For the three months ended March 31, 2006, the Account’s total net return was 3.21% . This was 169 basis points higher than the return of 1.52% for the three months ended March 31, 2005. The Account’s strong performance in the first quarter 2006 period was primarily due to capital appreciation on the Account’s real estate-related assets, including interests in joint ventures and real estate equity securities, and an increase in interest rates earned on other marketable securities. The Account’s real estate holdings, including its joint venture holdings, which represent 75.70% of the Account’s total portfolio, had a gross total return of 3.59% . Its real estate equity securities, representing 4.30% of the Account’s total investments, had a gross total return of 11.62% . The market value of the Account’s real estate and real estate-related portfolios continued to benefit from robust economic conditions and the substantial amount of liquidity in the capital markets, which continues to be invested into real estate markets by institutional and foreign investors.
The Account’s net investment income, after deduction of all expenses, increased by 26% for the three months ended March 31, 2006 compared to the same period in 2005. This was due to 45.32% increase in total net assets, which included a 40.20% increase in real estate and joint ventures holdings.
The Account’s real estate holdings, including real estate joint ventures and limited partnerships, generated approximately 81% of the Account’s total investment income (before deducting Account level expenses) during the three months ended March 31, 2006, as compared to 90% for the three month period ended March 31, 2005. The decline is due to the effect of the increase of total net assets, a decline in the total percentage of the Account’s assets held in real estate and joint ventures, and the corresponding growth in non-real estate assets owned by the Account. As of March 31, 2006, the Account held 75.70% of its assets in real estate and joint ventures and 18.23% in non real estate-related marketable securities, compared to 80.46% and 14.50%, respectively, in the same period 2005.
Gross real estate rental income increased 35% in the three months ended March 31, 2006 compared with the same period in 2005. The increase in real estate income for the three months ended March 31, 2006 was due primarily to the increase in the number of properties owned by the Account. Income from real estate joint ventures and limited partnerships in the three months ended March 31, 2006 was $10,231,748 as compared to $16,201,553 for the same period in 2005. This 37% decrease reflected the fact that several of the properties owned by joint ventures are funding certain expenditures, including capital improvements, within the joint ventures, thereby decreasing joint venture distributions. Interest income on the Account’s interest earning marketable
securities for the three months ended March 31, 2006 and 2005 totaled $22,615,133 and $5,874,621, respectively. This increase was due to an increase in the amount of non-real estate assets held by the Account. In addition, interest rates earned on these investments were higher during the period ended March 31, 2006. Dividend income on the Account’s investments in real estate equity securities decreased to $3,090,872 from $4,743,394 for the three months ended March 31, 2006 and 2005, respectively.
Total property level expenses for the three months ended March 31, 2006 and 2005 were $89,097,158 and $61,749,591, respectively. The 44% increase in property level expenses during the three months ended March 31, 2006 was a result of the increased number of properties held in the Account and an increase in the overall leverage of the Account. The interest expense incurred in the first quarter 2006 was $15,920,768, as compared to $8,015,610 for the same period in 2005. Without the interest expense, the increase in property level expenses would have been 36% on a period-to-period comparison, which is relatively equivalent to the increase in real estate assets.
The Account also incurred expenses for the three months ended March 31, 2006 and 2005 of $6,592,265 and $4,014,442, respectively, for investment advisory services, $8,996,205 and $5,956,858, respectively, for administrative and distribution services and $2,822,385 and $1,876,878, respectively, for the mortality, expense risk and liquidity guarantee charges. The aggregate 55% increase in these expenses is a result of the larger net asset base in the Account and the increased costs associated with managing and administering the Account.
