Those of you who have seen me speak in public will have heard me talk about market valuation by looking at the house price to earnings ratio. This is an approach used by investors to assess the “affordablilty” of properties in respect of the average persons earnings for a specific type of property. Well, another ratio that can be assessed is the house price to annual rent ratio (HP/RE Ratio). Whereas the house price to salary ratio works well for establishing the potential liquidity in the market for selling, the house price to rent ratio provides a good barometer for the rental market.

This is calculated by comparing like with like, house price with rental figures for the same type of property. This is VERY important.  For example when considering one bedroom flats you must review the average property price in a specific area and rentals for the same type of property. This calculation is essentially the reverse of the yield calculation whereby the gross rent is divided by the house price.

An example would be an apartment that costs £200,000 and an annual rent of £7200 indicates a ratio of 28. In the same town another apartment with a market value of £200,000 can receive a rent of £1500 per month (£18,000 per year) giving a HP/R ratio of 11. By carrying out this exercise on a range of areas and properties you will be able to assess when properties are “undervalued” and “reasonably valued” and “overvalued” with respect to the rental market. Naturally, the lower this ratio, the better the income for you as an investor.

One has to be careful not to take too simplistic a view on this as there are many other factors and it is one that is widely debated. A great place to view such a debate is at the following site – this was a New York Time article last year