1. CAPM Versus Expert Opinion: Do practitioners’ Perceptions Meet Theory? Evidence from the Survey of Estonian Commercial Real Estate Market Presentation at 22 nd Annual European Real Estate Society Conference 24-27 June 2015 Istanbul, Turkey by Kaia Kask Email: kaia.kask@ut.ee 25 th of June, 2015

2. Background and aim of the study In valuing real estate or making decisions over investments, various market-players are concerned with the problem, how to measure the expected rates of returns of targeted real estate asset. The current research aims to measure and compare the size of the commercial real estate market-based rates of returns in Estonia, using both direct and indirect assessment methods. The chosen methods were questionnaire conducted among market experts, from the direct methods, and modified CAPM from the indirect methods. 25.06.2015 2 Commercial real estate rates of returns in Estonia

3. Alternative methods for valuing the size of market-determined rates of return 25.06.2015 3 Commercial real estate rates of returns in Estonia Measurement methods for discount rate Indirect methods: c)Capital Asset Pricing Model (CAPM) d)Modified Capital Asset Pricing Model (mCAPM) e)Arbitrage Pricing Theory (APT) f)Fama and French Three Facor Model g)Dividend Discount Model (DDM) h)Internal Rate of Return (IRR) i)Weighted Average Cost of Capital (WACC) j)Ramsey’ formula k)Other methods Direct methods: a) Interviews b) Questionnaire

4. The applied formula of modified CAPM Long-term historical expected overall rate of return (E(R i )) was assessed with the following formula: R F – risk-free rate of return β i – unleveraged (asset) beta RP m – market risk premium RP liq – liquidity risk premium 25.06.2015 4 Commercial real estate rates of returns in Estonia

5. Content of the components of CAPM in terms of Estonia 25.06.20155

6. CAPM structures based on historical average data 25.06.2015 6 Commercial real estate rates of returns in Estonia 2010 survey: 2012 survey: 2015 survey:

7. The aim and assumptions of the questionnaire The aim of the questionnaire conducted among various real estate companies in Estonia was to ascertain the size of the market-based real estate rates of returns of typical commercial real estate assets (i.e., office, retail, warehouse buildings). The questionnaire targetted and the results of the questionnaire are applicable on a typical A-class commercial real estate assets assuming a view of a typical real estate investor in the market. 25.06.20157 Commercial real estate rates of returns in Estonia

8. Background of the rates of returns questionnaire 25.06.2015 8 Commercial real estate rates of returns in Estonia

9. Object of the questionnaire The conducted questionnaire covered both time and space: i.e., the market experts were asked to give their opinion about different expected rates of returns for different commercial real estate assets in different regions over the long-term time-frame according to the following matrix: 25.06.2015 9 Commercial real estate rates of returns in Estonia

10. Overall long-term expected rate of return of commercial real estate in Estonia (%) 25.06.2015 Commercial real estate rates of returns in Estonia 10 * Excl. retail real estate assets ** Excl. investors

11. Conclusion and discussion Both in theory and in practice one of the mostly suggested indirect assessment methods for expected rate of return is CAPM. In terms of Estonia it is suggested to use modified CAPM. However, based on current database, CAPM model allows little differentiation in terms of small market and among its sub-markets considering different spaces and regions. Therefore, a questionnaire among market experts will give more diversified overview of the commercial real estate market. Both CAPM and expert opinion assessments are a certain synthesis from historical data, experiences and current economic situation and its future forecast, only the perspectives are different. While in terms of CAPM there is used indirect, market-based historical aggregated data, then a single expert opinion is based mainly on smaller-size portfolio-specific factors, which are aggregated together. In all questionnaires, due to the real estate market and sample peculiarity, the answers were biased towards Tallinn (i.e., capital city in Estonia) region and office buildings. The lowest rates of return were in Tallinn region and in office buildings. According to the results of the survey, it is possible to conclude that for a typical investor investing into a typical commercial real estate in Estonia, the average long-term expected overall rate of return is 9% (i.e., a rate of return that should cover the investors’ investment expenses together with the compensations for the taken risk), which is also comparable with an expected unleveraged equity rate of return. 25.06.201511 Commercial real estate rates of returns in Estonia

12. Thank You for Your Attention! 25.06.201512 Commercial real estate rates of returns in Estonia