Net Realized and Unrealized Gains and Losses on Investments
The Account had net realized and unrealized gains on investments of $229,766,395 and $21,210,579 for the three months ended March 31, 2006 and 2005, respectively. The difference is primarily due to the substantial increase in net realized and unrealized gains on the Account’s real estate properties and debt; $114,348,636 compared to $28,176,422 for the three months ended March 31, 2006 and 2005, respectively. In addition, the Account had unrealized gains on joint ventures and limited partnerships of $66,185,795 in the first quarter of 2006, as compared to unrealized gains of $19,510,609 in the same period of 2005. This substantial increase in net realized and unrealized gains is due to the increase in market value of real estate assets owned by the joint ventures and appreciation of the Account’s interests in the limited partnerships. In addition, the Account’s marketable securities posted net realized and unrealized gains of $49,231,964 as of the three months ended March 31, 2006, as compared to net realized and unrealized losses of $26,476,452 for same period in 2005.
During the three months ended March 31, 2006, the Account had no real estate sales. The $629,643 of realized loss in the three months ended March 31, 2006 was due to post-closing adjustments made in the current period for properties sold in 2005.
Liquidity and Capital Resources
At March 31, 2006 and December 31, 2005, the Account’s liquid assets (i.e., real estate equity securities, commercial mortgage-backed securities, commercial paper, gov-
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ernment agency bonds and cash) had a value of $2,830,577,299 and $2,090,768,483, respectively. The increase in the Account’s liquid assets is primarily due to net positive inflow of transfers and premiums into the Account, which is in response to the strong relative performance of the Account.
During the three months ended March 31, 2006, the Account received $264,251,599 in premiums and $321,393,415 in net participant transfers from TIAA, the CREF Accounts and affiliated mutual funds, while, for the same period in 2005, the Account received $225,790,274 in premiums and $298,766,769 in net participant transfers. The Account’s liquid assets are 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
Effects of Inflation and Increased Operating Expenses
Inflation, along with increased insurance, utilities and security costs, may increase property operating expenses in the future. These increases in operating expenses are generally billed to tenants either through contractual lease provisions in office, industrial, and retail properties or through rent increases in apartment complexes. However, depending on how long any vacant space in a property remains unleased, the Account may not be able to recover the full amount of such increases in operating expenses.
Critical Accounting Policies
The financial statements of the Account are prepared in conformity with accounting principles generally accepted in the United States.
In preparing the Account’s 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.
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Management believes that the following policies related to the valuation of the Account’s assets reflected in the Account’s 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 Real Estate Joint Ventures:Real estate joint ventures are stated at the Account’s equity in the net assets of the underlying entities, which value their real estate holdings and mortgage notes payable at fair value.
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 or 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.
Accumulation and Annuity Fund:The Accumulation Fund represents the net assets attributable to participants in the accumulation phase of their investment. The Annuity Fund represents the net assets attributable to the participants currently receiving annuity payments. The net increase or decrease in net assets from investment operations is apportioned between the accounts based upon their relative daily net asset values. Once an Account participant begins receiving lifetime annuity income benefits, monthly payment levels cannot be reduced as a result of the Account’s adverse mortality experience. In addition, the contracts are required to stipulate the maximum expense
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charge that can be assessed, which is equal to 2.50% of average net assets per year. Accordingly, a small risk charge is paid by the Account to TIAA to assume these risks.
Accounting for Investments:Real estate transactions are accounted for as of the date on which the purchase or sale transactions for the real estate properties close (settlement date). Rent from real estate properties consists of all amounts earned under tenant operating leases, including base rent, recoveries of real estate taxes and other expenses and charges for miscellaneous services provided to tenants. Rental income is recognized in accordance with the billing terms of the lease agreements. The Account bears the direct expenses of the real estate properties owned. These expenses include, but are not limited to, fees to local property management companies, property taxes, utilities, maintenance, repairs, insurance and other operating and administrative costs. An estimate of the net operating income earned from each real estate property is accrued by the Account on a daily basis and such estimates are adjusted as soon as actual operating results are determined.
The Account has limited partnerships interests in various real estate funds (limited partnerships). The Account records its contributions as increases to the investments, and distributions from the investments are treated as either income or return of capital, as determined by the management of the limited partnerships. Unrealized gains and losses are calculated and recorded quarterly when the Account’s accounting records are compared to the fund’s financial statements and the Account’s equity values are adjusted.
Income from joint ventures is recorded based on the Account’s proportional interest in the income earned by the joint venture that has been distributed from the joint venture to the Account.
