Rentals on high tide

Surging demand is pushing up rents in cities. But investing in a home for renting remains unviable because rental yields are still below the borrowing costs.

By Rakesh Rai | Print Edition: August 9, 2007

Why should anybody be happy when the interest rate on housing loans goes up? Borrowers shell out more in interest. Lending companies see a drop in loan applications. Real estate developers get fewer customers. There’s really no reason for anybody to smile. Anybody except landlords. One segment of the population that has welcomed the consistent rise in interest rates and property prices with glee is landlords, especially those who aren’t repaying a home loan. Rising interest rates and property prices are pushing new homes out of reach. More and more people are being forced to postpone their plans to purchase a house and continue living on rent.

This has led to a surge in demand for rented accommodation, which in turn is pushing up rentals of residential property. “There is always a time lag when the effect of high prices starts showing on the residential rental market,” says Sanjay Verma, joint managing director of real estate consultancy Cushman & Wakefield. In a survey done by indiaproperties.com in February, 30% of the respondents said that low rentals were the chief reason why they were opting to live on rent. That configuration is going to change now.

Rental agencies say a combination of factors has contributed to the surge in rental values in different cities. The growth and spread of the IT sector has played a major role in pushing rentals up. The fat salaries in the IT sector have pushed up the affordability and demands of tenants and the expectations of landlords. “From single-bedroom and double-bedroom houses, tenants now want three-bedroom houses and penthouses. Rental budgets have shot up,” says Harender Kumar, a Noida-based property consultant. Kumar has seen a spurt in business recently. Call it the low base effect, but the rise in rentals has been more pronounced in suburbs of metros.

Reasons for renting

% respondents

New in town20
Convenient location15
High property prices15
Uncertain market10
Good deal5

In Noida on the outskirts of Delhi, rentals have risen by almost 20% in the past six months. Till last year, a threebedroom house used to fetch a rent of about Rs 10,000. Now you can’t get one for even Rs 12,000 a month. The same story is repeated across the country, whether it is Kalyani Nagar in Pune or Old Mahabalipuram Road in Chennai.

Then there are markets like Mumbai where rental accommodation has always been in demand and rental yields seen a healthy growth. “Mumbai's residential rentals are zooming. In the past one year, rents have doubled and in some locations, even tripled,” says Sandeep Sadh, chief executive officer of mumbaipropertyexchange.com. The escalation has been the steepest in Bandra, Andheri and Malad. In Bandra, you could rent a two-bedroom apartment for Rs 25,000-40,000 a month about six months ago. Today, you will have to shell out Rs 45,000-90,000. Besides, according to Rashid Bastvi, a Mumbai-based real estate broker, in metros such as Mumbai and Bangalore, a two month advance will no longer be enough. Some landlords now insist on a 6-12 month advance. That sacrifices a lot of liquidity but most tenants have no choice.

Even smaller cities have caught the contagion of rising rentals. Nagpur, Jaipur and Chandigarh have recently seen an increase in demand for rental accommodation and rents have spurted northwards. When Ravi Girdhar arrived in Jaipur on a transfer, he was told that he could easily get a two-bedroom apartment within Rs 5,000 a month around his office in Transport Nagar. But when he actually started looking out in areas such as Raja Park and Jawahar Nagar, he could not get anything below Rs 8,000 a month.

His budget of Rs 4,500 could only get a flat in Vaishali Nagar, some 8 km from the main city. A two-bedroom flat in the Malviya Nagar area of Jaipur was available for rent for roughly Rs 5,000-6,000 about a year ago. Now, a similar accommodation won’t come for less than Rs 9,000 a month. Similarly, even as new hubs like Panchkula and Mohali are coming up around Chandigarh, rents in the city have gone up by 25-30% in the last one year.

One yardstick used to assess rental income is the ratio of average house prices to average annual rents, which captures whether investments for rental income is worth it or not. Though the ratio is still much lower compared to the high property prices, it has been going up slowly (see table: Rental Yields are Going Up).

All this should sound like a dream come true for investors who want to buy property to rent it out. After all, they can buy property and use the rental cheque to pay the loan EMI. That’s easier said than done. This is not the time to invest in residential property for rental income with borrowed funds. Rental yields have been rising but are still much lower than the cost of borrowing. This means investors will have to rely more than just the rental income to pay the EMI on the loan.

For instance, a flat that was going for Rs 30 lakh in July 2005 when the home loan interest rate was 7.5% is now priced at around Rs 55 lakh when the interest rate is 12%. Assuming that a buyer paid 20% as down payment and took a loan for the balance, the EMI for a 10-year loan would have been Rs 33,250 two years ago. It is now Rs 63,125. It’s a glum scene.

Experts also point out that the factors affecting the property market are very different from those governing the rental market. “Local factors affect the rental market. No one shifts into a flat just because a flyover is likely to come up there in two years,” says Anuj Puri, chairman, Jones Lang LaSalle Meghraj. Another important fact to be kept in mind is that a large supply of houses will hit the market over the next 12-18 months in many cities across India. “That will help keep rents under check as the demandsupply equilibrium is reached,” points out Puri. However, prime inner city locations where fresh supply is unlikely will continue to see increasing demand.

However, emerging Tier II cities, where IT and ITeS companies are setting up shop, will continue to be hubs of increased real estate activity. For instance, Nashik, Coimbatore, Kochi, Ahmedabad and Indore promise investors an attractive rental yield as well as capital appreciation. “These cities still have reasonablypriced real estate rates, and the appreciation potential is high.

Moreover, there will be an assured customer base for lease-rentals— especially if the property is near to an IT hub or Park,” says Verma. The market today is in stark contrast to the situation about five years ago. In 2002-3, subdued property prices and falling interest rates made house buying a compelling option. Why pay rent when you can afford an EMI, would-be home owners asked themselves. For many of them, the question is now a statement: Pay rent because you can’t afford the EMI. Unfortunately for some, even the rent has become unaffordable now.

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