True value test

Most people end up buying a property at a price that is more than its value. As a result, they have to either wait unduly long to get a good return or sell at a loss.
Follow these steps to correctly evaluate a rent-worthy property. Assume the asked price is Rs 35 lakh and the down payment is Rs 8.75 lakh (or 25 per cent of the property's value)

Step 1: Expected net operating income (NOI)
This is rental income minus operating expenses such as repairs. This cost excludes EMI

Rental Income - Operating Expenses = NOI
Rs 2.4 lakh-Rs 15,000= Rs 2.25 lakh

Step 2: Annual debt service amount
Lenders want the expected NOI to cover your annual debt obligation. So, they lend in a way that the repayment is covered by the NOI. If the bank wants a debt coverage ratio of 1.15 times, the annual debt service amount will be Rs 1,95,652.17

NOI / Debt Coverage Ratio = Annual Debt Service
Rs 2.25 lakh / 1.15 = Rs 1,95,652.17

Step 3: Debt service ratio
This is the annual debt obligation as a percentage of the total loan

(Annual Debt Obligation / Home Loan Amt)* 100 = Debt Service Ratio
(Rs 1,95,652.17 / Rs 26.25 lakh) * 100 = 7.45%

Step 4: Rate of return on your down payment
This depends on NOI yield and down payment portion

NOI Yield * Down Payment Contribution = Return on Down Payment
[(Rs 2.25 lakh / Rs 35 lakh) * 100 = 6.43%] *
[(Rs 8.75 lakh / Rs 35 lakh) * 100 = 25%]
6.43% * 25% = 1.61%

Step 5: Market capitalisation rate
This is the sum of the debt service ratio and the return on your down payment

Debt Service Ratio + Return on Down Payment = Market Capitalisation Rate
7.45% + 1.61% = 9.06%

Step 6: Property's right value
This is the true value of the property (V). This calculation shows the property is worth Rs 24.84 lakh, which is lower than the asked price of Rs 35 lakh.

NOI / Market Capitalisation Rate = V
Rs 2.25 lakh / 9.06% = Rs 24.83 lakh