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Rent and Building Value

A.Mohammed Ibrahim 
on 10 July 2013

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If a property produces a net income of INR 3,00,000 per annum and a purchaser desires 5 percent return on his capital, he will pay INR 3,00,000 x 100/5 = 60,00,000/- maximum for that property. 100/5 = 20 is a multiplier. The multiplier of the net rent to obtain Capital value is known as Year’s purchase.

Security is Rent / Capital x 100, which is 5 percent and Year’s purchase is found by dividing Capital by rent: 60, 00,000 / 3, 00,000 = 20.

Year’s purchase in perpetuity

Y.P. in perpetuity: 100 / Rate percent

What is the year’s purchase in perpetuity of 8%?

Y.P. = 100 / 8 = 12.50

Net Income of a residential property in Chennai is INR 4,80,000/=

What is its market value by Rental Method (Rent Capitalization Technique)?

Annual Net Income: INR 4, 80,000/=

Y.P = 12.5

Market Value: 4, 80,000 x 12.5 = 60, 00,000/=

(INR Six Million only)  

Example I. A building has a net income of INR 3, 60,000 per annum which is expected to last for a long period. Security on investment capital is 5% in current market. What is its market value by Rental Method?

INR 3, 60,000 = C x i (i = Rate of interest from investment & C is Capital)

=C x 5/100

C = INR 3, 60,000 x 100/5 = INR 72, 00,000/=

Capital representing the value of the property:  INR 72, 00,000/

(INR Seven Million and Two Hundred Thousand only).

Example II. A building yielding a net income of INR 1, 50,000 per annum, has an economic life (Effective life) of 5 years. The 55 years old building is abutting a 30 feet main road in residential location in West Mambalam, Chennai.  Market value of site as open land is 60,00,000/=

As per Development Control Rules, a G+2 building is permitted and maximum built-up area permissible is 1,100 sf (Land extent is 675 sf and 1.5 FSI is allowed; FSI is total built-up area divided by total land area). Prevailing capital value in that locality for new building is around INR 8,000 psf.

Security on investment capital is 4% and the rate of interest for safe investment of sinking fund for redemption of capital is 3%. Cost of reproduction of the building is INR 29, 00,000/= (INR Two Million and Nine Hundred Thousand only)

Determine the market value of the property.

Years purchase for rental income receivable for 5 years with 4% security on capital and 3% interest for investment of sinking fund, from the  Tables (Dual Rate) = 4.379

Capitalized value of rent = 1, 50,000 x 4.379 = INR 6,56,850/- Say “A”

Salvage value of the structure is taken at 15% of cost of reproduction, which is: 29, 00,000 x 0.15 = INR 4,35,000/- Say “B” (Salvage value of building varies from 10 percent to 20 percent). In the old building teakwood doors, windows, rafters and beams available. In the absence of existing building statistics, proposed building construction cost x salvage percentage of maximum 15 percent is considered).

Market value of site: INR 60,00,000/- Say “C”.

Present value of INR 1 deferred till the expiry of 5 years @ 4% (From the Tables. Single rate = 0.822)

Hence, present value of property at the end of economic life: 0.822 X INR (B+C):

0.822 x (4,35,000+60,00,000) = INR 52,89,570/- Say “D”

Capital representing the value of the property: A+D, which is INR 6,56,850+52,89,570 = INR 59,46,420/- or Say INR 60,00,000/=

(INR Six Millions only)

If prevailing market rent and Fair Market Value of Open Land is known, the above formula works in any urban area of India. A year’s purchase / Security of 20 (5%) in e.g. 1 & around 23 (4.5%) in e.g.2 is a fair allowance; it must not be understood as laying that down as a rule in cases of this kind of (analyzed) residential properties. Every case must depend on its own circumstances, on the evidences available and the nature of the property. (The author has support in “Hesham v. Bholanath Mullick, II B.L.R. 1873).

Under Rule 3 of the Wealth-tax Act 1957, a freehold property has a multiplier of 12.5 in calculation of capitalized value of NMR (Net Maintainable Rent) of an immovable property. Cambridge Dictionary meaning of freehold is the legal right to own and use a building or piece of land for an unlimited time

Multiplier 12.5 in the WT. ACT is a concession given to general public. Therefore, in the opinion of the author, a year’s purchase of 20 is reasonable in the open market under normal condition. 

Lending/Deposit Rates: June, 2013

Reserve Bank of India (RBI)

 http://www.rbi.org.in/home.aspx

 http://dbie.rbi.org.in/DBIE/dbie.rbi?site=home

Saving deposit  %

Term deposit  %

10-year-G-Sec Benchmark yield around %

`4.00

7.50 – 9.00

7.45

India Post – Post Office            ^ http://www.indiapost.gov.in/POSB.aspx

Saving Account %

Recurring Deposit (RD) %

National Saving Certificate (NSC)

%

4.00

8.30

8.50

It appears open market value of real property security is about 250 basis points below benchmark gilt yield. It reverses the theory of 1950s.

In immovable property valuation, value arrived by rental method is counter checked with value by Land and Building Method aka Cost Method.

A. M, Ibrahim

Architect


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