Previously we have checked what factors should you consider when deciding between buying and renting. In this article we’re gonna check how the price to rent ratio affects the final outcome. Maybe a house looks cheap, but when you compare it with the rental fees of similar properties, you will realize that it just doesn’t worth it. Of course it also works the other way around. Let’s see some examples!
In the previous post we checked an example which will be our starting point. A 380k house in a neighborhood with a price to rent ratio of 18 (the purchase price is 18 times the annual rental fee). We take a 30 years annuity mortgage with 2.4%, 10% down payment. We keep on calculating with 2% inflation and the same amount of monthly home ownership costs.
Under the above example we saw that if you live in the house for about 6 or more years, you would be better off if you buy. Let’s see how the numbers would change if we change the price to rent ratio from 18 to 16 or 20. Taking a 380k house it means that we change the initial EUR 1,760 monthly rental fee to 1,980 and 1,580, so roughly +- EUR 200 difference.
Price to Rent = 16
Price to Rent = 20
If we change the price to rent ratio to 16 (i.e. higher rental fee), the monthly EUR 200 difference would mean that after 4 years you’re already better off with buying. Nevertheless with a ratio of 20, the turning point only happens around 11 years (but buying still seems the better option if you plan for a long term).
Let’s move that number up a little bit. Let’s say 23, which means a EUR 1,376 monthly rental fee in the first year for the same property.
Wow, the rental is a huge winner here. This is due to the fact that now the monthly rental fee roughly equals the home ownership costs. But while you had some big initial expenses around the purchase of the property, your saving of EUR 48k kept on returning 6.8% annually above inflation. What this chart doesn’t show you is the increase of the value of the property. So within 20 years, the price of the house should’ve increased by EUR 140k (the difference between the red and the blue line) in order to be equal, which is not unrealistic at all. But still then it’s just an amount on a paper. Furthermore once you sell your house you will be immediately hit by a large amount of additional expenses that comes with the sale.
Of course the above examples are only theoretical calculations. It might very well be that the actual turning point will be earlier or later by a few years. There might also be a sudden housing boom which would make it favorable to buy a property with a price to rent ratio with well above 20. You might read guidelines that if this ratio is below 15, you’re better off buying, if above 20, you’re better off renting. Take these as very rough indications; I believe this oversimplifies the whole story. There are plenty of other factors to consider, which can totally change the math. We will all cover these in the following articles.
What is the price to rent ratio in your area? Do you know how much was it when you bought? If you already own your house, did you make a good decision, or do you regret?
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