Whenever we plan to buy a property, The biggest dilemma for a buyer is what is the Fair Value of Property? It is because of fear of paying more than the market price. There is no straight forward answer to resolve this dilemma. In fact, sometimes people postpone purchase decisions in anticipation of price correction. In other words, they wait for the fair value of property. I am tracking real estate sector of key markets from last 6 years but i have never seen instances of sharp price correction.
In last few years, prices have softened and corrected by 10%-15%. I do agree that there can be distress sale which can happen both during good and bad times. The price of property under distress sale is generally 15-20% cheap compared to market rate. These properties are also referred as discounted property. In other words, we can say that buyer discovers Fair Value of Property under distress sale.You also need to find out the reason behind discounted property, it can be a trap. In some instances, good negotiation skills can fetch you a better price. To negotiate a property deal is an art as i shared in my post, Negotiate Property Deals.
To search for discounted property or discover fair value of property requires a lot of patience & time. Risk involved is high. Risk in the sense that if i am looking for discounted property and current rate of property is 10 Lac. If i keep searching indefinitely then i should keep in mind that property rates may increase. Say after 5 months, i found distress sale at 20% discount but by now price of same property is 13 Lac so effectively i am at a loss. Based on my experience i can say that any time is the best time for property purchase at market rate if you are buying for own use. Market rate may or may not be a fair value of property. If you are buying for investment purpose then you can wait for Fair Value of Property. For investment, I always suggest 2BHK unit as i explained in my post 2BHK – Best Real Estate Investment.
Now million dollar question is what is the Fair Value of Property? While calculating Fair Value of Property you should listen to your mind, not heart. The Fair Value of Property should be decided broadly on 2 factors (a) Accessibility i.e. Location and (b) Site i.e. Society, Flat, Amenities etc. The seller can command premium for prime location. The best way to find prime location is to look out either for Heart of City say MG Road in Bangalore, Nariman Point in Mumbai or Connaught Place in Delhi. Alternatively, check the CBD (Central Business District) say BKC in Mumbai, ORR or ITPL in Bangalore or Gurgaon in NCR. The property far from prime location of the city is cheaper (Of course there will be exceptions also). The second criterion is site i.e. Flat, Society, Builder etc. In Mumbai, Hiranandani commands a premium so as Mantri and Shobha in Bangalore. I would not like to name but there is a project in Bangalore that is practically in Jungle. It is almost 30 km from MG Road but this well-known builder is asking for rates that are never heard off. In short, Builders also command a premium. There is always an exception to Fair Value of Property.
As per basic principles of Economics, Demand and Supply should play a crucial role in deciding Fair Value of Property. Sometimes sentiments & Purchasing power play an important role which overpowers all the principles of economics. This is what is happening in Delhi and Mumbai. The prices in pockets like Dwarka & Gurgaon are never heard of. It’s because Govt/builders have acquired land from farmers at too high rates. It has increased the purchasing power of many people which in turn have boosted the sentiments thus property prices have skyrocketed. You cannot talk/think about the fair value of property in such pockets.
Secondly, this scenario induces insecurity among others. The fear of missing the bus or we may not get a property in future so everyone join the rush to buy property which further increase the price. All these situations defy basics of Fair Value of Property. I can give it in writing that prices in these areas will fall like a pack of cards shortly. The reason being, there are no growth drivers in most of these areas. If the increase in property price is not linked to any growth driver then the price is artificially inflated by hoarders/investors. If property prices are increasing in Whitefield and Electronic City of Bangalore then reason is a lot of SEZ’s have come up in these areas. These areas are contributing one of the highest addition to office space in the country.
My personal advice to readers is to make a well-informed choice as it is your hard earned money. If you are not finding the right property then better to stay on rent. The sentiments should not overpower your conscious and thinking process. For a common man, it is not possible to consider, evaluate and analyze all the important factors. After a lot of studies, i have concluded that Rent is the best criterion to fix Fair Value of Property. Rent covers all factors like Demand, Supply, Accessibility, Site, Sentiments, Growth Drivers etc. that should be considered while purchasing a property. To find Fair Value of Property, All you need to do is just check the Rent that you can potentially earn by putting similar flat in same society on rent. It will give you a fair idea of property valuation and you will be in a better position to take an informed decision.
How to calculate Fair Value of Property?
After finding out the rent just calculate Price of a Property by simply applying following 2 methods and you will get a Fair Value of Property.
Method A: This is a well known international method to arrive at the fair value of property and is adopted by well known real estate firms. It states that Fair Value of Property should not be more than 25 times the Annual rent you can earn as of date. For example, if a property has potential to earn Rs 20,000 rent per month i.e. Annual Rent of Rs 2.40 Lac. In this case, 25 times of annual rent is 60 lac therefore fair value of property is 60 Lac
Method B: This is well known Indian method to calculate Fair Value of Property in the current scenario. It states that price you are paying for a property should not be less than 3% of Annual Rent you can potentially earn from the property. Let’s take the example mentioned example above, Annual rent is 2.4 lac and on a higher side if yield is 3% then Fair Value of Property should be 80 Lac.
