The Rent To Value ratio is a simple calculation. It is the value of a home divided by 12 months of rent. EXAMPLE:
$175,000 value home rents for $1100/month $175,000 / $13,200 ($1,100 x 12) Rent to Value ratio or Rental Yield is 13.29%
The home is valued at 13.29 times the annual amount of rent it commands in the current market, or the rental yield is 13.29%. Rental Yield is considered one of many ways in which one can evaluate a potential rental property or area. It is similar to the Earnings to Price Ratio in the stock market, the earnings of a stock compared to its cost per share.
This number can vary quite a bit, from under 2 in some markets to over 15 in others. The idea is that a higher number means that you can accept a lower level of appreciation in value purchasing in an area if this ratio is high. You’ll more than make up for low appreciation over the ownership period with higher cash flow over the expenses of ownership. That is of course if rents hold and you can keep vacancy down.
This ratio can be very different in a city or market area for different neighborhoods. When some areas have been harder hit with more distress and foreclosure sales, the prices have been depressed enough to drive up this ratio. Rents are higher in relation to the value of the property.
An example of this is Atlanta, GA. The south side of Atlanta had significantly higher rates of foreclosure than the northern areas of the city. Rental homes on the south side have higher ratios, sometimes double or more the yields for the north side. Northern areas of the city fared better during the real estate and mortgage crash that began in 2006. Prices didn’t suffer as much, and home values have been higher over time than those on the south side.
Two areas, New York and Las Vegas, show two very different pictures for rental yields. In the New York area, prices for homes are high, and in Las Vegas, distress and foreclosure sales were huge during the market crash. The New York area shows the vast majority of homes with rental yields between 2% and 8%. On the other end, Las Vegas has a majority with yields over 14 percent.
Making a rental property purchase decision on rental yield or cash flow alone isn’t a good idea. Appreciation in value over time is also very important to the investor. While rents can vary over time due to economic and demand factors, it is a better investment if the property is appreciating in value at a decent rate.
Locating a potential rental property purchase in an area with historically solid price appreciation and at a price that has a higher rental yield than other homes for sale in that area is probably worth serious consideration.
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