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Buying Property For Own Use – Is Asking Price A "Value Buy"?

How does one know whether that wonderful property you want to call home is valued right and is a good buy? There are no standard parameters – other than few thumb rules like if you buy property at 10 to 15 times going annual rent, you are getting a good value.

On the face of it, it seems these thumb rules are not of much help in Indian context. I can’t speak of other countries but here, using this criterion, it seems one will never be able to call himself an owner because most of the property deals never come close to this criterion of “value”. Case in point – I recently sold the only residential property I owned. If I consider what the buyer paid to me and the government (levies like stamp duty, registration cost etc) – it went for quite close to 30 times annual rent. Deals at such price are very common / normal. What is going on in the property market here? All the folks out there can’t be out of their minds in putting so much value on being an owner rather than being a renter. Fact is – while pride of being “property owner” is always there, key objective of owning your place of residence is to save on all the rent you will pay in your and other family members lifetime plus you want to tame the rent inflation monster.

Let’s cut the talk and do some number work. As we say in equity investments, “TIME IN THE MARKET” is of prime importance. Can the same be true for property ownership also? Thinking on these lines, I did some tinkering with MS excel and came up with a calculator for objective value assessment. Parameters considered:

-          All-inclusive cost of property acquisition

-          Whether buying on loan or with own funds

-          Current going rent for similar property

-          Rental inflation and property appreciation expected

-          Time horizon

Not tinkering with the saying that a property’s value is what market rent it can fetch. We will only be playing with time element, rent inflation, property appreciation and discount rate (return required from alternative investment) here. Some assumptions:

1.       Inflation: Rather than going by RBI’s CPI figures, I am more inclined towards using the CII numbers released by Income Tax department annually for working out capital gains indexation. The series in much longer (the latest one extends back to 2001) and is mostly derived from CPI. Makes life easier. I use this for projecting rent inflation and property appreciation rate. Better to start with some basis for these projections rather than plug the numbers randomly

2.       Time Horizons: 30 years as long term, 10 years as medium term and 5 years as short term

3.       Property appreciation: I will again, not challenge the common knowledge that land appreciates while the structure requires upkeep expenses. To account for these, we’ll say structure depreciates by 2% every year while land appreciates as per the rate mentioned in my calculator

What opinion did I form by digging into the numbers?

4.       Say you are eyeing a property whose current rental is INR 25,000/- per month, and you plan to stay in it for 30 years at least. a price of INR 1 Crore is actually a very good price – IF (A BIG ONE) you buy the property with your own money and only consider risk free options as alternative investment. The rents you saved by being the owner, plus the terminal property value whether you sell the property or bequeath it give you a property CAGR of 9.44%. Depending upon what tax spectrum I lie, I will be happy with rate ranging from a high of 11.10% to a low of 8.73% (see sheet named “Return Requirement” in the attached calculator). Mind you, going by my assumptions, nominal property appreciation with respect to “realization to seller” comes to around 6.65%. If we consider “price to buyer”, with additional 15% cost, property appreciation CAGR comes to 6.99%. This is quite a reasonable expectation on property appreciation front and comes quite close to the rate at which my 15 year old property appreciated. And mind you – the buy price mentioned is all inclusive, even the money you spent on renovations. For an all inclusive price of INR 1 Crore, the realization to seller should be around INR 87 Lacs. See sheet named “Property Cost Details” in the attached calculator

5.       What if we go down to 10 years holding period. The property CAGR, including rentals saved goes down to 8.33%. Still not bad, considering now property appreciation CAGR is just 5.14% in nominal terms. Am still ok with the same – anything close to 8.5% is fine with me (refer to “CAGR Requirement” sheet again!!!)

6.       What if we go down to 5 years holding period. The property CAGR, including rentals saved goes down to 7.63%. I am looking for a CAGR of nearly 8.4%. Now we are not getting a good value and the property is not a good buy!!!

Off course, the key point here: assumption regarding starting rent, rent inflation and home price appreciation should hold true for such periods, and MOST IMPORTANLY, you can buy the house outright with money in your bank and not from the bank. That’s where the problem lies – most of us don’t have this kind of money in the bank. Mostly, it’s a scramble to even muster up the down payment of 25% or so. And when the house is bought on loan, the whole workings change. Say some bank loans you full amount of cost of property acquisition. I also assume that cost of loan, after accounting for all tax benefits (one reason cited how loan benefits home affordability / ownership) comes to 5%, to be applied on principal amount on reducing basis. What do the numbers say now?

  • 30 years time horizon: CAGR goes down to 7.80%. Still ok, if you are ready to reduce the risk premium by nearly 1%. Don’t forget – you got to stay put for 30 years as major benefit is accruing from rents saved
  • 10 years time horizon: CAGR is now a low of 4.76%. We have a problem with such low CAGR, which is even less than risk free yield post tax!!!
  • 5 years time horizon: CAGR now goes down to 3.34%. Understandably, because loan interest payments eat up all the rentals saved and then some. With such low ROI on property ownership, I would rather stay a renter!!! 

My opinion on whether the asking price makes sense - I would consider the 10 year horizon AND:

  • .       If buying the property with 100% own funds, I don’t mind paying even 32 times annual rent. The realization to seller at this level would be lesser, around 28 times annual rent. And this is the reason property prices are so high. Most residential properties are bought with an intention of never to sell. Buy and hold truly holds good here!!! Even if 20% of properties are bought self funded or with a very low loan outlay, property prices will match up to these levels.
  • .       If buying with 50% own funds and rest bank funding, I would consider the property to be a good buy if I get it around 21 times going annual rent. The realization to seller would be lesser, around 18 times annual rent
  • .       If I am buying with 25% as own funds and 75% bank funding, which is what mostly happens, property is a good buy if I get it at close to 17 times annual rent. Realization to seller – 15 times annual rent
If I am too much enamoured in getting the “owner” branding, for scenarios other than 1, I would reduce the risk premium and be ok with even 1% above risk free rate. Going by this logic, and assuming I buy the property with 75% funding, I am ok with a CAGR of 6.5% - which gets us to a price of nearly 26 times annual rent. Realization to seller at this level is nearly 22.5 times annual rent.  

As we see, thumb rules are not that out of sync. Just that it changes with the funding methodology and time element. The calculator is uploaded here. I have tried to keep things self explanatory. If you have nay doubts, comment below and I will surely respond.


Location: Delhi, India

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