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Price-to-rent ratio

One of the metrics used by housing analysts, economists and real-estate investors to determine fair value of a house is the Price-to-rent ratio. One of the two simple and sometimes contested metrics (price-to-income is the other).

I think the burst US housing bubble should be a great post-mortem learning exercise for Canadians, especially those active in the housing market (agents, realtors, mortgage brokers, banks, buyers, sellers, etc)

I’ll get to the point now, the chart and summary below (via GreaterFool) shows the price-to-rent ratio globally for the last two decades.

The data is normalized with 100 being the long term average. Here are some quick take aways:

  • Japan’s real estate continues to slide into an abyss
  • US housing market doesn’t seem so bad now, does it?
  • not surprised to see Spain at the top but am surprised at Canada being second
  • data hides a lot of regional disparities – for example, within the US, Florida and California would trump Spain
  • Ireland is ahead of other markets in correcting – but it also started earlier

Here is a long-term chart of price-to-rent ratio for US

Many US financial/economics bloggers have blamed the government/fed for not reading this very apparent bubble sign among many others.

Where does that leave us? While I couldn’t find a central source of rents across the nation, I put together data from the Toronto real-estate board to come-up with this chart…

Note: I have used a crude way to determine the average rent and price but the focus here is trend, the level is clearly out of whack since early 2000.

When you compare the top graph of global price-to-rent ratios to the one above, I think it can be reasonably deduced that the Price-to-rent ratio has only gotten worse since 2007.

I would really appreciate your thoughts/comments on this topic.

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  1. Capitalist Pig
    September 26, 2010 at 1:19 PM | #1

    Curious if you have found a source of the real price-to-rent ratios versus the indexed numbers.

    Here’s one data point: we currently rent a townhouse in central Toronto. An identical unit 5 doors down recently sold and was profiled in the newspaper. Based on this data, the price-to-rent ratio of our unit is 18.33. If we were to buy our unit at that price as an investment, it would require well over $100k of cash and I estimate it would have negative cashflow of about $1000 per month.

  2. September 27, 2010 at 1:26 AM | #2

    I think price-rent ratios are a good measure for condos and, to a lesser extent, townhomes. Condos, for the most part, are commodity-level assets that can be liquidated reasonably quickly in most markets. Their income streams are well-defined, based on rental increases that track inflation closely. Actually, same unit rents will likely trend a bit below inflation due to depreciation of the building relative to the average stock. In addition condos to not carry any future land considerations that could lower the yield. That is, a detached house that will be re-zoned for apartments will carry a premium due to its future revenue increasing above inflation. Not so for condos.

    I think it a mistake to think that low interest rate financing plays a long-term role in keeping prices high indefinitely. Low rates for a prolonged period of time are deflationary — aggregate incomes are likely treading water at best and along with them rents. If rates do remain low for many years a la Japan it will mean deflation or no-flation. That means the expected increase in rents implied by current condo valuations is going to come up short. If wage growth returns and unemployment drops, rates are going up in a big way.

    Either way — rates staying low for a long time with low wage growth and high unemployment, or rates go up with higher wage growth and lower unemployment — housing is going to be in trouble.

  3. April 2, 2011 at 4:23 PM | #3

    Hey your article came up at the top for googling “price-to-rent ratio Toronto”. Good job.

    Some analysts say that since rent control artificially keeps rents low, that this ratio is invalid. Do you have other analysis based on price-to-income ratios? ie, How prices are out of whack with respect to average salaries?

  1. October 3, 2010 at 11:41 AM | #1

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