Why are some markets more affordable to buy and some more affordable to rent?
Do I want to invest rental properties in markets that are more affordable to rent or buy?
Before I answer these questions and explain how I identify cities that fit, I want to remind you what we covered in Parts 1 and 2. In Part 1, we started out asking the question – “Why do rentals perform better in some markets that others?” In order to answer that question, we look at the following demographic data:
- Job Growth
- Population Growth
- Income Growth
We also discussed:
- Why this data point is important to our analysis?
- Where do we get this data?
- How do we use this data?
In Part 2, we asked “How well do local residents care for their neighborhood?” and “How educated are residents in an area?”
Answers to Today’s Questions…
The reality is that some markets are more affordable to buy and some are more affordable to rent.
Why is Affordability Important?
If a market’s rental cost is close to the same as buying, paying a mortgage payment, paying the property taxes and buying the insurance, then more residents in the area will be more interested in buying that renting. This will tend to help push down rental rates due to lower demand for renting.
Where do I get this data from?
There are three pieces of information that I gather to compute my affordability ratio and all three are available on http://www.city-data.com/, which we have already been using to the get the data in the prior two posts. The three pieces of data that I gather are:
- Median Gross Rent for the most recent year available
- Median House or Condo Value for the most recent year available
- Median Property Taxes (annual) for the most recent year available
How do I use this data?
I use the three pieces of data to compute an index. First, based on Median House Value, I calculate a typical monthly mortgage payment using current average mortgage rates. Second, I sum this newly calculated Median Mortgage Payment and the monthly Median Property Taxes to get a typical monthly payment for ownership. Finally, I divide the newly calculate typical monthly payment by the Median Gross Rent to get a price-to-rent ratio.
The higher this ratio is the more likely a resident will choose to rent rather than buy. Due to market forces, over time this will tend to pull rents upward in these cities with the higher ratio.
I calculate quartiles for the cities based on this ratio in order to categorize the cities. However, this data point is not as important as the data points I discussed in Part 1 and Part 2. I use this data to further separate and rank cities after ranking by demographic data and crime statistics.
There are two more pieces of data that I use to determine the best cities to invest in residential rental properties and one of those helps address how COVID-19 might affect the investment desirability of different cities.
Please comment below with your comments or email me to discuss. If you would prefer to talk on the phone or Zoom, please use this Calendly Link to Schedule a Call.