How to Calculate Property Value Based on Rental Income?
Real estate rental is yet another way to earn regular and increasing income from your property. However, before investing, many often get confused about how much a property is worth. Therefore, it is important that you evaluate a property and its potential to generate rental income before making such a big investment. There are several ways to calculate rental property value.
If you are new to these investments, this article will be a useful guide for you. So keep reading to know more.
What Is Rental Income?
According to the Income Tax Act of 1961, rental income refers to any type of income received through renting a building, house, or land by the property owner. Therefore, in order to generate a rental income, you must own a property. It is an easy way to ensure regular cash flow without having to invest regularly.
For further understanding, you must know the two different types of income:
- Gross rental income
Gross rental income generally refers to the total income received by a property owner from their tenant. It includes monthly rent, utility fees, late fines, parking fees, and others. However, if the tenant has paid a refundable security deposit, it will not get calculated under this category unless it is used to cover damages caused by the tenant.
- Adjusted gross rental income
In general, adjusted gross income refers to the gross income minus certain activities or itemised deductions. In terms of rental income, it refers to the gross rental income minus the number of days the property was not rented. During rental property investment, this metric can help you to evaluate the demand for a property.
Importance of Property Valuation Using Rental Income
Property valuation through rental income is a popular method through which you can assess the value of a property you want to invest in. This can apply to any property, such as industrial, residential or commercial.
Employing this method can be useful since property values keep changing from time to time. It also depends on locality, nearby facilities, transportation, etc. Therefore, if you are thinking of investing in a property in an unfamiliar area, knowing the current average rents can deliver an idea.
Rental income can also help you understand the ongoing rates in the market for a particular property or area, so you can get the best market price while investing. Knowing the market rates not only helps you while making a sale but also while purchasing a rental property.
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Different Ways to Calculate Property Valuation Based on Rental Income
There are several methods you can use to calculate property value based on rental income. The most popular ways are as follows:
- Gross rent multiplier method
This is one of the most widely used methods to calculate property value. Using this method, you can find the average rental value in an area and then find the gross multiplier value. The gross multiplier value refers to the total investment on a property divided by annual income through rent.
For instance, if you invest ₹10 lakh on a property, and the average rental value in that area of similar properties is ₹10,000, then,
Gross rent multiplier = ₹10,00,000 / (10,000 x 12) = 8.333.
This indicates that the market price of that property is 8.33 times the average rental income annually.
Therefore, you can understand that the lower the gross rent multiplier value, the better your chances of generating higher rental income.
- Comparison method
The comparison method is a simple method to re-evaluate the market value of a property in terms of other similar properties. This method is also referred to as the price per sq. feet method. It helps you determine the value of your preferred property by comparing the prices of similar properties sold recently in the neighbourhood.
If you are new to real estate investment, this method can be useful for you, as it gives you a flat value estimation of a property. However, it would help if you considered the following factors before comparing:
- Property age and condition.
- Average price per sq. foot and total area.
- Selling price of comparable properties.
- Location of the property.
- Other added facilities.
After comparing their sale prices, you should also compare the rental income of similar properties and operating costs. This will help you determine the gross annual income from the property and assess its profitability.
- Profits method
This method can be useful if you are looking to invest in commercial properties such as hotels, guest houses, pubs and cinemas. It compares how much profit a business is making with the annual rent it is paying. So, when the valuation report suggests that the gross income of the business will be much higher in terms of the rent or lease paid with the income, it becomes preferable for rent.
- Income method
This approach uses the annual capitalization rate of the investment. It determines the projected annual income from the property. To calculate it, you have to divide the annual rental income by the property’s current value.
For instance, if the current price of the property is ₹10 lakh and the expected rental income per month is ₹20,000, then the annual capitalization rate will be:
Annual Capitalisation Rate = (₹20,000 x 12) / ₹10,00,000
= ₹2,40,000 / ₹10,00,000
Things to Remember before Calculating Rental Property Value
If you own a property, there are certain factors that you must keep in mind before calculating its rental value. These are:
- Rental rate
The rental rate, an important factor in determining the rental value of a property, varies widely in India. It can range between 2.5% to 3.5% of the property’s value depending on its location, condition, and facilities. For example, if the market value of a property is ₹10 lakh, rental rate of 5% would lead to ₹50,000 per annum. If demand is higher than supply, then the rental rate may go up.
- Rental rate in neighbourhood properties
You can also consider the ongoing rental rate being charged by other property owners in the same area. It would help if you calculated your rental value in accordance with the prevailing rental rate of similar properties to attract more tenants while making a reasonable income.
- Market value of property
The market value of property largely depends on developmental factors. Apart from location, improvement in infrastructure, means of communication, transport, etc., can boost a property’s market value. Therefore, it would help if you re-evaluate your property’s market value and then fix the rental rate accordingly.
What Are the Top Properties for Rental Income in India?
In India, rental income can come from a variety of properties. Therefore, if you are looking to invest, make sure to select from the category that fits your purpose while generating a higher rental yield.
Here are the top rental properties you can invest in:
- Rental housing
Rental housing is accommodations built with the intention of renting tenants. In India, the demand for these properties is high due to the increasing number of workers, labour classes, and daily earners who cannot afford residential ownership. Therefore, investing in these properties can generate better profits.
- Co-living models
This type of property is in growing demand with increased relocation by students and employees. College students and young working professionals, the group popularly called millennials, majorly opt for co-living solutions for affordability. They make up 30% of India’s population, making it great for a high-profit rental investment option.
- Commercial real estate
Another popular option for rental income is investing in commercial properties such as offices, retail businesses, service centres etc. In India, commercial real estate properties generate about 6% to 10% of the rental rate annually on average. However, you can receive higher rent yields if you invest a larger capital. Therefore, you must assess your budget beforehand.
Moreover, you can also invest through fractional ownership in these properties to fit your budget.
How Can You Save Taxes on Rental Income?
Any income coming from rented residential or commercial properties is taxable in India. It falls under “income from house property.”
However, here are a few ways you can reduce your taxable rental income:
- Standard deduction
As per Section 24(a) of the Income Tax Act, you can get a standard deduction of 30% as a provision for repairing and repainting.You can claim this tax deduction only if you are not receiving any form of housing rent allowance.
- Home loan interest deduction
If the property you have rented is still undergoing loan repayment, you can deduct the interest value from the rental income as per Section 24 (b).
- Home loan principal deduction
You can claim a deduction of up to Rs. 1.5 lakhs on the home loan principal amount under Section 80C of the Income Tax Act.
Several other factors, such as inflation, market fluctuation, etc., also play a significant role in determining rental income. Moreover, to ensure a steady cash flow, you need to invest in properties favourable for renting and choose tenants wisely. Therefore, the above factors can help you get an estimate of your rental property value before investing.
Frequently Asked Questions
Is a hike in rent every year mandatory?
No, although property owners have the provision to increase rents every year, it is not mandated. The rate of rent hike varies from locality to locality in India as per individual Rent Control Acts. Therefore, landlords and tenants must carefully discuss the rental clauses before signing the contract.
Is rental income part of earned income?
No, rental income is not part of earned income. However, it is taxable as passive income under the heading “income from house properties.”
Who takes care of the renovation and repairs of a rented property?
This depends on the type of rental property you own. In the case of commercial spaces, any renovation or repair work is undertaken by the tenant, while for residential spaces, the owner usually takes care of the costs.