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How to tell if a home is fairly priced

By Kate Ashford, Money magazine


NEW YORK (Money magazine) -- Q: I heard you could check on the price of a house by comparing it with local rents. How does this work? -- Pedro V., Arlington, Va.

A: What you're talking about is the price-to-rent ratio, essentially the value of a home divided by the typical annual rent for something similar in the area. It's one of many numbers used to gauge the health of housing markets.

When prices rise far faster than rents do, the thinking goes, buyers will eventually move to the sidelines. As the gap narrows, owning starts to become more appealing again.

During the housing bubble, price-to-rent ratios climbed to crazy peaks -- it wasn't unusual to see numbers in the 20s and 30s in 2005 -- but the collapse of home prices has brought the nationwide average down to about 15.

Economists generally consider that level a sign of a balanced market. "If you had a very high ratio -- in the 20s, say -- I think it'd be appropriate to be very cautious about buying," says Dean Baker, co-director of the Center for Economic and Policy Research in Washington, D.C. "There's a strong likelihood that the price could fall."

But what you really want to look for is the long-term average for your area. Although Miami's price-to-rent ratio has dropped from 30 to 15, for example, it's still not as low as the average pre-bubble ratio of 12. Also keep in mind that a high number may be the norm -- the pre-boom average in San Francisco was 24 (it's 28 now).

"Some metro area houses will always be overpriced relative to apartments," says Andres Carbacho-Burgos, an economist with Moody's Analytics.

If you're buying a home for the long haul, the price-to-rent ratio is only one of many factors you should consider. But if you're going to stay for five years or less, do the math.

"There are no guarantees," Baker says, "but it's something you'd want to look at carefully."  To top of page

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