The Account’s total net return was 8.90% for the nine months ended September 30, 2004 and 5.83% for the nine months ended September 30, 2003. This increase in the Account’s total return was primarily due to substantial increases in the market value of the Account’s real estate holdings.
The Account’s net investment income after deduction of all expenses was 30% higher for the nine months ended September 30, 2004 compared to the same period in 2003. This increase was primarily due to a 45% increase in total net assets and the 64% increase in real estate holdings over the same period.
The Account’s real estate holdings, including unconsolidated joint venture investments, generated approximately 91% and 94% of the Account’s total investment income (before deducting Account level expenses) during the nine months ended September 30, 2004 and 2003, respectively. The remaining portion of the Account’s total investment income was generated by marketable securities investments.
Gross real estate rental income increased approximately 32% in the nine months ended September 30, 2004, as compared to the same period in 2003. This increase was due to the increased number of properties owned by the Account as of September 30, 2004 as compared with September 30, 2003. Income from unconsolidated real estate joint ventures was $12,443,808 for the nine months ended September 30, 2004, as compared with $14,620,644 for the same period in 2003. This decrease in unconsolidated joint venture income was partially due to the increase in leverage on one of the regional malls. Interest income on the Account’s marketable securities investments increased to $9,319,462 for the nine months ended September 30, 2004 from $4,402,372 for the nine months ended September 30, 2003 due to the increase in the amount of non-real estate assets held by the Account. Dividend income on the Account’s REIT investments increased to $15,208,315 for the nine months ended September 30, 2004 from $7,499,103 for the nine months ended September 30, 2003. The increase was primarily due to the strong performance by the Account’s REIT holdings.
Total property level expenses for the nine months ended September 30, 2004 and 2003 were $150,738,045 and $107,046,155, respectively. This 41% increase in property level expenses reflected the increased number of investments in real estate by the Account (76 properties as of September 30, 2003 compared to 101 properties as of September 30, 2004). In addition, during the nine months ended September 30, 2004, the Account incurred interest expense of $2,695,856 related to the mortgages on a portfolio of storage facilities in which the Account has a 75% joint venture interest and an industrial property purchased in the third quarter 2004.
The Account also incurred expenses for the nine months ended September 30, 2004 and 2003 of $10,225,925 and $9,370,775 respectively, for investment advisory services, $11,166,357 and $11,087,140, respectively, for administrative and distribution services and $4,182,234 and $2,916,020, respectively, for the mortality, expense risk and liquidity guarantee charges. Such expenses increased primarily as a result of the larger net asset base in the Account and increased costs associated with managing and administering the Account.
The Account had net realized and unrealized gains on investments of $274,082,980 for the nine months ended September 30, 2004, as compared with net realized and unrealized gains on investments of $33,488,062 for the nine months ended September 30, 2003. The increase in net realized and unrealized gains is primarily due to the substantial net unrealized gain on the Account’s real estate properties of $131,871,469 for the nine months ended September 30, 2004 as compared to net unrealized losses for the nine months ended September 30, 2003 of $13,695,618. In addition, the Account had an unrealized gain on its unconsolidated joint venture holdings of $113,240,871 for the nine months ended September 30, 2004 as compared to unrealized gain of $26,675,169 for the nine months ended September 30, 2003. The substantial net gains in the nine month period ending September 30, 2004 are due to the increase in market value of several real estate properties, including the value of three regional malls in which the Account owns an unconsolidated joint venture interest. The Account’s marketable securities for the nine months ended September 30, 2004 had net realized and unrealized gains totaling $28,970,640, as compared with net realized and unrealized gains of $20,508,511, for the nine months ended September 30, 2003.
Results from Discontinued Operations
During the nine months ended September 30, 2004, the Account did not sell any properties but moved five properties to the held for sale category. During the nine months ended September 30, 2003, the Account sold two properties and had five properties moved to the held for sale category. The investment income and unrealized gains for the nine months ended September 30, 2004 related to the properties held for sale, as well as the investment income and unrealized and realized gains and losses for the properties sold or held for sale during 2003, were removed from continuing operations in the accompanying consolidated financial statements and were classified as discontinued operations. The income for the nine months ended September 30, 2004 from the properties held for sale during 2004, consisted of rental income of $6,374,458 less operating expenses and real estate taxes of $3,937,105, resulting in a net investment income of $2,437,353. The income for the nine months ended September 30, 2003 from the property sold during 2003 and the properties held for sale during 2003, consisted of rental income of $22,641,742 less operating expenses and real estate taxes of $8,655,224, resulting in net investment income of $13,986,518. The net realized and unrealized gain on discontinued operations for the nine month period ended September 30, 2004 and 2003 was $7,714,562 and $9,040,768, respectively. At the time of sale, the properties sold during the nine months ended September 30, 2003 had a cost of $154,626,452 and the proceeds of sale were $187,225,000, resulting in a net realized gain of $32,598,548.
