On this blog, we often point to the various factors that indicate a worthwhile investment market.
It’s part of what we do — we identify, investigate, and target real estate markets that have immense potential for real estate investors, not only in short-term gains but in long-term stability.
That said, there’s one factor in particular that we have not mentioned: price-to-income ratio. Now, we don’t necessarily refer to this in the context that you are likely accustomed to. In investing, a price-to-income ratio usually refers to what you pay for an investment or stock versus the income yield from it.
When we’re looking at real estate markets, the price-to-income ratio refers to the cost of the property versus the average income of those living in the market. This metric can be used in a specific real estate investment context (usually called price-to-rent), but both are valuable in market evaluation.
So let’s talk about price-to-income ratios.
How to Calculate Price-to-Income Ratio
Calculating price-to-income is fairly simple:
Price-to-Rent Ratio = Average Home Price / Average Annual Rental Income
This formula can be modified to compare to your individual income or property. Instead of looking at average rental income, you can look at the average income (salary) for those in the market. This will give you an idea of the relative affordability of the market as well as its profitability for you as an investor.
These ratios sound similar (and they are), but they tell us very different things. For the investor, one should pay attention to both metrics.
Why Does it Matter?
So why, in light of so many other factors, does the price-to-income ratio matter? It’s fairly obvious that it helps investors quickly predict their margins for profit. However, when determining a worthwhile investment market, it’s even more valuable.
We all know how crucial location is in the real estate business. As we see housing growing in unaffordability nationwide, price-to-income ratios become even more significant. While affordability is relative, using this metric as a benchmark in making your own investment decisions is a savvy move.
Impact on Out-of-State Investors
For out-of-state investors, the price-to-income ratio demonstrates the power in markets beyond their own. Because unaffordability is growing, it’s important that investors target markets where their dollar goes further. Most of our investors are out-of-area for this reason!
When we look at the map from Brookings (linked above) we see that all of our investment markets fall within normal ranges. This is by design. While “hot” markets can be appealing, they often do not share a reasonable price-to-income ratio.
Additionally, investors can reverse engineer this metric to see how value increased over time. In comparing the purchase price versus income to current value versus income, you can, in a way, see how the value of the property has grown. While the first metric points to your ratio, the second points to a margin of growth.
It’s also important to remember this: there are numerous factors that impact a market’s viability for real estate investment. Price-to-income ratios can point you in the right direction, but they hardly tell the whole story. A too-low ratio can point to decreased rental demand. This is another indicator — the demand of the market alongside the availability of properties, local economic strength, and more.
Know Your Value
At REI Nation, we’re upfront with the fact that our services are premium. Turnkey real estate of our caliber does come with a price. Investors have to keep this in mind when looking at metrics like income-to-rent ratios. While numbers matter, there is an intrinsic value in the services investors receive.
In our case, the value of our expertise prevents costs and risk associated with mistakes and missteps. Because we anticipate problems, your property stays in tip-top condition and protected from any number of risks that threaten your passive income.
When evaluating the value of a property, we can’t forget these factors. Premier management, avoiding costly mistakes, and expertise in the field come at a price— but the worth far outweighs the cost, particularly in the big-picture.
No one factor can determine the worthiness of an investment opportunity. Due diligence is demanded, not only in assessing markets and individual properties, but in assessing the value, security, and services of your investment partners.
That said, cost-to-income calculations can help investors see more clearly where they should invest in real estate.
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