House price appreciation in the last five years has brought cheer to home owners in most metros. But the rent on the same properties hasn’t kept up with the property value. In fact, rental yields, or the ratio of rent to property values, have actually fallen from five per cent to three per cent over the last decade or so. Renters and owners may both be wondering if rents are expected to stay put, plummet through the floor or shoot through the roof.

While reliable data on house prices is available through sources such as the National Housing Board’s Residex Index, similar long term data does not exist for rents. But data from Savill’s, a global real estate service provider, offers a sense of how low rents are in relation to capital values in India. In Mumbai, buying a new property entails shelling out four times the annual rent, even with rents increasing in the first half of 2012 and prices falling. Similar data for London shows that you can buy property for a single year’s rental value, indicating higher rents relative to price.

Rents — demand-based

Comparing rent to capital cost may lead us to believe that rents move in step with house prices. But that isn’t true. House rent and prices march to different tunes.

One big factor that decides rent in a locality is the demand for rented homes relative to their availability. This is why it becomes important to know the proportion of owner-occupied homes.

For instance, rental yields in India are often much lower than elsewhere in the world because relatively few people seek rented homes: 66 per cent of homes in Indian cities and 90 per cent of homes in rural areas are owner occupied. Owner occupation is far lower in many international cities such as Berlin (11 per cent) and New York (45 per cent). Essentially, the number of people on the look-out for rented accommodation is pretty low in India.

The proportion of floating population in a city, usually seeking employment opportunities, also decides rent. Bangalore, with nearly 57 per cent of its homes up for rent, is a good example of a city with relatively high rents. However, cities with lower proportion of floating population, such as Pune, and smaller towns, typically have lower rents.

Rents and home prices

Theory says that in an efficient market, house prices and rents will adjust so that an individual is indifferent between renting and owning. However, in reality, it does not work out so neatly. Rents need not always move when property prices do.

For one, rent control laws in cities such as Mumbai and Delhi keep rents on some properties out of tune with the market.

Two, many owners may just choose to keep their homes locked up, rather than rent them out due to other factors. They may be worried about wear and tear and the tenants’ willingness to vacate the property. Concerns about rental disputes, particularly as most rental agreements are informal, may also discourage renting out. Data from the Ministry of Housing shows that over 1 crore homes in urban areas were empty, as of March 2012. Locked houses reduce supply and help to keep rents artificially high.

Localised factors sometimes tend to drive rents and prices in opposite directions. Data from online real estate site MagicBricks shows that in EM Bypass region of Calcutta, prices increased by 13 per cent in the December 2012 quarter, while rent fell by five per cent. Demand from affluent buyers in this area led to soaring property prices. On the other hand, in Nizampet area in Hyderabad, capital value fell by five per cent, while rent rose by five per cent. Fall in price was due to concerns about construction quality.

Rents may also move out of sync with property prices due to short-term mismatches in demand and supply in a locality. For example, rental rate for Bangalore’s high-end villas was on an upward trend from 2007 due to demand from ex-pat community and limited supply. The rate of rent increase has slowed down since 2012, due to reduced demand.

to rent or to buy?

What are the factors one should consider when choosing to rent or deciding to buy? Affordability is a big factor that makes individuals stay put in a rented property. Affordability is measured as a multiple of annual salary to house price, with a multiple of 3 or less considered affordable by international standards. Soaring property prices in recent years have put many homes beyond the reach of buyers. Yet the rents on these properties are still within the reach of renters.

In fact, one may even turn a quick profit by staying on rent and investing the down-payment in a high return investment instead of buying a home. March 2013 data from real estate advisory firm Jones Lang LaSalle shows that a 1,000 sq.ft apartment in Adyar, Chennai, costs between Rs 1 crore and Rs 1.7 crore and fetches rent of Rs 20,000 to Rs 30,000 per month. Suppose one were to rent it for Rs 20,000 and invest 30 per cent of the property value (down payment) at 8 per cent, it would easily cover the rent. This is particularly true when high interest rates are available on safe investment options.

Renting may also be preferable when comparing the cash outflows for rent against the monthly EMI. In fact, December 2012 data from online real estate portal Makaan.com’s buy vs rent index (MBRI) shows that this is the case in almost all major cities — Mumbai, Chennai, Pune, Ahmedabad, Delhi, Bangalore and Hyderabad.

Exceptions could be when salaries rise faster than property prices. For example, HDFC’s home loan borrower profile shows that the years of salary needed for home purchase has reduced from 5.1 years in 2002 to 4.8 years in 2011, indicating that salaries are rising faster. Since most of the home purchases are funded by home loans, one may consider the number of years needed to save for down payment. A person with an income of Rs 10 lakh and saving rate of 25 per cent will be able to make the 20 per cent down payment towards a Rs 40 lakh-property in three years.

Even when salary is stagnant, affordability improves by spending less and saving more. A low interest rate on home loans and government tax breaks for home purchase also enable purchase of higher value homes.

For many people, the decision to buy may be based primarily on the ability to manage the EMI payments, rather than on absolute property price. So a renter must weigh these financial factors vis-à-vis the psychological yearning to be a home owner.

Next move likely up

So if rents in India are generally low, can renters count on this happy state to continue? Sadly, it is likely to change, for many reasons.

Home purchase for ownership or as investment helped buoy home prices, while metros as well as smaller cities saw anaemic growth in rent. For example, data from Jones Lang LaSalle shows that rents in Wakad area of Pune have been stable at around Rs 10,000-12,000 from May-2012 to March 2013, while price per square foot increased from the range of Rs 3,200-3,500 to Rs 3,800-4,800.

However, rents may increase from these levels. As the urban population grows in the coming decade, demand for housing space in the cities will increase.

Expansion in the working population and higher mobility of employees would lead to greater demand for rented homes.

As older homes are re-developed to good quality and newer construction, rent escalation will likely happen too. Also, delays in urban infrastructure development create rental hot-spots where demand far outstrips supply.

The trend of rents rising faster than prices is already seen in markets such as Noida-Greater Noida Expressway.

Jones Lang LaSalle data shows that rents increased from Rs 11,000-12,000 in May 2012 to Rs 12,000-14,000 in March 2013 while sale price per square foot was stable at Rs 4,000 to Rs 5,500.

Higher rents may not be welcomed by renters, but the higher monthly cash flow will bring cheer to investors.

REITs in India

If rents are set to climb, is there a way to benefit from this, without all the hassles of owning a property? Yes, you could benefit if there were Real Estate Investment Trusts (REIT) in India. REITs raise funds from investors, purchase rent generating assets and pay out majority of the rental income. So far, Indian real estate investment has focussed on capital appreciation rather than income generation. The launch of REITs would offer an alternative to purchasing property and develop income focussed investing. This could also potentially reduce speculation and stabilise house prices.

But REITs face a lot of challenges in the Indian context. For one, the low rental yield may discourage investors. Laws that protect tenants and inherent long delays in seeking legal recourse are also dampeners. The lack of transparency in real estate dealings would also make companies cautious about launching REITs. Tax structure and schemes that offer incentives to home owners rather than renters also lower REIT uptake.

>meera.siva@thehindu.co.in

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