3 Real Estate Investing Metrics You Should Know

Real Estate was the darling of Indian investors till 2011, post which they went into an extended slump. We now see activity picking up again after the RBI’s actions to counter the economic impact of COVID has brought borrowing rates to multi year lows. Here are three simple metrics that can help you assess, as a real estate investor, whether property prices in a certain region are quoting at attractive valuations or not.

Price to Rent Ratio

An important metric is the “Price to Rent” ratio for a given region. Here’s how it’s calculated – divide the quoted price of the property by the annual rent that it commands. For instance, say that a 2,500-square foot flat in South Delhi quotes at Rs. 4 Cr today, but commands a monthly rent of Rs. 70,000 per month of 8.4 Lakhs a year. The price to rent ratio for this area would be 47 times. Mature markets globally use a price to rent ratio of 10 to 25 as an investment grade valuation range. In India, we may consider a price to rent ratio in the range of 20-30X as a fair investment grade range for most urban areas in the country; implying that the said property is still quite overvalued!

QTS (Quarters to Sell)

When demand is rampant, and lenders are lenient with their purse strings, real estate development flourishes. Since real estate development – starting from land acquisition and going on to the actual construction – is a heavily cash intensive affair, the industry is heavily dependent upon the availability of capital. The assumption is that post launch of a project, cash from booking amount sales will help repay some of the loans. However, what often happens is that development activity starts spreading out too far and wide from a certain commercial hub (for instance, NCR) and unsold inventory piles up. If the quantum of unsold inventory in an area becomes very high, it eventually tilts the demand/supply balance and brings down prices. QTS (Quarters to Sell) is an important metric to help assess the levels of unsold inventory in an area. For instance, if the demand for units in an area is 20,000 per quarter, and the number of unsold units if 2 lakhs, the QTS figure for that region would be 10. As a thumb rule, a QTS figure of 5-8 is healthy; anything more implies that prices will correct further in order to absorb the excess units, hurting existing investors in the process.

Rental Yields

The Rental Yield is the gross annual rent commanded by a property, divided by the price that it’s quoting at. Basically, it’s the reverse of the Price to Rent Ratio. A Price to Rent ratio of 30X would translate to a Rental Yield of 3.3 per cent. Very low rental yields may be symbolic of overvaluation within a specific area, and could imply that a price correction might be due. The Rental Yield number would also help investors benchmark real estate investing with other income generating financial assets, such as bonds or blue chip, high dividend yield stocks. Generally speaking, a rental yield of 3 to 4 per cent is an investment grade one for most pockets of urban residential real estate. Buying into anything lower essentially means that you’ll be settling for a low rental income that’s not in sync with the lack of divisibility, low liquidity, and high maintenance costs associate with real estate.