I have received some very positive comments about my blog: http://www.rohanlive.com/house-price-to-rental-ratio and have received many requests to expand on this. I therefore thought it would be good to write a few blogs on House Price to Rent Ratio Vs percentage of properties rented in an area. Actually, house price to Salary ratio is a factor that very few investors actually consider. House price to salary ratio is simple to calculate and should be used in context to the exit strategy you are looking to achieve e.g. selling or renting.
Let’s explore this further. In any market, any country anywhere in the world you can look at the average house price and divide it by the average salary to give you the HP/S ratio. This can be an extremely valuable tool for those wanted to find out if a market is too expensive and also whether there is potential for more growth. For investors, this this calculation allows us to establish if the properties we are buying can be sold on easily for profit. I will explain.
Depending on who you speak to, the ratios work like this – Low = 3 – 5, Medium = 5 – 7.5 (8) and High = 7.5 (8) and above. So for example, if the average house price was £150,000 and the average salary was £30,000 then the average house price to salary ratio would be 5. If these figures were based on national averages then your national HP/S ratio would be considered to be Medium. National averages on their own are quite valuable on their own as they give you a measure of where the country is – however, when you start to use them with regional or local HP/S ratios, then they become very useful.
For example – if you were looking at a property to purchase, renovate and sell then you would want to ration to be equal to or ideally lower than the national average. When the HP/S ration is lower that the national average it will be more affordable to the people who are looking for that type of property. Imagine you look at two properties to buy, renovate and sell. Both will make you a profit of £25,000 when you sell. Property (A) has a re-sale value of £180,000 and Property (B) has a re-sale value of £270,000. Now imagine that the the typical salary in the area for the type of people looking at these type of properties is £43,000. If you had not established this, if you had not done your research and found out what the demographics of the typical buyer is and what they do and what they earn, then you may miss an important point. Imagine that you had purchased property (B) because you thought it would be a nice deal and people would “like” it. Unfortunately if you run the numbers you will see that actually Property (A) is a better strategy.
Property (A) HP/S ratio: £180,000 / £43,000 = 4.2
Property (B) HP/S ratio: £270,000 / £43,000 = 6.3
You can see that (B) is above national average and relative to (A) is higher and less affordable. When this happens, properties in the (B) catagory always tend to stay on the market longer, don’t sell easily and cause problems for the investors. RESEARCH IS ESSENTIAL.
I will discuss this more in my next few BLOGS.
One last thing I want to leave you with. When the House Price to Salary Ration is HIGH, then more often than not, the percentage of properties in the areas being rented is generally higher. If you think about the logic it makes sense. If HP/S is high, properties are less affordable to buy, therefore people choose to rent until they can save up enough money to buy.
MAJOR TIP: When looking to invest in an area or buy and sell in an area – carry out the HP/S calcualtion for the exact type of property you are looking to buy. If you are buying one bedroom apartments, then find out who buys them and what they earn then use those figures to calculate HP/S ration NOT the salary of a person who would normally be buying a four bedroom property. This will give you a more accurate assessment and you can compare like with like. Average HP/S ratios for apartments can be compared with other apartments, housese with houses etc etc.