5 Reasons Why Property Rental Value Will Decrease in Future

“Property Rental Value is all set to decrease”. I told this to one of the readers of this blog Mrs. B during our interaction. She is planning to buy a property in Gurgaon where the property prices already corrected by 25% post demonetization. She is of the opinion that now it is a good time to invest in the property. Maybe she is right in case she is planning to buy the property for self-use but not for investment purpose. The reason being, if you are buying the property for investment then you also need to check the property rental value. If correction of 25% in property price is accompanied by 30% correction in rental yield then i will not suggest going ahead.  I shared this topic in my post, Fair Value of Property.

The second key concern is if you are buying a property for investment through a home loan. I discussed this topic in detail in my post, Avoid Property Investment through Home Loan. You should always find out the net property rental value after adjusting home loan interest rate, maintenance and other costs. Sometimes investors compromise on the current property rental value in anticipation of future appreciation. Currently, this scenario is completely ruled out because of demonetization. The property prices will remain soft. Even end user stable markets like Bengaluru delivered negative returns the first time in last so many years.

Therefore, if you are buying a property for investment then it is a double whammy for you. The prices will remain soft and it will be accompanied by the decrease in property rental value. Now you must be wondering why the property rental value will decrease. For this, we need to understand some of the factors that will impact the property rental value post demonetization. These factors will hit the rental market hard. Thus good times ahead for people who prefer to stay on rent and not so good times for property owners. Let’s check out 5 such factors.

5 Reasons Why Property Rental Value Will Decrease in Future

1. People Staying on Rent will buy a Property for Self-Use

Affordability is the buzzword. Every individual has his/her own definition of affordability. For example, in the case of Mr. A, he was planning to buy a property worth Rs 1 Cr for self-use. After a lot of research and study, he concluded that he cannot get this property for less than 1 Cr at any cost. A correction of 25% brings this property within his budget. Not only Mr. A but large no of people are now willing to buy the same property for 75 Lac. Earlier Mr. A was of the opinion that financially it is beneficial to stay on rent. Correction in property price changed this perception and will make a lot of fence sitter buyers buy property for self-use because of affordability.

Therefore, Last week Mr. A decided to buy the property for self-use. Though he is very well aware that prices may correct 10% more but he is not willing to take the risk. The reason being, it’s a matter of fact that most of the times people are willing to pay more in case they are buying a property for self-use. The low-interest rate will also fuel this growth. There is no incentive for an individual to invest for single digit return. As i highlighted in my earlier posts that double-digit return is a mirage for time being. Therefore better to invest in an asset like property in anticipation of future appreciation.

To conclude, correction in property prices will bring more buyers who will buy for self-use. Therefore, it will put a lot of pressure on property rental value.

2. No CASH 

It was a very common practice for owners to accept rent through CASH and declare that PAN is Not Available. This practice changed post demonetization and after IT department sent large no of notices to people who have not filed ITR. Based on my interaction, i can conclude that two-third cases are related to property income. For example, a lot of PG accommodations are near our apartment and during the casual discussion, the owners admit that in past they accepted rent only in CASH. These people made high value transaction and caught by the Income Tax Department. Now i can see Paytm and other cashless options on reception counter to accept rent. Therefore, whether an owner receives rent through cash, mobile wallet, NEFT or cheque, he has to declare the rental income and pay tax.

Secondly, post demonetization there will be cash crunch in the market so that people should go cashless. There are news reports that RBI will infuse only 40% cash deposited in the bank’s post demonetization. Therefore, most of the property owners will be forced to adopt cashless payments thus will pay income tax on the rental income.

Now if you read point 1 and point 2 together the rental market will remain depressed and as an owner, if i have to pay tax say 10% tax on my rental income. In this case, my net property rental value will decrease by equivalent amount i.e. 10%. To offset the loss, i should pass on tax liability to the tenant but it is not possible now and owners have to bear the tax liability. In short, net property rental value will decrease due to tax liability.

3. The fear of missing the bus

I have observed that property owners are not willing to delay the renting a property. The calculation is simple and based on the fact how long they will take to rent a property at Rs X per month say Rs 15,000 per month. For example, if my assumption is that it will take 2 months then my annual rent will be Rs 1,50,000. Therefore, i will not mind renting immediately on a rent of Rs 12,500. Thus property rental value took a hit of approx 16%. In short, any lack of demand will reduce the property rental value at a faster rate.

Please note that longer the property is vacant, the lower is the probability of putting it on rent. The potential tenant becomes skeptical i.e. why the owner was not able to rent it out. In turn, the potential tenant negotiates the lower rent. Lastly, the rental value has ripple effect i.e. it set the benchmark. For example, last year 3BHK rent in my neighboring apartment was Rs 26,000 per month. With good luck :), one of the owners managed to rent the 3BHK at Rs 30,000 per month. It became benchmark rate. Recently, a couple of properties were rented at Rs 25,000 per month and now it is the benchmark rate. I am not sure whether the decrease is because of demonetization or some other factor. The only reason i came to know was that the tenants lost their job. This concern we will discuss in next point.

Though it is very early to conclude but Post demonetization i observed that it is becoming difficult to rent a property and property rental value is on the slow decline.

4. The slowdown in Economy:

Whether we accept or not, there will be a slowdown in some sectors post demonetization. I shared these sectors from a stock market perspective in my post, Demonetization impact on the stock market. The floating population and economic growth are the 2 key drivers of property rental value. Recently, i was reading news articles that there is a double-digit de-growth in certain segments like 2 Wheeler, 4 wheeler etc. Quite surprisingly even FMCG sector that is considered to be conservative also de-grew. There will be more pain ahead and experts are predicting more job losses.

Secondly, IT sector is expected to perform badly due to change in policies of the USA and an overall slowdown in the IT sector. Therefore, it will impact property rental value in IT hubs like Bengaluru, Pune, Hyderabad etc. The experts are expecting acceleration in the manufacturing sector but a slowdown in the service sector.

5. Unsold Inventory will be converted to Rented Property:

Though it is not a new phenomenon but earlier only very small builders were converting unsold inventory to rented property. In last few months i observed that as it is becoming difficult to sell the house, the small and mid-size builders are converting their unsold inventory to rented property. The unsold inventory has reached alarming levels. You must have observed large no of assured rental schemes in the market for ready to move in property for buyers. It is basically to lure the potential investors. Under such schemes, the assured rent is almost 50% of the market rent.

This trend will have a snowball effect. Thus it will increase the supply of property on rent. Any increase in supply will reduce the property rental value. Secondly, due to a decrease in property prices, many owners will prefer to rent the property and wait for right time to sell the property. For example, one of my friends was planning to sell his property. Post demonetization, the prices dropped by 20% in the secondary market. Recently, he rented the property as he is not willing to sell the property at 20% less price.

Words of Wisdom:

The real impact of demonetization will be visible after 9-12 months. The real estate sector is undergoing a sea change. One set of experts is expecting a revival of the sector and another half is of the opinion that worst is yet to come. One of the reasons for optimism is lower interest rate but it will decrease property rental value as discussed in point no 1.

Any meltdown in real estate will also impact the property rental value with an assumption of a slowdown in the economy. The best possible scenario for investors dependent on rental income is to expect the negligible impact of demonetization on the economy, stable interest rates, and high property prices :).

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