John SkinnerOne way to decide whether you are better off financially renting or buying a single family residence (SFR) is to consider its price-to-rent ratio. This rule of thumb figure evaluates the price of a property and is more commonly referred to as the gross revenue multiplier (GRM). The GRM is calculated by dividing the asking price for a residence by the annual rent a comparable property commands.
Many analyst feel the GRM tips at 20 times a property’s annual rent (fluctuate between 17-23 depending on demand) when considering whether to purchase or lease a home. As perceived, an asking price more than 20 times a property’s annual rental value means renting is a better bet than owning. Likewise, if the price of a property dips below 20 times its annual rental value, purchasing a home will be the more prudent financial decision. [Full New York Times article, see In Sour Home Market, The Gross Revenue Multiplier (GRM) Renting vs. Buying, Buying Often Beats Renting.]
It is important to understand the financial scope of the decision to rent or to purchase a property. A number of social amenities – externalities in economic parlance – are favorably associated with owning a home: the appearance of family stability; a safe investment; activism for the benefit of one’s community; civic responsibility and political involvement.
These amenities are in addition to income tax savings through itemized deduction of property taxes and mortgage interest; equity buildup due to amortized principal payoff, property improvements and the property’s asset value inflation; and neighborhood appreciation in value due to increased desirability of the location.
On the other hand, the true costs associated with owning a home remain largely unspoken. First of all, the monthly payment on a maximum mortgage is not equivalent to the rent a tenant would pay to lease the same or a similar SFR. Implicitly, the financial lure of ownership is not significant unless the mortgage payment is less than the rental value of the property. This is because a homeowner’s mortgage is bundled with additional ownership and operating expenditures which come with the acquisition of any property: Taxes; Insurance; maintenance; replacement of structural components; homeowners’ association (HOA) fees if the property is located in a common interest development (CID); and furnishings.
With the exception of furnishings, these ownership expenditures as well as other expenditures such as water and trash are usually always included in rent. The expenditures included in rent are especially distinguishable if the SFR under consideration is a condominium unit.
Historically a GRM of around 14 was accepted but has had to be adjusted upward. Depending on market conditions, use a GRM between 17-23 while also analyzing sales comparables and the price per square foot method.
*Sources: New York Times; First Tuesday
