Property Valuation: Fixation of Rent

Property Valuation: Fixation of Rent

One of the important aspects of property valuation is the fixation of standard rent for a property. The standard rate may be defined as the rent which can be charged on the tenant under the prevailing law and regulations. Rent fixation can be done efficiently from the known value of the property. On account of this, higher the value of a property,  higher will be the rent. The method of rent fixation is simply the reverse process of the rental method of valuation of a property. The rent is generally fixed based on a certain percentage of the annual interest on the capital cost after deducting all the expenses or the outgoings. The rent fixed should not be in any case greater than the standard rate and must be in accordance with the related prevailing rules and regulations. Thus, the rate of interest is considered only for a fair secured return by the way of interest. With due consideration to the drawbacks such as security and regularity of the income, liquidity of the capital, inflation rate etc the rate of interest is taken 2 % higher than the interest on the Government security boards.

 

General Procedure of Standard Rate Fixation

The general procedure of standard rate fixation involves the following series of steps:

1. The first step involves the calculation of annual net return. The annual net return includes the summation of the following:

i. A certain annual interest on the cost of construction of the building including the expenses for water supply and sanitary works, electrical fittings, installations etc.

ii. Certain annual interest is also considered on the cost of land. The rate of interest on land may be the same or a little less than the rate of interest for the total cost of construction.

2. The next step includes the calculation of the outgoings i.e. all the expenses incurred.

3. Finally, the standard rate of the property is calculated using the following formula:

Standard Rent = Net Return + Outgoings

 

Solved Numerical Example

Q. In an urban plot of land, a new building consisting of six equal flats are constructed with a total cost of Rs. 3,00,000. The cost of the plot of land is Rs. 1,00,000. The owner of the property expects a 12% return on the total cost of land. Determine the total standard rate to be fixed for each flat of the building considering the following data:

a. Interest on the sinking fund is 6% and sinking fund coefficient for 70 years at 6% is 0.0010.

b. The future life of the building is 70 years.

c. Scrap value is 10%.

d. Annual repairs at 1% of the cost of the construction.

e. Outgoings at 30% of the net return from the building.

Solution,

Step 1: Calculation of Annual Net Return Required

a. The return on building at 12% of cost of the building = 12% * 3,00,000
=0.12 * 3,00,000
= Rs. 36,000

b. The return on land at 8% of cost of land = 8% * 1,00,000
= 0.08 * 1,00,000
= Rs. 8,000

Step 2: Calculation of Outgoings

a. The total sinking fund allowing 10% scrap value = 100 – 10 = 90 percent of building cost
= 3,00,000 * 0.90
= Rs. 2,70,000

Thus,

The annual sinking fund = S {i/ (1 + i) n – 1}

Where,
S  =  total amount of the sinking fund  =  Rs. 2,70,000
i  =  rate of interest of sinking fund in decimal  =  0.06
n  =  number of years  =  70

Therefore,

sinking fund = 2, 70, 000 * {0.006/((1 + 0.06) 70 – 1)}
= Rs. 270

b. Annual repairs at 1% of construction cost = 0.01 * 3, 00, 000
= Rs. 3,000

c. Other outgoings at 30% of net return = 0.30 * 44,000
= Rs. 13, 200

Thus, total outgoings = Rs. 16, 470

Now,

gross rent per year = Net return + Total Outgoings = 44,000 +
16,470
= Rs. 60,470

Hence, the standard rent per month of each of the 6 flats = 60,470/ (12 * 6)
= Rs. 839.86 = Rs. 840

 

 

 

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