How to calculate the true value of a commercial property which provide steady stream of rental income for the investor?

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta

In our blog post titled “How to calculate the true value of the property”; we primarily focused on valuation of a residential property. In this post, we will however, focus on valuation of commercial properties which provide steady stream of rental income for the investor. This valuation approach is based on the principle that the value of a property is related to its ability to produce cash flows. For this approach 3 techniques are commonly discussed.

• Gross income multiplier:

Gross income multipliers are relationship between gross income and the sale prices for all comparable properties that are applied to the subject property.

Gross income multipliers (GM) = Sales Price/Gross Income

In arriving at a value for the subject property, the appraiser must develop an estimate of gross income based on the market data on comparable commercial properties. For the comparable properties the gross income should be annual income at the time the property is sold. Some appraisers use potential gross income (which assumes all space is occupied). Others use effective gross income (potential gross income less vacancies).  Since this method relies on gross income, therefore an assumption is made that the operating expenses are about the same proportion of gross income for all properties. This method relies heavily on current market transactions involving the sale of comparable properties. These techniques resemble the sales comparison method for valuation of a property discussed in the previous section in many ways. The focus of these techniques is to determine a market value that is consistent with prices being paid for comparable properties trading in the market place. However, rather than giving priority to adjusting for differences in value by adding and subtracting directly from the prices of comparable properties for physical and location attributes, these two methods tend to focus first on the income producing aspect of comparable properties relative to the prices at which they were sold. Adjustments are then made for physical and location dissimilarities.

• Capitalization rate

This technique is similar to the Gross income technique except that it considers net operating income (NOI) rather than the gross income of comparable properties. When it is suspected that differences in operating expenses exist between comparable, the focus of the analysis should be shifted from gross income to NOI.

Capitalization Rate (cap rate) R = NOI/Sales Price

Following data should be collected to calculate capitalization rate:

Sale price, rent, and operating expenses should be collected from brokers, agents who were involved in the sale of comparable properties.

Important warning: both Gross income multipliers and cap rate approaches does not assure that the property will be a good investment if purchased. They only assure the buyer that it is a competitive market price and that if the method is applied correctly, the buyer is not overpaying or underpaying for the property relative to what other investors have paid for similar properties. The question of whether or not it is a good investment will depend on the future growth in rents, income, and property values.

• Discounted present value techniques

This income approach is based on the principle that investors will pay no more for a property than the present value of all future NOIs. Based on the knowledge of market supply and demand, lease terms, as well as income and expenses, a forecast for cash flow is developed for a period for which we have knowledge regarding supply and demand, lease terms, income, and expenses. Normal forecasting period are 10 years.

1. The first step in this technique is to forecast NOI (based on market supply and demand, lease terms, and expenses)
2. The second step is to select a relevant period of analysis or the holding period for the investment.
3. The third step is the selection of a discount rate (r) – this discount rate is the desired return for the real estate investment based on its risk when compared with returns earned on competing investments and other capital market benchmarks.
4. Present value of expected NOI beyond the holding period. These cash flows are represented with reversion value (REV) or resale price.

Presently, capitalization rate method is used in India when evaluating the worth of the income generating properties. The discounted present value method relies on assumptions about demand and supply and therefore, there are possibilities of arriving at the wrong value of the property. 

Now, whenever you as an investor are looking to sell your commercial property such as office space or retail outlet, do your calculations as explained by us and make sure you get the right value of your property. Alternatively, if as an investor, you are looking to buy a commercial property, make sure to do these calculations in order to ascertain that you are not overpaying.

In a nutshell:

Did you calculate the true worth of your property before selling?? Let us know at nirrtigo@nirrtigo.com

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Looking to sell the house or your property? Pay attention to these tips!

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta

In May 2012, one of our colleagues decided to sell his 250 square yard plot in Delhi NCR region. He has bought the plot in 2003 and therefore, the capital appreciation gains were substantial. He wanted to sell this piece of plot and buy another plot in different city. The idea was to build a house on this new plot and live there. Therefore, he has reasons to sell the plot. However, when looking to sell your property, the first question you should be asking is “do I really need to sell?”

• Do you really need to sell?

