As sales prices have risen, and rents have dropped, San Francisco’s residential “rent ratio” has climbed to a nation-wide high of 34.1 (according to The New York Times). We’re higher than New York City (25.4) and San Diego (28.9), and up from a rent ratio of 12.5 in 2000.
In other words, on average, properties in San Francisco are selling for 34.1 times the rental incomes they could generate in a typical year. Think of it as a property’s “P/E” ratio. And from an investment perspective, the higher the P/E, the higher the expectation of future returns. And the higher the risk.
In the stock market, a high P/E usually signals that investors are betting on a significant growth in future earnings (think Google). And from an income property perspective, a high P/E usually carries expectations of increasing rental income. If not, investors are speculating on market appreciation, rather than investing in a growing income stream, to provide a return on their investment.
Of course psychological factors play a role in housing purchases. A cultural emphasis on owning rather than renting, pride in ownership, and not wanting to ‘get left behind’ all affect our decision making processes. But from a purely analytic perspective, the increasing P/E ratio is cause for concern amongst investors (yes, even factoring in the mortgage deduction).
On the other hand, renters celebrate. It’s a great time to sign a new lease.