Bubble Economics - 150 to 200 Rule in Real Estate
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With all the talk over a real estate bubble right now, it is very hard to determine a rule that would carry over well to understand whether a local market is oversold or undersold. Reading the Motley Fool today, they had a nice simple rule that seems logical.
Bringing it home: The 150 to 200 rule
If a home is selling for 150 times the monthly rent (or less), it’s generally a good deal. If it’s selling for more than 200 times the monthly rent of a comparable property, you’re better off renting. I ran this little test for a house near Fool HQ in Alexandria, Va. House A has five bedrooms and 4.5 baths, and it sits on one pristine acre. You can rent House A for $3,900 per month. Based on comparable sales, this home would sell for approximately $2 million. Therefore, it’s selling for 512 times the monthly rent! Put another way, if you mortgaged the whole $2 million at 5.42% over 30 years, your monthly payment would be more than $11,000.
Let me know how this applies to your local market.
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Comment by David on 28 October 2005:
The place we rent is a townhouse in Silver Spring, MD for 2,300 a month. A similiar townhouse just sold for 600,000 so that would be a ratio of 260. Ouch.
Comment by John Doe on 28 October 2005:
I rent a home in Orange County for $2500 that would sell for $750K. That’s a 300! Homes in our neighborhood range from 720K to 895K, so $750k for a 2K sq ft 4br is a realistic fast-priced number and it’s still out of the ballpark.
Comment by S.weil on 29 October 2005:
Your VA example sounds terrible. I live in D.C. proper. I am owner/occupant, but rent the basement apt. for $1200/mo. I should be able to get $2500-$3000 for the rest of the house. Market price would be around $800K, so I am right around the magic 200 rule
Comment by Melissa on 30 October 2005:
We rent a house in the way outer VA suburbs of DC. It was brand-new when we moved in. We are paying $2250 and it would sell for at least $550. Ratio of 244. But we are paying a lot for it, really, due to the limited area we wished to live in. Areas like Gainesville and Haymarket have some amazing rent ratios on brand-new McMansions.
Comment by Jason on 14 November 2005:
I live in San Jose, Costa Rica. We’ve seen properties sit for years(!) for sale. The prices are simply too high for what you get.
Houses that sell for upwards of $300,000 can be rented for $2000 or less. Includes large lot, pool, gardens etc. That puts it at or below the 150:1 ratio. Not bad….
Comment by Anon on 23 September 2006:
Bay Area, California.
I looked at selling or renting our my home about 16 months ago. I thought there was a bubble so decided to sell. I sold for $679K. The rental price the real estate agent quoted was between $2,200 and $2,500. My guess was on the higher end. I have followed the price of my home since then by tracking the cost per square foot in the same PUD. The property went up by about $150K, and has now dropped back to about a rise of $100K.
So my number was about 270 at the time of sale, and is now about 285 allowing for a general rise in rent.
Don’t forget the cost of selling, and the savings on property tax repares, etc. if this were a business analysis, but this is about the property market being in a bubble.
Comment by Sundream Estate on 2 October 2007:
Our calculation here in Marbella, Spain is that we recommend the properties owner a ratio of 250:1 of the market price when they want to rent out.
Pingback by Why Prices Will Continue to Fall | Redfin Los Angeles Sweet Digs on 7 April 2008:
[...] meaningful measure is to compare a home’s selling price to its monthly rent. The conventional wisdom is that the price of the home should be no more than 200 times (150 times is better) the cost of the [...]