There can be in-numerous reasons to sell the piece of property you own and these reasons can range from shifting to new city, family wedding, education, or building/buying a bigger property, etc. Analyze those reasons carefully and discuss within your family members before arriving at the decision to sell the current property you own. Because make no mistake, selling is no easy job, it takes time as well as it incurs unwanted expenses such as brokerage fee, advertising fee, paper work, no-due certificates fee, etc. One can also explore the possibilities of obtaining loan against property (LAP) in order to fulfill the current need for funds rather than selling the property. However, once, you have considered all the possible options and selling is the best bet, then pay attention to the following advice.

• Verify the prevalent market sentiments

The true value of the property is what a buyer is willing to pay in a transparent and mature market. Therefore, once you have decided to sell, do the quick check of property valuation and this is how you do it:

• Check the selling price of highly similar properties which have been sold in recent months/days within the same locality. As a seller, you would not like to sell at below market prices. If there is no data available for similar properties, then check the selling price of dissimilar properties and adjust for dissimilarities in the selling price. For more on, property valuation, visit Property Valuation in India

• Check for the time-duration it took others to sell their property. If it takes longer to sell, then it can be safely concluded that market sentiment is low and you would have to wait for long time period before being able to sell your property. However, one can always 'sell in distress' at high discount. This is what happened to our colleague since market sentiments in 2012 were low and he had to wait for 6 months before selling the property at a substantially lower price.

• Check for the rental values of the similar properties within your locality and city as a whole. Sometimes, property transactions (sale/purchase) might be slow but there is demand for the housing and therefore, rental values may be appreciating whereas capital values have remained stagnant. This is what is happening in the current real estate market across India. In this scenario, it will be advisable to stay invested in your property and earn decent monthly income by renting it out for some time and sell the property when market sentiment is strong.

• Selling process

Finding the right buyer for your property is not easy. Because property transaction involves large amount of money, one needs to be careful in advertising the property, dealing with brokers, and prospective buyers. 

• Online classifieds: list your property on online classifieds portals. Don’t just list the property blindly on all available classifieds portals. Rather select the ones which have high degree of trust among other sellers and buyers and at the most list your property on 2 online classified portals.

• Brokers: approach the local area property brokers and enquire about current property market sentiments before listing your property with them. One should never list the property with multiple brokers. Rather list with 2-3 trustworthy brokers. "The best approach is to ask some brokers about buying the similar property and ask some brokers about selling the property. If there is substantial difference in the buying price and selling price as quoted by the brokers, then it indicates that there is demand for the property in the market but real estate brokers are downplaying that demand". In that scenario, it is better to wait and strike the deal when you get the best possible price for your property.

• Agreement to Sell: once you have identified the buyer, check for his/her credential to pay the required amount in mutually agreeable time period. It is advisable to ask the buyer to make reasonable advance payment (say 20% of the property value) with the condition that in case the buyer subsequently backs out from the deal or fails to make full payment and take possession of the property in accordance with the terms & conditions of the deal/agreement, such advance payment will stand forfeited and will not be paid back to the buyer. This is known as “option” and should be included in the “agreement to sell” paper. The time period between “agreement to sell” and “sale deed” can be mutually decided between the buyer and seller. The prevalent trend is about 45 days or 2 months.

• Sale deed: after the “agreement to sell”, the next step is to formalize the “sale deed”. ‘Sale Deed’ should be signed and title documents handed over to the buyer only on the receipt of full and final payment. Once the deal is concluded, full payment is received and Sale Deed signed, insist on the registration of the property in the name of the buyer with the Sub-registrar of assurances under the provisions of the Indian Registration Act. Consulting and engaging a good lawyer before selling the property to a person or organization is a good and sensible idea.

• What are the risks in property selling?

As explained in the article above, the property selling process is long and there are inherent risks and one should be careful with the following elements:

1. Inappropriate valuation of the property
2. Selling through too many real estate agents
3. Dubious buyers

• Taxes

In case of sale of house property, long-term capital gains are taxed at the rate of 20% after availing indexation benefit. The indexation rates are released by the Income Tax department each year, which can be applied to arrive at the indexed cost of acquisition of the property sold. Short terms capital gains on house property, on the other hand, are included in the gross total income and normal tax rate is applicable.

