If you're looking to buy, you're likely wary of the effect a hot real estate market can have on your investment. After all, not only are bidding wars frustrating, but get too caught up in them and you can wind up paying far above the accurate value of your property.
To protect yourself before entering a bidding war, consider calculating the price-to-rent ratio to determine a safe purchase price. While this calculation is typically used by investors- allowing them to compare the going price of real estate with what they can realistically redeem in rent- it's a great way of making sure your property price is in line with historic averages.
The calculation itself is simple. Visit a site such as viewit.ca or mls.ca to determine the going monthly rental rates of similar properties in your area. Multiply that number by 12, to get the annual rental rate, and divide your proposed purchase price by the annual rental rate.
The equation should look like this:
Price-To-Rent-Ratio= Purchase price/Annual Rent
Between 1987-2007, the average ratio was about 15. During the US real estate bubble between 2005-2007, that number skyrocketed to over 20 in some areas.
Paying more than what a property is worth doesn't only have dire consequences if a potential real estate bubble bursts, but it can also prevent you from obtaining financing. If a lender believes you've overpaid for a property, they don't have to approve your mortgage for that property!
-Axiom Mortgage Partners