Three Months Ended September 30, 2004 compared to
Three Months Ended September 30, 2003
Results from Continuing Operations
Performance
For the three months ended September 30, 2004, the Account’s total net return was 4.48%. This was 186 basis points higher than the return of 2.62% for the three months ended September 30, 2003. The returns were higher in the 2004 period as compared to the same time in 2003 primarily due to the strong performance of the Account’s real estate and REIT holdings. The Account’s net investment income, after deduction of all expenses, was $80,672,232 for the three months ended September 30, 2004 and $60,602,380 for the three months ended September 30, 2003, a 33% increase.
The Account’s real estate holdings including income from unconsolidated joint ventures generated approximately 89% and 92% of the Account’s total investment income (before deducting Account level expenses) during the three months ended September 30, 2004 and 2003. The remaining portion of the Account’s total investment income was generated by investments in marketable securities.
Gross real estate rental income increased 33% in the three months ended September 30, 2004 compared with the same period in 2003. The higher real estate income for the three months ended September 30, 2004 was due primarily to the increase in the number of properties owned by the Account. Income from uncon-
25
solidated real estate joint ventures was $4,923,248 and $4,468,598 in the three months ended September 30, 2004 and September 30, 2003, respectively. Interest income on the Account’s marketable securities investments for the three months ended September 30, 2004 and 2003 totaled $4,463,220 and $2,096,425, respectively. This increase was due to an increase in the amount of non-real estate assets held by the Account. Dividend income on the Account’s investments in REITs increased to $5,612,876 from $3,381,215 for the three months ended September 30, 2004 and September 30, 2003. The increase was primarily due to the strong performance by the Account’s REIT holdings.
Total property level expenses for the three months ended September 30, 2004 and 2003 were $52,412,388 and $36,901,495, respectively. The 42% increase in property level expenses during the three months ended September 30, 2004 reflected the increased number of properties held in the Account and the interest expense of $1,328,250 for mortgages on a portfolio of storage facilities and an industrial property owned by the Account.
The Account also incurred expenses for the three months ended September 30, 2004 and 2003 of $4,322,840 and $3,635,544, respectively, for investment advisory services, $3,952,538 and $3,680,035, respectively, for administrative and distribution services and $1,570,186 and $1,074,003, respectively, for the mortality, expense risk and liquidity guarantee charges. Such expenses increased primarily as a result of the larger net asset base in the Account and increased costs associated with managing and administering the Account.
The Account had net realized and unrealized gains of $194,022,717 and $51,369,629 for the three months ended September 30, 2004 and 2003, respectively. The difference was primarily due to a substantial increase in the aggregate market value of the Account’s real estate holdings in the three-months ended September 30, 2004 as compared to lesser increases in market values in the same period in 2003. The Account posted net unrealized gains of $112,635,940 and of $19,557,920 on its real estate investments for the three months ended September 30, 2004 and 2003, respectively. The Account posted total realized and unrealized gains on its marketable securities of $19,444,969 during the third quarter of 2004, as compared to net realized and unrealized gains on its marketable securities of $10,931,378 during the third quarter of 2003. The Account had unrealized gain on its joint venture holdings of $61,941,808 for the three months ended September 30, 2004, as compared to unrealized gains of $20,880,331 for the same period 2003, which can be attributed primarily to an increase in value of the three regional malls in which the Account owns a 50% joint venture interest.
Results from Discontinued Operations
At September 30, 2004, the Account had five real estate properties in the held for sale category. During the three months ended September 30, 2003, the Account sold one property and moved five properties into the held for sale category. The investment income and realized and unrealized gains for the three months ended September 30, 2004 and 2003 relating to the properties moved to the held for sale category was removed from continuing operations and classified as discontinued operations. The income from the properties during the third quarter 2004 consisted of rental income of $2,052,569 less operating expenses and real estate taxes totaling $1,146,628 resulting in net investment income in the amount of $905,941. The income from these properties during the third quarter 2003 consisted of rental income of $5,835,692 less operating expenses and real estate taxes totaling $3,045,210 resulting in net investment income of $2,790,482. The net realized and unrealized gain/loss on discontinued operation for the three month period ended September 30, 2004 and 2003 was a gain of $6,400,737 and a loss of $767,796, respectively.
Liquidity and Capital Resources
At September 30, 2004 and 2003, the Account’s liquid assets (i.e., its REITs, CMBSs, commercial paper, government securities and cash) had a value of $1,223,928,053 and $1,173,529,230, respectively. The increase in the Account’s liquid assets is primarily due to net positive inflow of transfers and premiums
26
into the Account. In addition, there was an increase in the value of the Account’s REIT holdings during the same period.