Securities transactions are accounted for as of the date the securities are purchased or sold (trade date). Interest income is recorded as earned and includes accrual of discount and amortization of premium. Dividend income is recorded on the ex-dividend date or as soon as the Account is informed of the dividend. Realized gains and losses on securities transactions are accounted for on the specific identification method.
Mortgage Notes Payable:Commencing in 2005, the Account separately reports mortgage notes payable at estimated market value. Estimated market values are based on the amount at which the liability could be settled (either transferred or paid back) in a current transaction exclusive of direct transaction costs. Different assumptions or changes in future market conditions could significantly affect estimated market value. At times, the Account may assume debt in connection with the purchase of real estate. For debt assumed, the Account allocates a portion of the purchases price to the below or above market debt and amortizes the premium or discount over the remaining life of the debt.
Foreign currency transactions and translation:Portfolio investments and other assets and liabilities denominated in foreign currencies are translated into U.S. dollars at the exchange rates prevailing at the end of the period. Purchases and sales of securities, income receipts and expense payments made in foreign currencies are translated into U.S. dollars at the exchange rates prevailing on the respective dates of the transac-
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tions. The effect of changes in foreign currency exchange rates on portfolio investments are included in the net realized and unrealized gains and losses on investments. Net realized gains and losses on foreign currency transactions include maturities of forward foreign currency contracts, disposition of foreign currencies, and currency gains and losses between the accrual and receipt dates of portfolio investment income and between the trade and settlement dates of portfolio investment transactions.
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Account’s real estate and real estate-related investments, which as of March 31, 2006 represented 77.30% of the Account’s investments (not including real estate-related marketable securities), expose the Account to a variety of risks. These risks include, but are not limited to:
General Real Estate Risk — The risk that the Account’s property values or rentaland occupancy rates could go down due to general economic conditions, a weakmarket for real estate generally, and changing supply and demand for certain typesof properties;
Appraisal Risk — The risk that the sale price of an Account property (i.e., the valuethat would be determined by negotiations between independent parties) might differ substantially from its estimated or appraised value, leading to losses or reducedprofits to the Account upon sale;
Risk Relating to Property Sales — the risk that the Account might not be able tosell a property at a particular time for its full value, particularly in a poor market.This might make it difficult to raise cash quickly and also could lead to Accountlosses; and
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As of March 31, 2006, 22.70% 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 (CMBS), 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 values, 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 topay 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 marketsand, 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, real estate equity securities 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 regis-
36
trant’s Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure. Under the supervision and participation 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, 2006. Based upon management’s review, the CEO and the CFO concluded that the registrant’s disclosure controls and procedures were effective as of March 31, 2006.
(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 are reasonably likely to materially affect, the registrant’s internal controls over financial reporting.
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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. UNREGISTERED SALES OF EQUITY 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 SECURITYHOLDERS.
Not applicable.
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Item 5. OTHER INFORMATION.
Not applicable
Item 6. 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 Endorsements3, |
| | | | Keogh Contract,4Retirement Select and Retirement Select Plus Contracts |
| | | | and Endorsements2and Retirement Choice and Retirement Choice Plus |
| | | | Contracts.4 |
| | | (B) | Forms of Income-Paying Contracts3 |
| |
| | (10) | (A) | Independent Fiduciary Agreement by and among TIAA, the Registrant, |
| | | | and Real Estate Research Corporation5 |
| | | (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)2and the Amendment thereto6 |
| | (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 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 the Account’s Post-Effective Amendment No. 2 to the 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 the Annual Report of the Account filed on March 15, 2006 (File No. 033-92990).
6- Previously filed and incorporated herein by reference to Pre-Effective Amendment No. 1 to the Account’s Registration Statement on Form S-1 filed May 1, 2006 (File No. 333-132582).
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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 12, 2006 | | | |
| |
| | | 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 12, 2006 | | | |
| |
| | | By: | /s/ Russell Noles |
| | |
|
| | | | Russell Noles |
| | | | Vice President and |
| | | | Acting Chief Financial Officer |
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