As a very rough rule, price-to-earnings ratios for stocks tend to drift from 10 to 25. It varies a lot between industries – industries with high earnings growth will almost always have higher price/earnings ratios – but that’s a reasonable range to start from. The P/E ratio for the S&P 500 index was about 22.2 at the end of last year.
Equally, you can apply this to your house – just think of the “earnings” as being the net rental income. A house with high rent growth would have a higher price/earnings ratio; a house in an area where rent growth is stagnant would have a lower price/rent ratio and a lower outright price. But in theory, the P/E ratios should be roughly comparable to stocks, otherwise people would sell their houses and invest the money in stocks.
A couple of sample numbers from my favourite metropolises (metropoli?), assuming that maintenance and fees eat up one-third of the gross rent:
- San Francisco: A 1br/1ba condo on Nob Hill goes for $525,000; this similar apartment a few doors down would cost you $1775/month. After fees, the PE ratio would be somewhere around 37.
- Singapore: A 2-bed 1044sqf apartment in The Pier at Robertson (which is admittedly a very nice building) rents for $6,500/month (yeah, right!) or sells for $2.1 million. So your net rent is $52,000/yr, for a P/E ratio of just over 40. That’s a lot.
- Miami: firstly, sheesh, that’s a lot of “for sale” signs. You could have this little 1br/1ba 560sqft for $250k (probably less, actually), or rent an identical apartment for $1200/month. Or about a 26 P/E – which is almost reasonable, compared to shares.
You’d think twice about buying a stock with a P/E above 40. So why would you buy a house with a P/E above 40 and take on 5x leverage to do it?