A valuable number in real estate investing is the price to rent ratio, which is simply the purchase price dividend by the rent received. For example, the condo I purchased for $126,000 and rent for $1,300 / month would have a Price-Rent Ratio of 96.9 (monthly) or 8.08 (annualized).
The annualized ratio is comparable to the P/E of a stock (for which 8.08 is considered quite good!).
The only real problem with this approach is that you can’t really look up ratios for different areas easily. For example, what’s the average Price-Rent Ratio for Toronto? I have no idea! I’d love to know if Kingston or Waterloo have a better Price-Rent Ratio, but that’s not something I can easily look-up, unfortunately.
If you COULD determine this Canada-wide, a community with a very low Price-Rent Ratio, a decent population size and a low vacancy rate (say under 5%) would be an EXCELLENT place to purchase / build rental properties (the other info can be easily determined).
People sometimes talk about properties being cash-flow property from day 1 with 0% down, and I can’t imagine that very many deals like this are possible! As I’m writing this, I did some calculations. Given the fact that my property is $250 cash-flow positive. At the interest rate I’m paying (5.05%), the property could afforded an additional $250 / month in interest, which means I could have afforded to borrow another $59,405.94 (250*12/5.05%). Since I’ve put less than this into the property, if I could somehow have gotten the interest rate I got with 0% down (say with a VTB or something), I could have had this property cash-flow positive with nothing down, so I guess it IS possible.
Neat.
EDIT: FinancialJungle wisely pointed out that the ratio I’ve calculated is more like the Price:Sales ratio then the price to earnings.
{ 8 comments… read them below or add one }
I think you’re probably right. Would the earnings in P/E be net? That would be a P/E of 42 (126,000/(250*12)) for my condo -not so good, especially considering I had to put a fair bit of additional capital in right after purchase (the $126K is quite a bit lower then the actual “price”)
To me, Price/Rent is reminesent of Price/Sales in stocks. The “P/E” of a condo should be a little higher than Price/Rent. I think the general rule of thumb is Earnings = 2/3rd of Rents.
It’d be nice if the Price/Rent ratio is readily available though.
Well, the $1300 is market rent for the area / building I’m renting (one of the women who works in my condo corp office said the average rent for 2 bedrooms in the building is $1200 / month – I added a bit on for rent increases, her experience includes tenants who have been renting for a long term, and because I allowed pets, part of the cost was a “additional wear on unit” fee I charge pet owners and/or smokers), so I think I’d say that you’re paying too little for rent (or more accurately, your landlord paid too much for the condominium).
Since you’re in a “cool” neighbourhood, I’d wager that she feels the appreciation will be a big part of her ROI, and that your rent isn’t even covering her costs (i.e., the property is an alligator, costing her money every month, but she hopes to make it back with some of the other ways of making money with real estate).
At a 5%, 25 year mortgage, a 250K condo would cost $1,454.02 / month in mortgage payments alone (P&I, ignoring any down payment). Add on property taxes ($2000 / year in Toronto), condo fees ($300-500 / month), and insurance ($40 / month) and I think she’d have a very tough time breaking even with your unit.
I’d be looking to pay ~$155K at most for a unit that would bring in $1500 / month in rent, so there’s no way I’d be buying in your building.
I don’t think my tenants are reading this blog, but seeing as 1 month into the rental they thanked me for renting to them and told me how much they’re enjoying the unit, building and area, I don’t think they’d be upset (at least I hope they wouldn’t!)
According to Investopedia’s definitions of Price-To-Sales Ratio, Price-Earnings Ratio and Earnings Per Share – EPS I think my P/S would be 8.08, my EPS would be $250 and my P/E would be 42.
the condo I purchased for $126,000 and rent for $1,300
That’s quite impressive. I’m currently renting a very nice spacious condo in an allegedly “cool” neighbourhood for $1500 and I know the suite is worth in excess of 250K (the price of other units in the building on MLS)
Am I paying too little or is your tenant paying too much? If (s)he reads this, I hope for your sake it’s the former…
Good on you.
My tenants split their rent two ways too…
Any chance you’re interested in moving? I can set you up in a nice little condo for $1300 / month ðŸ˜‰ (I’ve been tempted to buy another similar unit in the same area).
your rent isn’t even covering her costs
yeah, I’m pretty sure that’s true. I did a back-of-the-napkin calc and figured there was very little chance she had +ive monthly carrying costs.
I should also mention that $1500 rent is split two ways.
I think the original calculation is wrong if youâ€™re trying to compare RE investment with other investments such as stocks. Your annual revenue on rents = 12 x 1300; divide this by your principal, 126,000; you get 12.3 %. In the USA, you can write off mortgage interest and taxes, but you will no doubt have some maintenance. You still pay taxes on other investments as well. So, is my math incorrect? Isnâ€™t his return 12.3%?