Question

A residential investment property has an expected nominal total return of 6% pa and nominal net rental yield of 2% pa. Inflation is expected to be 3% pa. Note that net rent is rent revenue minus rent expenses. So the net rental yield is just the income return of a house. All of the above rates are nominal effective rates and investors believe that they will stay the same in perpetuity. Which of the following statements is NOT correct? All numbers are rounded to 4 decimal places.

Select one:

a. The nominal expected capital return is 4% pa.

b. The real expected capital return is 0.9709% pa.

c. The real expected total return is 2.9126% pa.

d. The real expected net rental return is 1.9417% pa.

e. In real terms, the house price will fall. In nominal terms, the house price will increase at less than the rate of inflation.

Answer 1

Answer is d. The real expected net rental return is 1.9417% pa.

Statement d is not correct.

expected nominal total return = nominal expected capital return + nominal net rental yield

nominal expected capital return = expected nominal total return - nominal net rental yield = 6% - 2% = 4%

real expected capital return = [(1+nominal expected capital return)/(1+inflation rate)] - 1 = [(1+0.04)/(1+0.03)] - 1 = (1.04/1.03) - 1 = 1.009709 - 1 = 0.009709 or 0.9709%

real expected total return = [(1+expected nominal total return)/(1+inflation rate)] - 1 = [(1+0.06)/(1+0.03)] - 1 = (1.06/1.03) - 1 = 1.029126 - 1 = 0.029126 or 2.9126%

real expected net rental return = [(1+nominal net rental yield)/(1+inflation rate)] - 1 = [(1+0.02)/(1+0.03)] - 1 = (1.02/1.03) - 1 = 0.990291 - 1 = -0.009709 or -0.9709%

so, real expected net rental return of 1.9417% pa. is not correct.