One way to evaluate the real estate market is to compare rental rates to home values. This can provide a comparison of an approximate cost of buying a house versus the cost to rent. As the ratio of monthly rent to home price increases, at least on this measure or real estate value, the market can be seen as becoming more expensive.
Several points to keep in mind:
- This does not take into account things like tax rates (in higher tax areas the rents will be higher [since the owners will pass on that cost that is not reflected in the home price] – the ratio lower)
- This is only a comparison measure – it can be that rents also experience a bubble. So if rents experience a bubble then the ratio could stay low and fail to indicate an “expensive” market.
- Don’t rely on one measure – this is one useful measure there are plenty of others that matter for real estate prices (income levels, job growth, interest rates, zoning regulations…)
likely would have to fall considerably.
This paper is well worth reading. I would like to point out another factor here though. When those investing in real estate were focused largely on capital gains (say a few years ago) there could well have been an increased demand for rental property (which increased prices). That effect also moved extra supply into the rental market (that previously would have been sold to owners that would live there instead of investors). Those investors were more concerned with capital gains and it seems to me could well have been willing to accept lower rents just to have some cash coming in to help pay the expenses.
As those investors no longer believe they will receive large capital gains in the short term it is possible they will be more focused on cash flow – and seek increased rents. I will not be surprised that rent prices increase as investors focus more on cash flow and stop assuming such large capital gains will be where their profits are made. Thus the ratio will close both by real estate value declines and rental price increases.
Related: Explaining Rent-Home Price Ratios – True Rent-to-Price Ratio for Housing – articles on the real estate market – Real Estate Median Prices Down 1.5% in the Last Year – Rent Controls are Unwise