vacancies averaged 15.1% as of the end of the first quarter of 2005 as compared to 16.7% as of the same period in 2004. Similarly, the industrial market conditions continued to improve, with vacancies declining for three consecutive quarters. Torto Wheaton Research reported that the industrial market vacancies averaged 10.9% as of the end of the first quarter of 2005, compared to 11.7% as of the first quarter of 2004.
Apartment markets also showed modest improvement. M/PF Research reported that vacancy rates in institutional investment grade apartments averaged 5.6% as of the fourth quarter 2004, compared with 6.4% for the fourth quarter of 2003. (Data for the first quarter 2005 is not yet available. Because of seasonality in leasing, it is best to compare available data with data for the same quarter in the prior year.) The improvement over the course of the year was evidenced by four consecutive quarters of rent growth, including a 1.7% increase in the fourth quarter of 2004, The improvement in apartment markets was notable given that new and existing home sales were strong throughout the year, a pattern which continued during the first quarter of 2005.
Nationally, retail sales slowed during the first quarter of 2005. The April 2005 “Beige Book” reported that most districts reported improving retail sales overall, with several showing flat or disappointing results. This sluggish performance was generally attributed to weather and/or rising energy and gasoline prices. Available data, however, suggest that retail markets are well positioned to weather a modest decline in spending. Reis, Inc. reported that vacancies in shopping malls fell to 5.3% in the fourth quarter of 2004, which is the lowest level in three-and-a-half years. (Data for the first quarter of 2005 is not yet available.) Vacancies in neighborhood and community centers were 6.8% in the fourth quarter of 2004 compared with 6.9% in the 4th quarter of 2003. Absorption of available retail space during the fourth quarter of 2004 totaled nine million sq. ft., the highest in four years.
In total dollars the Account had a 15% net increase in net assets resulting from operations, $114,511,656 as of the end of the first quarter 2005, as compared to $99,622,233 as of the end of the first quarter 2004. The primary reason for this was a net increase in real estate income as a result of real estate acquisitions over the period.
For the three months ended March 31, 2005, the Account’s total net return was 1.52%. This was 49 basis points lower than the return of 2.01% for the three months ending March 31, 2004. The returns were lower in the 2005 period as compared to the same time in 2004 primarily due to a significant increase in the total net assets of the Acount, as well as the dampening effect of volatility experienced by its real estate equity securities holdings.
Income and Expenses
The Account’s net investment income, after deduction of all expenses, increased by 54% for the three months ended March 31, 2005 compared to the same period in 2004. This increase was due to a 50% increase in total net assets, which included a 57% increase in the Account’s real estate holdings, including joint ventures.
The Account’s real estate holdings including income from real estate joint ventures and limited partnerships generated approximately 90% of the Account’s total investment income (before deducting Account level expenses) during the three months ended March 31, 2005, as compared to 92% for the three month period ended March 31, 2004. The remaining portion of the Account’s total investment income was generated by investments in marketable securities.
Gross real estate rental income increased 55% in the three months ended March 31, 2005 compared with the same period in 2004. The higher real estate income for the three months ended March 31, 2005 was due primarily to the increase in the number of properties owned by the Account. Income from real estate joint ventures and limited partnerships was $16,201,553 and $10,052,991 for the three months ended March 31, 2005 and March 31, 2004, respectively. This 61% increase in joint venture income was primarily due to the timing of receipt of additional income from joint venture interests purchased in the fourth quarter of 2004, as well as increased leasing activity in several existing joint venture interests. Interest income on the Account’s marketable securities investments for the three months ended March 31, 2005 and 2004 totaled $5,874,621 and $1,772,803, respectively. This increase was due to a increase in the amount of non-real estate assets held by the Account. Dividend income on the Account’s investments in real estate equity securities increased to $4,743,394 from $3,954,036 for the three months ended March 31, 2005 and March 31, 2004, respectively.
Total property level expenses for the three months ended March 31, 2005 and 2004 were $61,749,591 and $37,297,038, respectively. The 65% increase in property level expenses during the three months ended March 31, 2005 reflected the increased number of properties held in the Account. In addition, in 2005 the Account incurred interest expense of $8,015,610 for mortgages on several of its real estate holdings.