During the nine months ended September 30, 2004, the Account received $524,415,992 in premiums and $808,836,329 in net participant transfers from TIAA, the CREF Accounts and affiliated mutual funds, while for the same period in 2003, the Account received $366,878,102 in premiums and $293,842,836 in net participant transfers. The Account’s liquid assets, exclusive of the REITs, will continue to be available to purchase additional suitable real estate properties and to meet expense needs and redemption requests (i.e., cash withdrawals or transfers). In the unlikely event that the Account’s liquid assets and its cash flow from operating activities and participant transactions are not sufficient to meet its cash needs, including redemption requests, TIAA’s general account will purchase liquidity units in accordance with TIAA’s liquidity guarantee to the Account.
The Account, under certain conditions more fully described in the Account’s prospectus, may borrow money and assume or obtain a mortgage on a property — i.e., to make leveraged real estate investments. Also, to meet any short-term cash needs, the Account may obtain a line of credit whose terms may require that the Account secure a loan with one or more of its properties. The Account’s total borrowings may not exceed 20% of the Account’s total net asset value.
Critical Accounting Policies
The consolidated financial statements of the Account are prepared in conformity with accounting principles generally accepted in the United States.
In preparing the Account’s consolidated financial statements, management is required to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Management bases its estimates on historical experience and assumptions that are believed to be reasonable under the circumstances — the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
Management believes that the following policies related to the valuation of the Account’s assets reflected in the Account’s consolidated financial statements affect the significant judgments, estimates and assumptions used in preparing its financial statements:
Valuation of Real Estate Properties: Investments in real estate properties are stated at fair value, as determined in accordance with procedures approved by the Investment Committee of the TIAA Board of Trustees. Fair value for real estate properties is defined as the most probable price for which a property will sell in a competitive market under all conditions requisite to a fair sale. Determination of fair value involves subjective judgment because the actual market value of real estate can be determined only by negotiation between the parties in a sales transaction. The Account’s properties are initially valued at their respective purchase prices (including acquisition costs). Subsequently, independent appraisers value each real estate property at least once a year. TIAA’s appraisal staff performs a valuation of each real estate property on a quarterly basis and updates the property value if it believes that the value of the property has changed since the previous valuation or appraisal. The appraisals are performed in accordance with Uniform Standards of Professional Appraisal Practices (USPAP), the real estate appraisal industry standards created by The Appraisal Foundation. Real estate appraisals are estimates of property values based on a professional’s opinion.
Valuation of Unconsolidated Joint Ventures: Real estate joint ventures (in which the Account does not have a controlling interest and therefore are not consolidated) are stated at the Account’s equity in the net assets of the underlying entities, which value their real estate holdings at fair value.
27
Valuation of Marketable Securities: Equity securities listed or traded on any national market or exchange are valued at the last sale price as of the close of the principal securities exchange on which such securities are traded or, if there is no sale, at the mean of the last bid and asked prices on such exchange. Debt securities, other than money market instruments, are valued at the most recent bid price or the equivalent quoted yield for such securities (or those of comparable maturity, quality and type). Money market instruments, with maturities of one year or less, are valued in the same manner as debt securities are derived from a pricing matrix that has various types of money market instruments along one axis and various maturities along the other. Portfolio securities and limited partnership interests for which market quotations are not readily available are valued at fair value as determined in good faith under the direction of the Investment Committee of the TIAA Board of Trustees and in accordance with the responsibilities of the Board as a whole.
Forward-Looking Statements
Some statements in this report which are not historical facts may be “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements about our expectations, beliefs, intentions or strategies for the future, and the assumptions underlying these forward-looking statements. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from historical experience or management’s present expectations.
Caution should be taken not to place undue reliance on management’s forward-looking statements, which represent management’s views only as of the date this report is filed. Neither management nor the Account undertake any obligation to update publicly or revise any forward-looking statement, whether as a result of new information, future events or otherwise.
28
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As of September 30, 2004, 17.83% of the Account’s investments were in market risk sensitive instruments, comprised entirely of marketable securities. These include real estate investment trusts (REITs), commercial mortgage-backed securities (CMBSs), and high-quality short-term debt instruments (i.e., commercial paper). The Consolidated Statement of Investments for the Account sets forth the terms of these instruments, along with their fair value, as determined in accordance with procedures described in Note 1 to the Account’s financial statements. Note that the Account does not currently invest in derivative financial instruments.
