How to Understand Rent to Value Ratios
I want to explain what Rent-to-Value ratios are and why you might be interested in them. These ratios differ depending on the market and will affect your Return-on-Investment (ROI). A Rent-to-Value ratio is essentially taking the average fair market rent that you have for a property, or residential rental property, and dividing it by the sales value of that property. Let’s look at an example.
If we receive $2,000 in monthly rent and divide that rent by a $400,000 property, that ratio would equate to 0.5%. Now, if you’re an investor, prior to all these interest rates coming down, many investors were looking for a 1% Rent-to-Value ratio, which is a great ratio. 1% ratios are harder to come by in today’s market, however. The large equity increase in these properties over the past year and a half has dropped that down. Recent interest rates have allowed lower ratios, such as 0.67% and up, to still retain a good ROI on your rental.
Higher Rent-to-Value ratios can’t exist in equity markets. San Diego, California, and Boise, Idaho, are examples of equity markets, which means that properties have had a large increase in equity. Boise is an example of an equity market that previously had low rents to begin with. San Diego is an example of an equity market in which the rent amounts cannot keep up with the equity increase. Evaluating the different markets will help you determine where you can obtain your best ROI. Here’s an example of what a 1% Rent-to-Value ratio looks like. $1000 in monthly rent on a $100,000 property equals a 1% Rent-to-Value. Look at the markets that have a high Rent-to-Value ratio to maximize the return of your money.
Finding High RTV Properties
These $100,000 properties are getting harder to come by, but they do still exist. These properties are usually found more frequently in the Midwest and it’s important to actually go into those markets in order to find these properties. One option to consider is to look at the equity that you have in some of your properties that reside in these equity markets like Boise, Idaho, or San Diego, California. Perhaps you have $200,000 or $300,000 in equity in your property. You can take that money out (sell) to liquidate that money, and then use it as a down payment on a $100,000 property or $200,000 property and put down $20,000 to $40,000. This enables you to buy four or five houses with the equity from that original property that exists in the high equity market that was giving you a poor return on your rent.
Strategizing Rent-to-Value Cash Flow
There are a couple options to maximizing your Rent-to-Value ROI. Moving your high equity cash into a different market is one option. In a market such as San Diego, you can also move it into a second dwelling or ADU, which means you don’t have to invest in the land. Since you already own the land on your own property, you only need to invest in the dwelling costs. Oftentimes you can calculate a high rent value because you don’t have to buy the land. Look at the cost for the improvements and then divide that out by the rent.
In this instance you calculate the value of the improvements rather than the value of the home. Once you divide the monthly rent by the cost of the improvements, you will have your Rent-to-Value based on the ADU/second dwelling itself. That could be a really good Rent-to-Value ratio in an equity market that allows you to have a second dwelling or ADU on your property. If you would like more information about building, buying, or selling your home or land join us and listen to “The Real Property Show” podcast.