Valuation of a let-out shop-cum-residence for a bank
A shop-cum-residence on a 120 m² plot on a town's main bazaar road is let out at ₹15,000 per month. The municipal tax is 10% of the gross annual rent, insurance is ₹3,500 per year, repairs are taken at 8% of the gross rent, and management charges at 5% of the gross rent. The building is 25 years old and, with present maintenance, is expected to last another 35 years. Land in the locality is currently selling at about ₹9,000 per m². A local valuer has put the fair value at ₹11.2 lakh but has not shown his working. A bank has asked for a valuation for mortgage purposes and wants to know how much weight to place on the valuer's figure, and whether the property is sound security given its age and remaining life.
1. Compute the net annual income and the capital value by the rental (capitalisation) method, showing every step.
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Gross income
Gross annual rent = ₹15,000 × 12 = ₹1,80,000
Outgoings (the only legitimate deductions are the owner's actual annual expenses)
| Item | Basis | Amount (₹) |
|---|---|---|
| Municipal tax | 10% of gross rent | 18,000 |
| Insurance | given | 3,500 |
| Repairs | 8% of gross rent | 14,400 |
| Management | 5% of gross rent | 9,000 |
| Total outgoings | 44,900 |
Net annual income = 1,80,000 − 44,900 = ₹1,35,100
Years' purchase for the remaining life of 35 years at 8%:
YP = [1 − (1 + i)^(−n)] / i = [1 − (1.08)^(−35)] / 0.08
(1.08)^35 ≈ 14.79, so (1.08)^(−35) ≈ 0.0676
YP = (1 − 0.0676) / 0.08 = 11.65
Capital value = 1,35,100 × 11.65 = ₹15,74,000, say ₹15.7 lakh.
Sanity check: the value must exceed the land value alone (120 × 9,000 = ₹10.8 lakh), and it does, leaving about ₹4.9 lakh for the 25-year-old building. That is low but not impossible for a bazaar property where the rent may be below full market rent.
2. The valuer's ₹11.2 lakh figure cannot be reproduced. Explain the common errors that produce a figure like this, especially the sinking-fund double count, and state the correct way to handle depreciation in the rental method.
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The double-count trap. Sinking fund and years' purchase are two ways of allowing for the same thing - depreciation and the eventual replacement of the building. You must use one or the other, not both:
- Method A (life-based YP): take net income without a sinking-fund deduction and multiply by YP for the remaining life (11.65 here). The finite-life YP already capitalises the income only for 35 years, so depreciation is built into the multiplier. Value = ₹15.7 lakh.
- Method B (perpetuity YP with replacement provision): deduct a sinking fund from income, then capitalise at 1/i = 1/0.08 = 12.5, which assumes the building is replaced at the end of its life. Applying YP for 35 years and deducting a sinking fund charges the owner twice.
Other likely errors behind ₹11.2 lakh
- Using a much higher capitalisation rate (12–14%) than the 8% supported by local evidence, when shop rents on a bazaar road are the safest class of rental.
- Deducting items that are not outgoings - income tax of the owner, mortgage interest, or a notional rent for the owner's own use.
- Deducting the sinking fund and using a finite-life YP (as above).
- Arithmetic error or an unstated assumption about the remaining life.
What to say to the bank. Ask the valuer to produce his working and his comparables. A valuation is an opinion, but it must be a reproducible calculation: same gross rent, same outgoings, same rate, same remaining life. On the data given the rental method supports about ₹15.7 lakh, and an unexplained ₹11.2 lakh is 29% lower and should not be relied on.
3. Compare the capitalised value with the land value, list the checks you would make on the rent before relying on this valuation, and advise the bank on the figure to adopt and on the security.
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Comparison with land value
- Land alone = 120 m² × ₹9,000 = ₹10.8 lakh
- Capitalised value = ₹15.7 lakh, so the building's contribution is only about ₹4.9 lakh for a 25-year-old structure.
Two readings are possible, and they lead to different advice:
- The rent is genuinely below market (an old tenancy or a friendly lease), in which case the rental method under-values the property and the land-and-building method (land value + depreciated cost of the building) should be the cross-check.
- The rent is at market and the plot is under-developed relative to the road's potential, so the value is being carried by the land, not by the building.
Checks before relying on the rent
- Is ₹15,000 a month a fair market rent or a controlled/old rent? Compare three or four similar shops on the same road, same frontage and access.
- Are the outgoings realistic - is the municipal tax based on the current assessment? Are the repairs adequate for a 25-year-old building?
- Title, approved plan and permitted use; whether any part is unauthorised.
- Structural condition and the basis of the "35 years remaining life" - that is the valuer's opinion, and it drives the YP.
- Whether the plot's permitted floor area is being used; a bank must value what exists and is approved, not a hypothetical redevelopment.
Advice on the figure. Adopt a figure in the region of ₹15.5 lakh, but as the lower of the rental method and the land-and-building cross-check, and state the assumptions. The valuer's ₹11.2 lakh should not be adopted without his working.
On the security. The land value (₹10.8 lakh) already covers about 70% of the capitalised value, which is reassuring because land does not depreciate; the building does. For a mortgage the bank should also look at the borrower's repayment capacity and the resale market for bazaar shops, and should not lend on the assumption that the present rent will continue unchanged for the whole 35-year life.