The Account also incurred expenses for the three months ended March 31, 2005 and 2004 of $4,014,442 and $3,154,486, respectively, for investment advisory services, $5,956,858 and $4,027,093 respectively, for administrative and distribution services and $1,876,878 and $1,238,660, respectively, for the mortality, expense risk and liquidity guarantee charges. The 41% increase in these expenses is a result of the larger net asset base of the Account and the increased costs associated with managing the Account.
Net Realized and Unrealized Gains and Losses on Investments
The Account had net realized and unrealized gains of $21,210,579 and $39,194,907 for the three months ended March 31, 2005 and 2004, respectively. The decrease in net realized and unrealized gains was primarily due to net realized and unrealized losses on the Account’s marketable securities during the period ended March 31, 2005 of $26,476,452 compared to substantial net realized and unrealized gains on its marketable
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securities in the three-months ended March 31, 2004 of $25,484,713. The Account posted net realized and unrealized gains of $28,176,422 and losses of $13,583,646 on its real estate investments for the three months ended March 31, 2005 and 2004, respectively. The increase in net realized and unrealized gain for the real estate is due to the significant inflow of capital into the real estate market from institutional and other investors which has increased the pricing of real estate investments. The Account had unrealized gains on its real estate joint venture and limited partnership holdings of $19,510,609 for the three months ended March 31, 2005, as compared to unrealized gains of $27,293,840 for the same period in 2004. The decline in unrealized gains on the Account’s joint venture and limited partnership holdings is primarily due to a moderation in the appreciation of the real estate owned by the underlying entities.
During the three months ended March 31, 2005, the Account sold one property for $3,825,000.
Liquidity and Capital Resources
At March 31, 2005 and December 31, 2004, the Account’s liquid assets (i.e., its real estate equity securities, CMBSs, commercial paper, government securities and cash) had a value of $1,602,412,299 and $1,045,733,841, respectively. The increase in the Account’s liquid assets is primarily due to net positive inflow of transfers and premiums into the Account.
During the three months ended March 31, 2005, the Account received $225,790,274 in premiums and $298,766,769 in net participant transfers from TIAA, the CREF Accounts and affiliated mutual funds, while for the same period in 2004, the Account received $164,850,645 in premiums and $180,858,568 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, benefits 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 assets.
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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As of March 31, 2005, 19.16% of the Account’s investments were in market risk sensitive instruments, comprised entirely of marketable securities. These include real estate equity securities, commercial mortgage backed securities (CMBSs), and high-quality short-term debt instruments (i.e., commercial paper and government agency bonds). The 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. The registrant maintains a system of disclosure controls and procedures that are designed to ensure that information required to be disclosed in the registrant’s reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the registrant’s Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure. Under the supervision and partici-
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pation of the registrant’s management, including the registrant’s CEO and CFO, the registrant conducted an evaluation of the effectiveness of the registrant’s disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act as of March 31, 2005. Based upon the management’s review, the CEO and the CFO concluded that the registrant’s disclosure controls and procedures were effective as of March 31, 2005, except as noted below.
The registrant had previously consolidated its investments in certain joint ventures prior to December 31, 2004, as a result of the registrant’s majority financial interest in, and shared control of, those joint ventures. Based on consultations with Ernst & Young LLP in connection with its audit of the registrant’s 2004 financial statements, it was determined that the investments in certain joint ventures that had previously been treated as consolidated subsidiaries in 2003 and 2002 should instead be treated as investments in unconsolidated joint ventures, despite the fact that the registrant owned a majority financial interest in the entities. Ernst & Young LLP audited both the registrant’s 2003 and 2002 consolidated financial statements. The registrant’s 2003 and 2002 financial statements were restated in the registrant’s 2004 Form 10-K, filed in April 2005, to show the treatment of these investments consistently with the 2004 treatment, which reflected the registrant’s equity in the net assets and operations of the underlying entities. The interim 2004 financial statements contained herein have been restated to conform to the 2004 treatment. This restatement did not affect the registrant’s total net assets, net asset value per accumulation unit, net increase in net assets resulting from operations nor the Account’s total return, as previously reported in the Account’s interim 2004 financial statements.
