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The price-rent ratio is the average cost of ownership divided by the received rent income (if buying to let) or the estimated rent that would be paid if renting (if buying to reside):

The latter is often measured using the "owner's equivalent rent" numbers published by the Bureau of Labor Statistics. It can be viewed as the real estate equivalent of stocks' price-earnings ratio; in other terms it measures how much the buyer is paying for each dollar of received rent income (or dollar saved from rent spending). Rents, just like corporate and personal incomes, are generally tied very closely to supply and demand fundamentals; one rarely sees an unsustainable "rent bubble" (or "income bubble" for that matter). Therefore a rapid increase of home prices combined with a flat renting market can signal the onset of a bubble. The U.S. price-rent ratio was 18% higher than its long-run average as of October 2004.

More about Price-to-rent ratio:

The Price-to-rent ratio is the ratio of residential real estate prices to the annual rents that can be earned from the real estate.

Price-to-Rent Ratio = Real Estate Price / Annual Rent

The price-to-rent ratio can indicate whether home prices are rising or falling or the desirability of owning rather than renting. The US average ratio for 1987-2007 has been about 15, meaning that home prices were 15 times the annual rent that could be earned from the homes. During the real estate bubble 2005 - 2007, the price-to-rent ratio increased to more than 20 times in some areas.

Example—Calculating the Price-to-Rent Ratio

If a residential home cost $200,000 and rents for $1,000 per month, what is its price-to-rent ratio?

Annual Rent = $1,000 x 12 = $12,000

Price-to-Rent Ratio = $200,000 / $12,000 = 16.67

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