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Consider rental yield while buying property

Capital appreciation is harder to come by now; it's time to consider rental yield

Traditionally, Indians look at property as a source of estate building for the family and a store of value rather than an active investment. For many years, and in some cases even now, people live in houses covered by the Rental Control Act, and rent itself has historically not been an important consideration. However, prices and rents especially in metro cities have increased at a very fast pace. Also, the average Indian not only buys property for consumption but also has started considering it as an active part of her investment portfolio. Despite this change, rent still remains a relatively unimportant factor (for the owner). This is because demand to own residential property exceeds supply and due to the fast-paced price appreciation.

Nevertheless, rental yields should be considered if you are looking at investing in real estate for long-term wealth creation. This is pertinent to your overall real estate investment more so now given that the cycle of meteorically rising prices is turning and slowing down. Don’t give up on capital gains, but if you are looking at investing in property, it’s wiser to consider expected capital gains plus yield. Here are some aspects to be considered.

What is rental yield?

Before we get into where you can invest, let’s be clear on what rental yield is. Sample this: If you earn an annual rent of 1.8 lakh on a property which is priced at 50 lakh, then the rental yield is 3.6%. It essentially measures the return you make on the asset without considering the expected capital gain or loss.

Rental yields on residential property

If you are looking for that additional yield to build a long-term annuity, residential property is not a preferred choice. Yield hasn’t been an important consideration for residential property primarily for two reasons. Says Yatin Shah, executive director, IIFL Wealth Management Pvt. Ltd, “What matters is the total return (i.e capital app + rental yield) and when the capital appreciation has been to the tune of 7-8% compounded annually for many years , especially in residential , then that becomes the more attractive aspect. Moreover, in many places the carry or the difference between rental yield and cost of borrowing is negative ( i.e residential rental yield in Mumbai is lower than home loan rate), thus investors focus on capital appreciation."

Thanks to the high cost of loan and partly because of the experience in the last decade or so, hope still lies in chasing capital gains. According to Anand Moorthy, head-real estate services, RBS Financial Services (India) Pvt. Ltd, “If appreciation in price takes a beating it won’t lead to investors flocking in for yield as they wouldn’t see the benefit in re-deploying given the limited visibility for further capital appreciation."

The problem also lies in the limited and unorganized rental market. The rental market is developed only in the metros where people from other states come and settle for work. Even in metros the yields at present aren’t much to work with. According to Om Ahuja, chief executive officer–residential services, Jones Lang LaSalle India, Mumbai and the National Capital Region typically have rental yields lower than 2.5%; Hyderabad, Kolkata and Bangalore are all in the range of 3-4%; Pune too quotes a rental yield of up to 2-3%. For other smaller cities, rental markets are not developed or uniform. If you want to invest, the numbers above are unlikely to get you going.

Opportunities in commercial property

If not residential, consider commercial property for yield. Though opinion is divided and risks are higher thanks to the oversupply, there may be opportunities for investing in pre-leased property on the commercial side which can deliver good rental yield. Pre-leased properties are those where the premises have already been rented out, hence source or income and yield is known. IIFL Private Wealth, for example, has customized a product around yield from commercial property. It has created a special purpose vehicle which takes funds from investors and buys commercial property to take advantage of the above situation. Shah says, “We think commercial real estate is well placed today. In the last five years or so, thanks to excess supply rates have fallen. Now there is no new supply expected for some time and at current capital value, yields are in the range of 8-9%." Moorthy adds even though yields have fallen and transactions are lower, in addition to expected capital appreciation over time, around 8% yields in commercial space make for a good annuity for those looking for long-term returns.

Look outside India

Given the low domestic yields destinations such as London, where property prices have fallen, are seeing quite a lot of interest from Indian buyers. According to Ahuja, “In markets such as Singapore and London, rental yields are in the range of 5.5-6% and borrowing costs are around London Interbank Offered Rate plus 2-3%. This makes them attractive destinations for real estate investors." Indian investors are not permitted to take a loan and invest in property overseas, however, they can do so via a legal company formed in say a country such as Singapore. Ahuja says this route of buying property through a Singapore-based company has picked up pace and the enquiries for overseas property investment has increased in the last six months. Samantak Das, chief economist and director–research and advisory services, Knight Frank India, says, “While such structures exist we haven’t had too many queries though interest in overseas property investment is definitely increasing."

Mint Money take

If you are the end user of the property you are buying, then worrying too much about rental yield versus capital appreciation is pointless.

As an investor, knowing that capital appreciation is harder to come by compared with the last decade, it is now time for you to also consider rental yield. Balance your property investment and look for deals which get you comparatively (depends on location) higher rental yields to safeguard against declining capital values. In case of residential property, it may be worth your while to just do a check of relative yields across locations before buying. For commercial property and overseas buying, it’s best to take the help of experts who have transacted in those markets rather than jumping in solo.

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