Ernst & Young LLP determined, in connection with its audit of the registrant’s 2004 financial statements, that pursuant to Public Company Accounting Oversight Board’s Auditing Standard No. 2, a restatement of the registrant’s previously issued financial statements indicated a material weakness, notwithstanding the fact that the adjustment had no net impact on net assets and operations. This determination was reported to the registrant’s Audit Committee.
Subsequent to the review of its disclosure controls, the registrant revised its controls related to the presentation of joint ventures. The CEO and the CFO have concluded that the disclosure controls and procedures that are now in place at the registrant are effective to ensure compliance with the Exchange Act.
Management believes that this matter has been adequately addressed by the corrective action summarized herein.
(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, except as noted in Item 4(a) above.
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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.
Departure of Directors or Principal Officers; Election of Directors;
Appointment of Principal Officers.
On May 10, 2005, TIAA-CREF issued a press release announcing that Elizabeth A. Monrad, Executive Vice President and Chief Financial Officer of Teachers Insurance and Annuity Association of America (“TIAA”), has requested, and been granted, an unpaid leave of absence without day-to-day responsibility at the company. On May 9, 2005, Russell Noles, currently Vice President, Internal Audit for TIAA, was appointed to serve as acting Chief Financial Officer during Ms. Monrad’s leave of absence. The text of the press release is included as Exhibit 99 to this Form 10-Q. Mr. Noles, age 46, has served as Vice President, Internal Audit for TIAA since July 2004. From November 2001 to June 2004, he was Vice President of Internal Audit for the St. Paul Companies (which became St. Paul Travelers Company, upon a merger with Travelers Property & Casualty, in April 2004). Prior to that, he was Vice President of Internal Audit for US WEST Inc./Qwest, where he was employed since 1984.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS
| | | (3) | (A) | | Charter of TIAA (as amended) 1 |
| | | | (B) | | Bylaws of TIAA (as amended) 1 |
| | | | | | |
| | | (4) | (A) | | Forms of RA, GRA, GSRA, SRA, IRA Real Estate Account Endorsements,3 Keogh Contract,4 Retirement Select and Retirement |
| | | | | | |
| |
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| | | | | | |
| | | (4) | (A) | | Select Plus Contracts and Endorsements2 and Retirement Choice and Retirement Choice Plus Contracts. 4 |
| | | | (B) | | Forms of Income-Paying Contracts 3 |
| | | | | | |
| | | (10) | (A) | | Independent Fiduciary Agreement by and among TIAA, the Registrant, and The Townsend Group,5 as
amended 6 |
| | | | (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) 3 |
| | | | (C) | | Distribution and Administrative Services Agreement by and between TIAA and TIAA-CREF Individual & Institutional Services, Inc. (as amended) (filed previously as Exhibit (1)) 2 |
| | | | | | |
| | | (31) | Rule 13a-15(e)/15d-15(e) Certifications |
| | | | |
| | | (32) | Section 1350 Certifications |
| | | | |
| | | (99) | Press Release |
| |
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 December 22, 2004 (File No. 333-121493).2 - 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).
3 - 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).
4 - Previously filed and incorporated herein by reference to the Account’s Post-Effective Amendment No. 1 to the Registration statement on Form S-1 filed May 2, 2005 (File No. 333-121493).
5 - 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).
6 - 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).
(b) REPORTS ON 8-K. The Account filed a report on Form 8-K on March 3, 2005 under Items 4.01 and 9.01 of the form with respect to a change in the Account’s certifying accountant. After the end of the quarter, the Account filed a report on Form 8-K on May 6, 2005 under Items 4.01 and 9.01 of the form with respect to appointment and engagement of the Account’s certifying accountant.
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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: May 13, 2005
| | 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: May 13, 2005
| | By: | | /s/ Russell Noles |
| | | |
|
| | | | Russell Noles |
| | | | Vice President and |
| | | | Acting Chief Financial Officer |
| | | | |
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