Now from these two methods, we get 2 different values i.e. 60 lac and 80 lac so we can consider this as a range to buy the property. If you get it at lowest point i.e. 60 lac then you strike the Gold and if you get it at 80 lac then also it’s a fair deal.
In a nutshell, there is no hard and fast rule to fix fair value of property but we can set some rules and guidelines to make well-informed decision to avoid regrets in future.
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i think, one more way to arrive cost of property (old or new ) could be based on prevailing land (pertaining to the property) and the prevailing construction cost for the type of the construction of the property concerned, factored by the appropriate depreciation factor depending on the age of the property and its condition. it could be approximately the sum of these two parts. if the particular property is available at different rate. it could be considered as premium or discount over the fair price of the property and that could be the guiding poinfor sale or buy. i found in my city surat , the newly constructed/under construction flats in adjoining developing ‘pal’ area are priced at @10% premium of their fair prices, whereas in my already developed area ‘anand mahal road’,flats 10-15 yrs old but very well conditioned and maintained and well located are priced at @20-30% discount than their fair prices. 2-3 yrs. before the were equally priced , but now the prices of new flats in developing area are almost doubled whereas old flats’ on developed ‘anand mahal road’ prices are stagnant /decreased, though the land prices are now same in both area. kindly comment.
Hi, thanks the info was really useful. Is the rule applicable for commercial properties too?
No as the yield on commercial property is high.
I agree with u on the method suggested but this method is more suitable & applicable for independent houses..In case of flats, its very difficult to divide cost of land between flats of different sizes…Just to add construction cost can be standardized i.e. in metro cities it is 2000 Rs psf whereas in semi Urban, its between 1500 Rs – 1700 Rs psf…Also this method has few shortcomings
(a) Its not a scientific way to calculate becoz there is no set definition for depriciation..The normal life of a building is between 40-50 years depending on quality of construction so ideally depreciation on yearly basis shud be between 2% to 2.5% but it is not the case becoz cost of maintenance after 10 years of cosntruction is roughly twice the maintenance cost during initial years..so depreciation rate is much higher during initial years compared to later years..We dont have any fix method to calculate the same.
(b) Secondly as i mentioned its a matter of demand and supply also..Lets take 2 scenarios in 1st scenario i bought a flat 10 yrs back when cost of land and construction cost was one tenth of today’s rate..The flat costed me 12 Lacs that time and assume u are buying today in new construction where builder has paid ten times the land price as he would have paid 10 years back..Also construction cost is high today so builder is selling flat @ 80 Lacs today…Now its obvious that no one will pay 80 lacs for my old house becoz in this rate he will buy new flat which will have 10 years more life so it will never happen that new and old flats will sell at same rate and secondly if we asume after 3 years we both decide to sell…Since my initial cost was just 12 Lacs and ur initial cost is 80 lacs so u will not sell below 80 lacs at any cost but in my case since my initial cost is very low & cosntruction is 13 years old so i might sell it at 60 lacs also…Conclusion is new flats will command more premium but at the same time seller should not sell old property at discount of 20-30%..He can easily sell it at Fair Value as suggested by me which is more scientific way to calculate.
To add 2-3 years back might be due to lack of demand in new area, the old & new flats would have been sold at same rate but this trend will change as the demand will pick up in new area..so the premium over fair value will increase for new construction becoz of high cost of land and construction cost whereas old flat will be sold at lower rate becoz of high depreciation of property.
Last but not the least post re-development i.e. after 40 years of construction, the old flats which will be in centre of city i.e. fully developed area will sell at mutiple times compared to flats in today’s developing area so dont worry think long term, u r sitting on gold mine :)Hope u agree with my views
Extremely useful informaton … thanks a lot for the crystal-clear explanation.
Hi Nitin, didn’t understand how you arrived at 80L with method B, could you elaborate on this?
In method B, the age of property is considered is 33.33 years and annual rental yield should be 3% therefore if annual rent is 2.4 Lac than 2.4 Lac X 33.33 = 80 Lacs. Normally Method B is used to find upper or max price which you should pay for the property.
excellent keep up the good work
Sir will you please discuss in detail about the method B to calculate the fair value of property.
I have shared an example. You can calculate fair value with the help of an example.
I actually liked the 2nd meothod to sell my property. But I don’t think people will be ready to pay such a huge amount. Though my property is quite huge. But still no one one is ready to pay more than 60 lakhs for it. In 2000, when the property was constructed we paid 24 lakhs for it but now almost 16 yrs later why can’t we get doubled of it?
Any method to sell property at very relaxing price?
Wait for right time if you are not in a urgent need of money..Currently prices are depressed.
Method B is calculated based on the rent. Post demonitisation; does the 3% rule still apply in mumbai, specifically wadala west area?
It is subjective but in my opinion this rule will not apply in your area.
What about the depreciation of old building ? Is it not to be considered ?
In Mumbai it does not work as the redevelopment will hugely unlock the property value. In fact people prefer apartments nearing redevelopment.