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Buying Property To Let – Working Out The “Value” Price


Here I looked at how to get a rough idea of valuing property for own use. I had a doubt whether the oft cited thumb rules make sense or they have long lost their relevance. After making life a bit complex by bringing in host of numbers, I did realize that if you are buying for your use, and with the “popular” capital structure of 25% down payment and rest on "loan", the thumb rule of buying property at maximum 15times is mostly in sync.  Now we look at the rental scenario – you are buying property to rent out and make an income stream. Before we move on, to state it bluntly – I am biased towards “Not being a landlord”, ‘cause it’s too much work for the money to be made going by rental yield in Indian cities. But then, that’s my opinion and still no harm in checking what the numbers say. My opinion may also change!!!

That said, for rental property to be a “value buy”, my guess is the costing should be way less than self-occupied property. Why? For starters, when you occupy property yourself – it is at zero cost, while when you rent, cost element comes into play. GOI’s income tax department also let’s landlords deduct 30% from realized rent as costs, in addition to interest outgo. This good blog also mentions that cost of renting comes to around 31.4% plus financing cost. Looks like GOI’s cost estimation for renting out is mostly on the mark (for a change).

Want to keep it simple – mark down the maximum price you would pay for own use by at least 30% if you want to buy for letting / renting out. If you are ready to pay 17 times going gross rent for the property for own use, you should not pay more than 12 times when buying to let / rent.

Or we can go the detailed numbers way. This time, I tried a different methodology. If I want invest in a “buy to rent” property, my objective is to create a regular income stream. What better way than to compare the rental yield with risk free yield, post expenses and tax? With RBI Retail Direct portal in action, I can now buy a 30 year government bond which will give me “no effort” guaranteed half yearly payment in my bank account for 30 years. To make it a value buy as per my standards, the net annual rent from property after 5 years should match up to the net interest paid by risk free investment.

Going by above established standard, one should pay no more than 12.40 times annual rent for the property***. It’s another matter than in India context it will be very difficult to land with property valued as such.

One can argue that this approach does not take into account expected appreciation of property. My counter is:

-          Try my calculator uploaded in the blog buying property for own use. My guess is results will mostly be in line to above working, IF YOU ARE CONSERVATIVE in your property appreciation rate assumption. One can justify any price by projection high appreciation rates, so mind that

-          Until and unless one can really get a distressed deal, I don’t expect much appreciation from property for first 10 years. Decent rental income, growing as per inflation is one’s best bet

-          Even a 30 year government bond can appreciate if interest rates go down

         

Final word: A bit of qualitative parameter: if I do not have 50% of property value to put as down payment, I would steer clear of making such an investment. Going for a highly leveraged “risk” investment is simply not my way to go about. But then, each to their own.

***Check out the calculator here

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