Valuation of Property Investments

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Kavitha Menon | kavitha@ppfas.com

Like equity, property purchased for investment purposes needs to be evaluated both quantitatively and qualitatively. Of the most common and simple ways of quantitatively evaluating value of a property is by rental yield. Both potential buyers as well sellers can use this tool to decide on the true price of a property. 

Here is how you calculate rental yields

Net Rental Income = Monthly Rental X12
       Less: 1) Rent for the Period Unoccupied
       Less: 2) Brokerage Expenses
       Less: 3) Maintenance Expenses
       Less: 4) Tax payable on rental income
       Less: 5) Repairs and Maintenance expenses amortized
      
Net Rental Yield = Net Rental Income/Current Property Value

Needless to say a high rental yield indicates an undervalued property while very low rental yields could mean that the property is overvalued.

If you intend to fund the purchase of property with a mortgage loan you could look at how much positive cash flows the property generates for you by doing the following.

Cash In hand = Net Rental Income
       Less: Interest Cost
       Add: Taxes benefits if any (for example 1.5 lakhs tax exemption given on interest payments                 on a housing loan).

The reciprocal of rental yield is Price to Earnings or P/E, a concept most equity investors are familiar with. Factors like quality of construction, amenities, proximity to commercial space, connectivity, local infrastructure like schools and hospitals have to be taken into account while assigning an appropriate P/E to property. The higher the number of positive factors the more liquid your property is and higher would be the P/E. For example localities that are better connected will command a higher P/E as compared to one in a far flung suburb. This is very similar to stocks where P/E of quality business is always higher than industry averages as investors are willing to pay a premium for well run companies. Similarly high rental yields could mean stability of income flows and appreciation, while zero to low rentals are ok only if there are solid reasons for capital appreciation . 

Property investments offer both capital appreciation and rental yields .However just like in any investment, besides evaluating value, a thorough study of risks is a must. Since the outlay is very high you must ensure that your finances, in terms of maintaining sufficient contingency funds, future cash flows etc are taken into consideration before taking the plunge.

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