Property Right Value

“It’s a good deal”, “I think you paid more”, are the general expressions people say when they hear about our purchased flat/property value. I guess most of them comment based on comparison of the some property value they know and some comment based on their financial capabilities.

When I was buying the flat, I looked at my financial capacity to repay the loan amount, the areas in which I would like to buy, flat size and floor plan. I never calculate what would be the “true value” of the flat and am I paying more and if so how much.

The following is the article I read in Outlook Money /Rediff that says how to calculate the “Property True Value” to evaluate is it a rent-worthy property. I found it to be lot dependent on your down payment.
If you are lazy and cannot calculate yourself, send me a mail, I will share you an excel sheet that calculates these values. You can play around with different input numbers. :-)

Follow these steps to correctly evaluate a rent-worthy property. Assume the asked price is Rs 35 lakh and the down payment is Rs 8.75 lakh (or 25 per cent of the property's value).

Step 1: Expected net operating income (NOI)

This is rental income minus operating expenses such as repairs. This cost excludes EMI

Rental Income - Operating Expenses = NOI

Rs 2.4 lakh-Rs 15,000= Rs 2.25 lakh 

Step 2: Annual debt service amount

Lenders want the expected NOI to cover your annual debt obligation. So, they lend in a way that the repayment is covered by the NOI. If the bank wants a debt coverage ratio of 1.15 times, the annual debt service amount will be Rs 1,95,652.17.

NOI / Debt Coverage Ratio = Annual Debt Service

Rs 2.25 lakh / 1.15 = Rs 1,95,652.17

 

Step 3: Debt service ratio

This is the annual debt obligation as a percentage of the total loan.

(Annual Debt Obligation / Home Loan Amt)* 100 = Debt Service Ratio
(Rs 1,95,652.17 / Rs 26.25 lakh) * 100 = 7.45%

 

Step 4: Rate of return on your down payment

This depends on NOI yield and down payment portion

NOI Yield * Down Payment Contribution = Return on Down Payment

[(Rs 2.25 lakh / Rs 35 lakh) * 100 = 6.43%] *

[(Rs 8.75 lakh / Rs 35 lakh) * 100 = 25%]

6.43% * 25% = 1.61% 

Step 5: Market capitalisation rate

This is the sum of the debt service ratio and the return on your down payment

Debt Service Ratio + Return on Down Payment = Market Capitalisation Rate
7.45% + 1.61% = 9.06%

 

Step 6: Property's right value

This is the true value of the property (V). This calculation shows the property is worth Rs 24.84 lakh, which is lower than the asked price of Rs 35 lakh.

NOI / Market Capitalisation Rate = V

Rs 2.25 lakh / 9.06% = Rs 24.83 lakh