Exemptions from Tax

The Income Tax Act 1961 contains certain provisions that offer exemption from tax on long term capital gain arising on sale of house property, these are as under:

• If capital gain is invested in new residential property: Section 54 of the Act protects capital gains arising out of sale (or transfer) of a residential house (original asset) in either of the following situations:

1. One has purchased a new residential house either within a period of one year before the date of sale of the original asset or two years after the date of sale of the original asset.
2. One has constructed a residential house (new asset) within three years after date of sale of the original asset.

• If long term capital gain is invested in capital gain bonds issued by specified institutions:

Section 54EC, under various schemes (as listed below), provides exemption to capital gains arising from any long term capital asset (original asset), provided the capital gains are invested in long term specified assets covered by Section 54EC within 6 months from date of sale of the original asset. The said Section requires locking of the funds for 3 years. However, the investments made on or after 1 April 2007 in the long term specified assets during any financial year should not exceed Rs. 50 lakhs.

Section 54EC Schemes for Capital Gains Tax Savings

1. NHAI Capital Gains Bonds issued by National Highways Authority Of India.
2. REC Capital Gain Bonds issued by Rural Electrification Corporation Of India.

• Stamp duty and registration charges:

Stamp duty and registration charges are borne by the buyer and these charges differ from state to state. Visit Stamp duty and registration charges in India for more.

Above all be patient in the entire property selling process!

Data Source For Tax considerations: National Housing Bank

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How to calculate the true value of the property? What are the methods to real estate valuations? Am I paying the right price for the apartment?

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta

Alright, you have now decided to purchase your dream home or a commercial property. But hang on, before you jump on the bandwagon and go for property hunting, keep in mind the valuations. By valuations we mean how much the property is worth at given point of time. So, you got to ask these simple questions…am I paying the right price for this property. Can I get anything lower than this? You need to understand the concept of market value before financing or investing in a property.

Market Value:
It is the most competitive price which a property should bring in an open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably and assuming the price is not affected by undue stimulus.

How do you value a property?
There are 3 principle approaches to valuation of property. All these approaches require you to gather market information before you apply these approaches to value a property. The data you need to gather is:

• Identification of location or sector you are looking to buy the property
• Effective date of value estimate
• Gather market data on current rentals, capital values, and presence of social infrastructure

Approach 1 – Sales Comparison approach:
This approach is based on data provided from recent sales of property highly comparable to the property under consideration. If there are differences in size, scale, location, age, and quality of construction between the property being valued and recent sales of comparable properties, adjustments should be made to compensate for such differences. The more differences that must be adjusted for, the more dissimilar are the properties being compared, and less reliable the sales comparison approach. The fundamental principle for this approach is that an informed investor would never pay more for a property than what other investors have recently paid for comparable properties. Ideally the data should be collected of properties that are situated in the same locality (sub market).

For example, if you looking to buy an apartment in a builder project in Sector 85, Gurgaon. Collect the information about all other projects within the same locality and see at what price points apartments in those projects are being sold. Adjust for luxury specifications, approach towards apartment complex, and builder track record of successful and quality delivery. As an example, the price at which new apartments are being sold in Sector 85 is Rs. 5500 per Sq. Ft. A reputed developer has launched a new project at price point of Rs. 6200 per Sq. Ft. Why? Is this project offering luxury specifications? Is this project nearer to Highway or metro rail? Or what could be the reason for high prices? Ask these questions. Similarly, if something is being sold at below rate, try to understand why? Is there any litigation with the property? Are there any construction defects?


Approach 2 – Cost Approach:
For a new property, the cost approach ordinarily involves determining the construction cost of building, then adding the market value of the land. In other words, what will it cost you if you were to buy a piece of land and construct by yourself.

So, again, if you are looking to buy an apartment in Sector 85 in Gurgaon, check the prices of land or plots in the same locality. Let us assume, a 250 Sq Yd plot is sold at 60000 Rs. per Sq. Yd.

Below are the calculations you should do in order to arrive at the property value using cost approach.

Approach 3 – Income approach:
This approach is based on the principle that the value of a property is related to its ability to produce cash flows. This approach is highly recommended for commercial properties and least effective for residential properties. The income generated from commercial properties is capitalized to arrive at the correct valuation. We will cover this approach in details in next article.


So, now that you have some methods to calculate the worth of property you are considering to buy, we are hopeful that you will buy the right property at right price point.

