In a sector as dynamic and often volatile as realty, performance measurement has become an important part of the investment game
We know how vital the real estate sector is for the progress of our country – it is poised to contribute 13% of the country’s GDP by 2025 and touch the US $1trillion by 2030. In a sector as critical as this, it thus becomes imperative to “measure” the performance of your investments. Reviewing a property’s (whether owned or rented) value can ascertain if it operates at over or below-market rental rates, if income is being lost due to high vacancy rates and whether certain expenses need to be curtailed.
Below are some guidelines that investors are employing to gauge the performance of their real estate assets with a long-term goal of making more profitable investments.
Net cash flow & cash-on-cash yield
To explain it simply, net cash flow is the amount of money left in the bank after all pending payments have been disbursed. It is calculated through certain formulas like cap rate, cash on cash return and IRR. Investors measure this monthly or yearly to monitor the inflow and outflow of money over a period of time. It has proven to be quite effective to determine how a concerned property is faring.
The cash-on-cash yield measurement technique involves a basic calculation to estimate the return from any assets, including real estate. In a nutshell, it refers to the total amount of ‘distributions paid annually by an income-generating property as a percentage of its current price’. It provides an idea of whether a property is undervalued or overvalued and finds extensive usage, particularly in the valuation process for commercial properties.
The popular real estate indices like BSE Realty Index, NHB Residex and RBI RPPI have proved to be reliable sources to ascertain the performance of a property investment in recent years. These “market watchers” play an important role in investment decisions since they facilitate overall analysis, compare properties, and highlight the demand scenario across different cities over a period of time. Since the sources for these indices are reliable, namely top financial companies and housing finance organizations, they have gained immense traction in recent times.
This is a prevalent method across the world wherein a professional organization is often hired to determine the value of any property. These companies offer accurate information by relying on ‘economies of scale’. Usually, two methods, i.e. the ‘absolute valuation method’ and the ‘relative value method’ are used for realty valuations. While the ‘dividend discount model’ and ‘discounted cash flow’ are used in the former method, ratios such as ‘price to earnings’ and ‘price to sales’ fall under the purview of the latter. It is commonplace for companies like Real Estate Investment Trusts (REITs) and other financial bodies to obtain a certification from these realty valuation companies to maintain a record of their properties having been “valued”.
This is one of the principal reasons why people put in their money in real estate. Appreciation, of course, refers to the increase in the value of a property over a period of time. The supply and demand dynamics of an area, infrastructural growth, available amenities, new policies and the prevailing economic situation are some of the top factors affecting the appreciation of any property.
Experts in the industry opine that any property that appreciates steadily over a period of time is worth holding on to. Usually, the rate of appreciation should match the current national average. However, prudent investors usually prefer this number to be higher than the national figure to benefit from the equity growth arising out of appreciation.