Buying property? Check rental yield to avoid overpaying, assess fair value

Besides a high current yield, it is also crucial to assess whether it will sustain

Rental yield has emerged as the strongest driver of investment sentiment, according to Magicbricks’ nationwide Housing Sentiment survey of 2,769 prospective homebuyers across India’s 11 leading residential markets. Investors should assess the sustainability of rental yield instead of making a purchase decision based on the current figure alone. 

 

Understand rental yield

 

Rental yield measures how much rental income a property can earn. Investors calculate it by dividing annual rent by the property’s capital value and expressing the result as a percentage. “Residential rental yields in India range from 1.5 to 4 per cent,” says Ravi Shankar Singh, managing director, residential transaction services, Colliers India.

 

Purchase timing matters. An investor who bought five or six years ago may have paid less, so the yield on their original investment may be higher.

 

What a high yield signals

 

Rental yield can indicate whether a property is undervalued, overvalued or fairly valued. “A rental yield of around 3 per cent or above suggests fair pricing,” says Pankaj Kapoor, managing director, Liases Foras.

 

Rentals have risen faster than capital values over the past three to four years. Many locations in cities like Mumbai and Bengaluru offer rental yields of 3.5-4 per cent, and even higher. “Such yields indicate that property prices are productive. Productive rental yields can support annual property price growth of around 5-7 per cent,” says Kapoor.

 

What low yields signify

 

A yield below 3 per cent can signal that a property’s capital value is high. In 2015-16, yields in many locations were below 2 per cent as capital values had risen disproportionately compared with incomes and rentals. “Property prices subsequently experienced prolonged stagnation or correction,” says Kapoor.

 

Low yield can also indicate weak rental demand. Remote and poorly inhabited locations generally command lower rents and yields. Weak demand can hurt resale prospects and make it harder for investors to exit.

 

Use yield as a valuation check

 

Speculation can push capital values above fundamentals. “Rents, on the other hand, are linked closely to household incomes. Rental yield can therefore help distinguish underlying value from speculative pricing,” says Kapoor.

 

Investors may capitalise the prevailing rent using the rental yield for that market. “This will produce an indicative property value, providing them with a benchmark for deciding what price to pay,” says Singh.

 

This metric makes comparisons across cities possible. “It allows investors to compare markets based on expected rental cash returns,” says Anuj Puri, chairman, ANAROCK Group.

 

Beware speculative phases

 

Properties near emerging infrastructure can appreciate sharply for a time despite low yields and weak rental demand. Areas near Noida airport, for instance, have low habitation and low rental yields. “Speculation in land and property can push prices sharply higher. Such appreciation may continue for some time despite poor rental fundamentals. These price increases can subsequently be followed by prolonged stagnation,” says Kapoor.

 

Check tenant demand

 

Not just current yield but its sustainability is crucial. “The sustainability of rental yield depends primarily on the depth and consistency of tenant demand,” says Sachin Vyas, principal partner & chief sales officer, Square Yards.

 

Infrastructure upgrades can strengthen demand. “Economic growth drives employment, which in turn drives migration. Migration supports rental demand,” says Puri. Public transport and social infrastructure also support demand. 

 

Investors should examine the future supply pipeline. “A large volume of new residential inventory can limit rental growth,” says Vyas. 

 

Focus on net yield

 

Do not buy a property merely because its advertised yield is high. Estimate the rent it can realistically command and focus on net yield. “Maintenance costs, property taxes, repairs, and vacancy periods can affect return,” says Vyas.

 

Use the total acquisition cost to calculate capital value. “It should include stamp duty, registration costs, brokerage, interiors, and financing costs,” says Vyas.

 

Puri finally cautions that instead of relying only on rental yield, investors should also pay heed to how capital values are moving.