Question

A residential investment property has an expected nominal total return of 5% pa and nominal net rental yield of 3% pa. Inflation is expected to be 2% 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 2% pa.

b. The real expected capital return is 0% pa.

c. The real expected total return is 2.9412% pa.

d. The real expected net rental return is 0.98% pa.

e. In real terms, the house price will not increase at all. In nominal terms, the house price will increase at the rate of inflation.

Answer 1

Option E is correct because it is incorrect e. In real terms, the house price will not increase at all. In nominal terms, the house price will increase at the rate of inflation.

the price of a house will increase in real terms as well based on the locality of the house.

we can prove remaining option

1. Nominal expected capital return = total return - rental yield = 5% - 3 % = 2%

2. real capital return = (1 + nominal expected Capital return) / (1 + Inflation )] - 1 = 1.02 / 1.02] -1 = 1 - 1 = 0%

3. Real expected total return = (1 + nominal total return) / (1 + Inflation )] - 1 = 1.05 / 1.02] -1 = 2.9412%

4. Real expected rental return = (1 + nominal Rental return) / (1 + Inflation )] - 1 = 1.03 / 1.02] -1 = 0.98%

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