Price-rent ratio grows in selected urban areas

Property prices in some of the prime urban micro-markets of India have witnessed considerable hike in the recent years, observes the Reserve Bank of India (RBI). According to the bank, it is essential to closely monitor the housing sector in India which is among the fastest growing sectors of the nation.

Despite a steep fall in bank credit to the housing sector, house prices in some of the major urban centres have been on the rise. RBI’s half-yearly financial stability report reveals that, the bank credits to the housing sector have been reduced to 9.5 percent in FY13, from a high 13.3 percent in FY08.

In some of the areas of leading cities like Mumbai, it has been observed that the ratio of house price to annual rent has grown as high as 50. Due to lack of land for new projects, supply of residential projects in Mumbai has always been lesser than the demand. The ratio of price to annual rent in some areas of Mumbai is the highest in India because of unrealistic increase in house prices in the city. This is clearly a concern for RBI because if the ratio goes out of proportion, then it could even drive away the existing investors.

What is price-rent ratio?

If you are planning to buy a property, it is important to look at rental yield or price-rent ratio (price to rent ratio or P/R) that the property can earn. It is calculated by dividing price of a property by annual rent. Knowing this will help in making a decision whether to buy the property or to rent it on a long term basis.

For instance- A flat is available at Rs 40 lakh which can be rented out for Rs 10,000 per month, whose annual rent would be Rs 1,20,000. In this case, the price-to-rent ratio is about 3 percent, which is considered a good value in Indian rental market.

The table below gives you the average rents and rental ratios of some of the micro markets in Mumbai and Delhi-NCR.

A better understanding of price-rent ratio would help home buyers in choosing a better property that promises a better income in future. Let us consider an example which explains how is knowing rental yield beneficial.

Consider a house which has been rented for the past three years. The house was bought three years ago at a cost of Rs 10 lakh and was rented at a rate that had been yielding 3% annually. If the property would have seen 8% hike in price every year, then in three years its present cost would be Rs 12,40,000. If you add the 3% rental yield of three years to this, then the total hike you would be looking at will be 11% annually for the past three years.

The prices of properties in leading cities are rising exponentially in comparison to the rents of residential properties, observes RBI. Residential yields have stood at 2.5% to 3% for almost a decade but home prices and land costs have risen substantially, which bothers RBI.

However, the price-rent ratio is comparatively less in India than many other nations. The rental housing market in the United States gets a rental yield of approximately 4.5% to 5%, Dubai gets a rental yield of 6% to 7% per annum, Indonesia yields around 9% to 9.5%, rental yield in Singapore is around 3%, Japan’s rental yield is approximately 5.5% to 6%, and so on.

A recent report by stock brokerage Prabhudas Lilladher states that, lease registrations have risen at a tremendous pace, with April recording about 12,000 registrations, the highest in the last few months. The report indicates that leasing property is increasingly being preferred over buying, given the stagnant property prices and falling rentals. The report points out that despite sluggishness in commercial real estate market, lease numbers are on rise.

When the supply of residential units in the market becomes less and demand keeps growing, the property prices are surely to increase. Also there is no mechanism to check price-hikes, alleged Mr. Santhosh Kumar, chief executive at Jones Lang LaSalle.

Sunil Rohokale, chief executive and managing director at ASK Group said that if the landowner is a builder and if he has been holding land for a long time, then he would have made high margins due to the frequent price hikes.