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October 19, 2010


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I have heard about the one percent rule. Some will say that one should not buy a house to rent out unless it can be expected to bring in one percent of the house value per month. This calculation can be used by either the landlord or the renter to evaluate their particular situation.

I just did the calculation for the house we bought earlier this year and got 192... Although, it's a single family home and cannot really be compared to any rentals in the area. Plus, the mortgage payment is about what we were paying in rent anyway, so it's not like we're spending much more money.

8.97 here. I didn't know of the "rent ratio" before this post, but I can do basic math and when I bought my house it did make the most financial sense: total outgo (mortgage + insurance + taxes + incidentals) per month was comparable to the average rental for a comparable house in my area.

192? Did you use the monthly rent or the total annual rent? If you used monthly rent, it would be more like 16.

Yes I've seen these ratios before. Yes it makes sense. The 1% rules Wayne mentioned is an old rule of thumb for rental property investments.

I think this kind of rule helps people differentiate between buying a house as a place to live or buying a house as a speculative real estate investment.

But keep in mind that very attractive places to live will always be more expensive and a high ratio doesn't actually mean you'll lose money. San Francsico is always going to have higher ratio than Detroid and that doesn't make Detroit a better real estate investment than S.F. SF is up 20% since 2000 and Detroit is down 32%.

When I said S.F. is up I meant that property values are up. (not the ratio)

Bill Lewis' book, The Big Short, actually has a quote from a guy referencing that number. The rule of thumb he uses is to buy at 10 and sell at 20. Houses in California at the top of the boom were going at over 30.

woohoo! I came in a 18.9 :) And I'm in San Jose, CA.

"192? Did you use the monthly rent or the total annual rent? If you used monthly rent, it would be more like 16"

Oops. I need some reading comprehension.

We rent and I did the calculation using the market value of the home we're in and got a rent ratio of 23.

One thing often missing from rent vs. buy discussions that's important to me is quality of life. To buy the kind of home we want (that we could afford), we would have at least an hour in traffic every day (each way) and on weekends, our activities would be the same drive but in a little less traffic. I think we'd spend more time away from our house or working on upkeep than enjoying living in it. To buy near the area we currently live in, we'd have to squeeze into a lot less square footage (not that what we have is excessively spacious, by any means) and that doesn't seem like a way to live your life every day, either.

On a more practical note, my husband feels that renting gives us "emergency flexibility" if (God forbid) one of us loses a job or something. While we do have an emergency fund, we could also downsize out of our house more quickly than a home we owned if we needed to.

I'm not the type to buy a home for the pride of ownership. Where we live suits our family's situation right now and we enjoy it as our home. When things change (i.e. the kids grow up), we will look for something else in a place that better suits our needs. We are saving money with the idea of buying something (small) outright at that time.

Back when I was trying to decide whether I should rent or buy my 75' yacht, I made a decision to buy 2 yachts instead. I think it was a good decision - I use the second yacht as a storage container for my stacks of gold bullion.

bobsmith makes a good point. Boats are holes in the water to throw money, or bullion, into.

> "One thing often missing from rent vs. buy discussions that's important to me is quality of life."

It's implied when they talk about renting/buying a comparable place.

If one place is larger than the other, or in a worse neighborhood, or results in a shorter commute, then they're not directly comparable.

In order to use this ratio on places that aren't very similar, you have to first add in the value of the differences between them. For example, if buying has a worse commute and you'd pay $2000 per year to avoid it, then you can think of it as the rental giving you a refund of $2000 worth of perks. So you should calculate buy / (yearlyrent - 2000). If buying has a better commute by $2000 per year, think of it as the rental costing you $2000 of inconvenience and calculate buy / (yearlyrent + 2000).

Moved often in corporate, military and self-emplyed world, ALWAYS rented. Nice middle class+ homes ranged from $675 month (smaller townhome in very nice northern CA) in early 90's to$950 in Texas (central Texas military town in "oficers neighborhood)to $1250-1650 in late this decade (outside Tacoma in upper class area/neighborhood off teh Sound). Those homes were "newer" in great neighborhoods and cost from $160K~ to almost $400K. Where you see a LOT of "for Sale" signs, knowing you may be gone in 2-5,6,7~years, RENTING and "investing the difference" was one of several ways I retired a multi-millionaire (next door) at age 47! When you gottta move for a great promising business decision, renting makes it MUCH easier, less stressful and usually profitable!

Numbers aside, there are just some things you can't put a price or ratio on when it comes to owning your own home, like being able tocome and go w/o worrying about disturbing others around you, leaving stuff in the yard, etc.

The custom homes in my small development in the SF Bay area are in the range of $950K to $1.2M. Admittedly there are no rentals to my knowledge and resales are infrequent, maybe a couple per year, and prices have stayed fairly constant for the last 2-3 years. I would expect the highest possible rent an owner could get would be about $5,000/month giving a ratio between 15.8 and 20.0. The development is very quiet, has a very high percentage of retirees, very few children, hardly any cars parked on the street and obvious pride of ownership everywhere you look. The tracts with a high percentage of rentals are easy to spot because of all the neglected lawns and streets full of cars.

Housing along the coasts is still ridiculously overpriced. Of course, the Feds will not let the housing market correct naturally, instead preferring to stall price declines. When I see crapshacks still commanding $500K (and this is in small coastal towns in California--not in LA or SF), there is still way too much speculation and greed out there. I sold my California house in 2005--at a time when Realtors and just about everyone else said I was crazy for doing so; that housing prices never have dropped and "buy now or be priced out forever!" I think this economic debacle exposed the fraud of real estate and title agents, loan brokers, banks, and--not the least--borrowers. Borrowers were ultimately the more responsible party to this catastrophe: they lied on loan docs to get more house than they could afford (or mutliple houses) under the guise of being able to sell them to the next greater fool for more proft. And when things went south, these "masters of the universe" borrowers decided to cut and run en masse because their schemes didn't work. I think borrowers are the ones that should be prosecuted--which would help get more housing inventory on the market and lower prices to a level where the populace could afford them.

Boston often comes up as a high-cost place, and it is. But renting costs here are some of the highest in the country. I bought a house last year, and according to that price and make an estimation knowing some similar rents to places almost comparable, my ratio is 13. In many areas, in nice communities, but not the most expensive, it makes sense to buy here.

One easy way to try to deflate the local bubble in your city:

Click P/R Ratios tab and find the 15 year average for your area...

Then check out the more recent P/R ratios for your area....

If they are rather close, you should buy.

As an example, Northern NJ has a 15 year average of about 15 P/R and is currently in the 20's. STAY AWAY, seriously overvalued property.

I would say the ratio also should take into account the prevailing interest rate at the time and also the property tax rate in a given locale.

Example: a ratio of 20 would mean that the annual rental you would pay is 5% of the price of the house you would pay. In today's interest rate environment where you can get a 30 year fixed for under 5% the ratio of 20 is meaningful but if interest rates were to go up to 10%+ as they did in the early 80's then the ratio you should use drops to 10.

Another important factor this ratio doesn't include is property taxes. In California property taxes average around 1.2% of the purchase price, paid yearly and limited to 2% increases a year, thanks to proposition 13. In NJ the property taxes are astounding, 3-4% of the appraised value of the property. This is very expensive and is a driver to push people to rent especially if the rental market isn't so expensive.


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