Expanding rental yields –silver lining to a lackluster market?

In deteriorating markets, it is easy to fall prey to extreme pessimism. Amidst falling sales volumes and stagnant prices, might some of us have overlooked a strong buy trigger in the Delhi and Gurgaon residential markets? Look closely and you will notice that over the past 12 months, rental yields have been expanding quickly in Delhi and Gurgaon is catching up fast. In this post, I will attempt to address the following three topics:

1. What influences rental yields?
2. Rental yields even across the metros are low. Why is that?
3. Is rental yield a lagging indicator to appreciating capital values?

What influences rental yields?

The following factors have an inflationary impact on rental yields. These factors are especially relevant to the following four metros – Mumbai, New Delhi, Bangalore & Chennai.

1. Large renters to buyers ratio - the renters to buyers ratio in India is still very low. This will increase as people become more mobile and leave their home cities in search of better job opportunities. For example, New York City which has a population of approx. 8 Million, about two thirds of people are renters.

2. Expatriate population across the 4 metros mentioned is increasing rapidly. This will continue to be the case for the foreseeable future and increased demand from this segment will further fuel rental yields.

3. Increasing nuclearisation of families will lead to further demand for rental units exerting an inflationary pressure on yields.

4. Rental yield in Tier-II cities is likely to be lower. I expect this to be the case since prices in smaller cities are more affordable and Tier-II cities normally have smaller percentage of mobile workers.

5. High interest rate environment (as we are witnessing currently) makes buying less affordable thereby pushing up demand for rental units.

Rental yields even across the metros are low. Why is that?

Rental yields across properties in New Delhi (particularly South Delhi) have been consistently expanding over the last three years. The one silver lining to the otherwise bleak RE scenario appears to be inflating rental yields. In the earlier point I have already described some of the reasons which influence rental yields positively. As these factors become more predominant, yields will continue to rise. Moreover, investing is never about what has been. Good investing is about what can be. Therefore, seek out city centre properties in metros which are close to locations which already have high yields. Sooner rather than later, you will see the spill over effect of higher yields in the lesser desirable (historically) neighborhoods as more established locations become unaffordable.

Investment idea: Yields in Greater Kailash, Chittaranjan Park, Green Park, East of Kailash, etc have shot up dramatically over the last 2 years. Yields have expanded from the 2.5%-3% range to 4%-5% range in these locations despite significant appreciation in capital values in these locations. I expect further upward pressure on yields over the next 2-3 years. Seek out properties with below average rental yields (in comparison to other properties in the neighborhood). In particular, small 2 BR apartments will have significant demand over the next few years leading to very attractive yields.

Analysing rental yield as a lagging indicator to appreciating capital values

Indian RE has undergone a metamorphosis over the last 5 years. Entirely new townships and cities have been created where cows grazed only 5 years ago! The appreciation in RE prices has been no less spectacular during this period. However, rental yields in these up and coming townships have not moved in tandem creating dissonance for investors. One of the reasons why rental yields are low is because rental yields are normally a lagging indicator and capital appreciation in property is a leading indicator. Let me explain. As these new areas started to develop, there was a rush of new investment, early adopters and speculators moved in and prices appreciated fast. However, the government was not equally responsive and efficient in creating necessary infrastructure to support the new townships. Naturally, renters have resisted relocating to areas with inadequate infrastructure. Renters have options to choose from and will not move into new townships till they have the comfort of easy transportation, easily accessible malls, schools, hospitals and entertainment. Once this infrastructure is created, people will move in and yields will improve quickly. To give an analogy, in the earliest phases of development, a township is much like a growth stock. Just like in the case of a growth stock, a new townships capital value appreciates quickly but it takes a while for it to produce attractive rental yields. This compares favorably against a growth stock investment which may have low or no dividend yield in its earliest years whilst providing substantial capital appreciation.

Investment idea: Till 12 months ago, rental yields on Gurgaon-Sohna road were languishing in the 2%-2.5% range. Now, rental yields on Gurgaon-Sohna road have expanded in the range of 3%-4%. As this and other newer areas in Gurgaon become connected with metro and other associated infrastructure is created, I expect the rental yields to move up further and will continue to do so over the next 2-3 years.

Most Commented Posts

• Is the NCR real estate market in a bubble?
• Emerging trends in Indian Real Estate and how you can benefit
• Leverage - the new cocaine !

Comments