Realty investment performance metrics

According to NITI Aayog, the Indian real estate industry will rocket to Rs. 65,000 Crores (equal to $1.72 billion) by 2040. By 2025, the real estate industry is estimated to contribute a sizable 13% to the country’s GDP. This makes realty a sustainable route to financial success, offering significant benefits when approached with skill and precision. 

Beyond the extraneous factors such as infrastructural development, digital advancements, economic policies affecting real estate yields,  there are several property performance metrics that assist customers in assessing possible return on investments

Gross rental yield

Gross rental yield is a key measure that provides an initial insight into a property’s income potential and assists in comparing different properties. It is computed as a percentage of the annual rental income by the total property cost. The total property cost includes not only the purchase price but also all related fees such as closing costs and renovation costs. For example, if a property yields an annual rent of Rs 3 lakhs and was purchased for Rs 75 lakh, the gross rental yield would be (3 lakh / 75 lakh) x 100 = 4%.

It is important to recognise that regional variances play a substantial influence, especially location. For example, Pune’s average rental yield is roughly 3.7%, while Bengaluru offers a more appealing 8.1% rental yield as per Magicbricks Rental Index Report of Q2, 2023.

Net rental yield

Net rental yield presents a more complete financial picture of property ownership and is a practical way to assess properties. It includes all expenses and tax responsibilities incurred during the year, including maintenance, repairs, furnishings, vacant periods, and additional charges, in addition to rental income. 

Net Rental Yield = (Annual Rental Income - Annual Expenses) / Property Value] x 100. It is advisable to also consider external factors such as location, project type, and builder reputation when comparing rental returns in different cities. Typically, tier-I cities with strong property values and employment prospects fetch higher rental rates. Luxury properties provide lesser returns, whereas affordable and mid-tier properties frequently provide greater investment returns.

Capitalisation rate

Capitalisation rate, or Cap Rate, is the real estate equivalent of the stock market’s return on investment. It measures the ratio between a property’s income and its original capital investment or current value. To calculate it, Net Operating Income (NOI) is divided by the property value. 

For instance, a property with an NOI of Rs 9 lakh and a value of Rs 1.50 crore would have a Cap Rate of (R 9,00,000 / Rs 1,50,00,000) x 100 = 6%. 

Cap rate is instrumental in comparing different investment opportunities and offers insights into a property’s profitability and level of risk involved. Higher cap rates generally imply higher returns but also suggest higher risk. 

Cash-on-cash return

Cash-on-cash return provides a comprehensive view of cash flow in relation to the initial investment. It differs from other real estate metrics by incorporating debt service and mortgage into the equation and is arrived at by dividing the net cash flow after debt service by the total cash invested. Cash-on-cash return can help understand the overall return on invested capital, aiding in financing decisions, and predicting returns during periods of expected capital expenditure.

Internal rate of return

The internal rate of return (IRR) reflects the time value of money and considers multiple cash flows over time. It estimates the interest earned on investment in a rental property throughout its holding period. While IRR is valuable for property comparison, it is advisable to be used alongside other metrics as it assumes a stable rent environment and the absence of unforeseen repairs.

The big picture

In the fast-paced world of real estate investment, no single indicator can provide all of the answers. An integrated strategy that takes numerous metrics into consideration, in tandem, provides a more comprehensive picture of an investment’s potential. These financial measurements are a guidepost for investors, assisting them in informed decisions.

When considering potential investments, it is advisable to perform extensive study and obtain professional advice. Keep in mind that property investment is a long-term endeavour that requires a forward-thinking mindset.

(The writer is Head of Finance, Magicbricks)