formula is
Price-To-Rent Ratio = Median monthly rental price / Median sales price
The Drawbacks
Like anything, this ratio has some drawbacks.
First of all, everything about this ratio is related to the data. So, if the data isn’t solid, the ratio will be incorrect. And in this case, considering this ratio will only bring you a bad fortune in your venture.
Again, it doesn’t separate the assets or properties in lower-income areas of the zip code,it doesn’t consider the condition of the property, it’s doesn’t take in the fact that some have a large area with several bedrooms while some are single bedroom properties, and it doesn’t consider how large or small the property is. In short, the ratio treats everything on one scale where the properties are the same, all the time. Some are huge, some are limited in size. Some are new and shiny like a new mansion, others need a lot of renovation. So, without taking them, into consideration, the ratio cannot be a perfect factor to analyze and area. However, it definitely can give you an idea of the neighborhood.
