I received quite a few inquiries to further elaborate on my Price-to-Rent Ratio post, so here goes:
Even though we can do a quick calculation of the Price-to-Rent Ratio: what does that number really mean? Boiled down – just remember that if the number is lower than 20% it is in the best interest of the renter to at least consider buying a home and looking deeper into their specific situation.
To do so means understanding how to calculate the actual Net Monthly Benefit of owning a home. Owning a home over time has proved to be a strong contributor to building wealth – here’s why:
First and foremost, a home is a place to live. Over time, it’s also proved to be the single largest contributor to building wealth but still, that’s the gravy. One has to be prepared to make the payments that they sign up for as things like appreciation aren’t realized until the property is sold. However, other benefits such as tax deductions and of course, the fact that you’re paying your own mortgage rather than your landlord’s is the best thing of all.
Below is a portion of a worksheet that I worked up showing the net monthly benefit of ownership vs. renting. This spreadsheet takes a much deeper look at the number including appreciation, tax savings and typical costs involved with ownership. While some may ask “Why are you including Rent Saved because you will still have a monthly housing payment ?” – the amount of rent saved is offset by the costs which includes mortgage interest and other factors noted below and the Principal portion of your payment each month is factored into the Net Monthly Benefit.
Factors as follows: Mortgage Interest @ 3.75%, loan to value of 80%, rent calculated @ 6% of value, real estate taxes @ 2% of value, maintenance is .5% of value, insurance is $2.90 per $1000 of mortgage amount and marginal tax bracket used is 30%. "Costs" equal monthly interest expense + insurance + maintenance + property taxes. Net Monthly benefit = appreciation + shelter value/rent saved + tax savings - costs.
You could also use the above analysis as an example to potential sellers explaining that should they move up to a larger home, their net benefit also increases because as we all know – the higher valued the asset the higher the appreciation – might be a way to move some sellers who are on the fence!