The Account’s investments in marketable securities are subject to the following general risks:
| • | | financial risk—for debt securities, the possibility that the issuer won’t be able to pay principal and interest when due, and for common or preferred stock, the possibility that the issuer’s current earnings will fall or that its overall financial soundness will decline, reducing the security’s value. | |
• | | market risk—price volatility due to changing conditions in the financial markets and, particularly for debt securities, changes in overall interest rates. | |
• | | interest rate volatility, which may affect current income from an investment. | |
In addition, mortgage-backed securities are subject to prepayment risk — i.e., the risk that borrowers will repay the loans early. If the underlying mortgage assets experience greater than anticipated payments of principal, the Account could fail to recoup some or all of its initial investment in these securities. The market value of these securities is also highly sensitive to changes in interest rates. Note that the potential for appreciation, which could otherwise be expected to result from a decline in interest rates, may be limited by any increased prepayments.
In addition to these risks, REITs and mortgage-backed securities are subject to many of the same general risks inherent in real estate investing, making mortgage loans and investing in debt securities. For more information on the risks associated with all of the Account’s investments, see the Account’s most recent prospectus.
Item 4. CONTROLS AND PROCEDURES.
(a) Evaluation of disclosure controls and procedures. An evaluation was performed as of September 30, 2004, under the supervision of the registrant’s management, including the principal executive officer and principal financial officer, of the effectiveness of the design and operation of the registrant’s disclosure controls and procedures. Based on that evaluation, the registrant’s management, including the principal executive officer and principal financial officer, concluded that the registrant’s disclosure controls and procedures were effective for this quarterly reporting period.
(b) Changes in internal controls over financial reporting. There have been no significant changes in the registrant’s internal controls over financial reporting that occurred during the registrant’s last fiscal quarter that materially affected, or is reasonably likely to materially affect, the registrant’s internal controls over financial reporting.
29
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.
There are no material current or pending legal proceedings that the Account is a party to, or to which the Account’s assets are subject.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Not applicable.
Item 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.
Not applicable.
Item 5. OTHER INFORMATION.
Not applicable.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
| (a) | EXHIBITS |
| | (3) | (A) | Charter of TIAA (as amended) * |
| | | (B) | Bylaws of TIAA (as amended) * |
| | (4) | (A) | Forms of RA, GRA, GSRA, SRA, IRA Real Estate Account Endorsements2 , Keogh Contract3 and Retirement Select and Retirement Select Plus Contracts and Endorsements1 |
| | | (B) | Forms of Income-Paying Contracts2 |
| | (10) | (A) | Independent Fiduciary Agreement by and among TIAA, the Registrant, and The Townsend Group3, as amended5 |
| | | (B) | Custodial Services Agreement by and between TIAA and Morgan Guaranty Trust Company of New York with respect to the Real Estate Account (Agreement assigned to Bank of New York, January 1996)2 |
| | | (C) | Distribution and Administrative Services Agreement by and between TIAA and TIAA-CREF Individual & Institutional Services, Inc. (as amended) (filed previously as Exhibit (1))1 |
| | (31) | Rule 13a-15(e)/15d-15(e) Certifications |
| | (32) | Section 1350 Certifications |
|
1 | | Previously filed and incorporated herein by reference to the Account’s Pre-Effective Amendment No. 1 to the Registration statement on Form S-1 filed April 29, 2004 (File No. 333-113602). | |
| 2 | | Previously filed and incorporated herein by reference to Post-Effective Amendment No. 2 to the Account’s Registration Statement on Form S-1 filed April 30, 1996 (File No. 33-92990). | |
30
| 3 | | | | Previously filed and incorporated herein by reference to Post-Effective Amendment No. 6 to the Account’s Registration Statement on Form S-1 filed April 26, 2000 (File No. 333-22809). |
| 4 | | | | Previously filed and incorporated herein by reference to the Account’s Post-Effective Amendment No. 2 to the Registration statement on Form S-1 filed April 29, 2002 (File No. 333-83964). |
| 5 | | | | Previously filed and incorporated herein by reference to the Account’s Post-Effective Amendment No. 2 to the Registration statement on Form S-1 filed April 29, 2003 (File No. 333-83964). |
| * | | | | Filed herewith. |
| | | (b) | | REPORTS ON 8-K. The Account did not file any reports on Form 8-K during the period. |
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| DATE: November 4, 2004 | |
| | TIAA REAL ESTATE ACCOUNT |
| | By: | TEACHERS INSURANCE AND
ANNUITY ASSOCIATION OF AMERICA |
| | By: | /s/ Herbert M. Allison, Jr. |
| | |
|
| | | Herbert M. Allison, Jr.
Chairman of the Board, President
and Chief Executive Officer |
| | | |
| DATE: November 4, 2004 | By: | /s/ Elizabeth A. Monrad |
| | |
|
| | | Elizabeth A. Monrad
Executive Vice President and
Chief Financial Officer |
32
