True value test Most people end up buying a property at a price that is more than its value. As a result, they have to either wait unduly long to get a good return or sell at a loss.
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

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

Before you buy

    Approach a bank or a housing finance company (HFC) from where you plan to take a loan and use their home search facility
    A construction-linked payment plan minimises the loss if the project gets stuck
    Make sure an exit clause and the approved building plan are made a part of the Agreement to Sell
    Do your calculations (see True Value Test) and arrive at a fair value of the property
    Find a lender that is proactive in revising its loan rates when interest rates move up or down
    If you have a good credit score, use it to bargain for a better rate (personal credit scores will be available from December 2009)

    After you buy

      Regularly visit the construction site to check the progress
      Get in touch with others invested in the project. Form a group. If there is a problem, take it up as a group
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  • Dear frnd,

    The model shown is good but it is very much skewd towards rental income.
    This kind of calculation might not give right results in Indian scenario. My logic is based on following examples

    1) A flat costing 75 lakhs gives a monthly rental of 17000~22000.

    2) A plot in NCR( may be G. Noida / Faridabad) costing 30 lakhs with only compeltion work( one room set only). This kind of property will show alomost no value in the model given.

    3) This model is not calculating the intrinsic value of land in a demand driven market.

    4) The model is not considering the variable inflationary expectaions.

    5) The model has more concenteration on the facilities of the houses which will be given on rent and will fetch you returns.

    How ever the model given by you might give very good results in markets like US and other matured markets, where the rental income vs the cost of house has some sense.

    Also this model might be used to determine the true value of houses under constrcution.