How high does the buy-to-rent ratio have to be to make renting cheaper over the long term?

Question

As an example, San Francisco currently has an estimate buy-to-rent ratio of 30, which means it would take 30 years of rent to pay for purchasing the same piece of real estate. This supposedly means that it is more efficient to rent an apartment in San Francisco than to buy one outright. But is this "common wisdom" really true, at least for the buy-to-rent ratios currently seen in the US? Sure, it might take 30 years for your investment to pay off in San Francisco, but unlike the guy who spent 30 years in rentals you now have a private piece of property. Not to mention that San Francisco remains a popular city and land prices are likely to continue increasing there for the foreseeable future, so your resale value would be higher when adjusted for inflation.

How high does the buy-to-rent ratio have to be for renting to be a wise decision in the long term?

Answer 1

The total cost to own a home for 30 years with a 30 year mortgage paid on schedule with no prepayment will be roughly the following:

original value
+ original transaction costs
+ interest
+ insurance
+ taxes
+ maintenance
- final value
+ final transaction costs

The cost of renting over the same period are simply the rents collected (we'll ignore little fees or renter's insurance but you can feel free to include them).

If transaction costs are 5% of value and yearly insurance, taxes and maintenance are 1% each of the home value, and the value increases like inflation (let's be conservative and say 1% YoY), then the home's value increases by anout 35% over that time. 30 years of 3% holding costs are around 105% of the original value. If you pay 100% of the initial value in interest (somewhat higher than a 5% rate) then:

V
+ 0.05V
+ V
+ 1.05V
- 1.35V
+ 0.07V
= 1.82V

We want to see what the break-even point is. Assuming rents increase with inflation (again, 1%) then the total rent is about 35R. We can solve:

1.82V = 35R
V = 19R

If rent is $1k per month, or $12k per year, this suggests that a home of comparable total cost would have a purchase price of $228k. Note that if you believe inflation is 2%, the numbers are more like $336k for a comparable home. The higher inflation is, the better buying a house gets compared to renting. Enough deflation would eventually make buying at any price foolish.

These assumptions are simple but you can easily tweak the numbers to your taste and add things I did not consider to improve the analysis.