Cheers :)

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What are the various styles of real estate investment strategy and factors that affects property investment?

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta

Are you an investor looking to invest in real estate? What are your motivations for investing in real estate? In this article, we will consider motivations for real estate investment, variables that affect property market, and various styles of real estate investment patterns.

Make no mistake; most retail investors avoid investment in stock markets because of complicated financial jargon and relative ease of realty market to absorb cash. The idea is to invest in property (particularly residential) and leave it as it is for years to generate handsome capital appreciation value. However, one must be careful before blindly investing in real estate. Understanding, the local micro market such as its demand driver and supply is crucial in order to reduce investment risks. In the following document, we highlight the objective of real estate investment, risks, and what are the various ways one can invest in property market:

What are the various styles of real estate investment strategy and factors that affects property investment from Green Realtech Projects Pvt. Ltd

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Solutions for reducing the uninterrupted influx of black money into the real estate sector

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta
 

Talking to any common man on the street about real estate sector would draw animated conversations on how the sector is riddled with black money, corruption, and political maneuvering. In this section, we will focus on how the black money enters the real estate sector, its effects on economy, and ways to tackle it.



How black money enters the market?

1. Parking place:
Real estate has become the parking place for businesses to park their unaccounted cash in real estate particularly in residential real estate asset class. Most business houses, small or large, even though claims to be doing the business by rule of law but would under-report their profits to save on tax. And that under-reported income would land in the real estate sector which tends to raise the prices of real estate in a land scarce country like ours.

2. High rates of stamp duty and registration charges:
Stamp duty and registration charges account for 12.5 to 15% of property value in most states across the country. As an example, the property with market value of Rs. 1 Crore would elicit Rs. 12.5 to 15 Lacs for stamp duty and registration charges. However, the circle rates (or government decided rates) of property in most cities are much lower as compared to the market value of the property. There lies the incentive to under-report the true market value of the property to save on stamp duty and registration charges. The amount saved is paid in cash to the seller and that cash is again ploughed back into the real estate sector giving rise to a vicious circle leading to ridiculously exorbitant property prices.

3. Capital Gains Tax:
Most of us have observed the real estate deals wherein cash forms the significant part of whole deal. There are instances when cash constitutes as high as 75% of the total property value. Now, cash transactions are encouraged in real estate sector to save on capital gains tax which is 30% of the total gains. There is data available which suggests that more than 70% of that cash is again ploughed back into the real estate sector leading to rapid appreciation is real estate prices. The comprehensive knowledge of capital gains tax including exemption on profit from home sale can be found from following sources.
Capital gains tax exemption makes sale of house more profitable
Tax exemption on profit from home sale


Effects of black money

1. Unaffordable prices of property:
The entering of black money leads to irrational prices in real estate sector. In a country, where demand for affordable property is high and land supply is limited, the whole influx of black money spirals out the prices of property to a level which is almost unreachable for the middle class families. We all have seen how housing prices have multiplied in many cities across the country in the past decade and yet the rental prices haven’t kept the same pace of appreciation.

2. Negative impact on economy:
Real estate is an asset class where money is invested; it sits there and over a period of time produce capital value appreciation on account of true demand in a rational economy. However, when black money or the excess money enters the sector, it not only drives the property prices to irrational level but also leads to deviation of funds from productive sectors. This excess money which has been the subject of greed could have been invested in entrepreneurial ventures, business expansion plans, or if reported genuinely can be collected by government in the form of tax revenues. This would result in circulation of that money into the economy and subsequently expansion of economy creating more jobs, more demand, and production of goods and services.


Ways to eliminate the black money

1. Decrease of stamp duty and registration charges:
The reduction in stamp duty and registration charges can result in proper reporting of the true market value of the property. Even though, government revenues may get affected on account of reduced stamp duty and registration charges, it can however be compensated on accounts of capital gains tax.

2. Paying in Cheques:
We all have been inspired by Anna Hazare movement against corruption; however, we would do that cause a great justice by doing our bit when it comes to property transactions. What can we do? Well, quite simple, Stop paying or accepting in cash when it comes to property buying or selling. The simple yet practical step would reduce the entering of black money into the property sector and would drive away the speculators from entering the market to make quick bucks.

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