Real Estate Quarterly Highlights Third Quarter 2011...The NCREIF Property Index (NPI) for the four quarter period ending September 2011 posted a 16.1% total return vs. 16.7% for the

Quarterly Highlights 1

What’s Inside

Real Estate Investment Quarterly Highlights features overviews of:

§§ U.S. Real Estate

§§ Financial Markets

§§ Apartment Market

§§ Industrial Market

§§ Office Market

§§ Retail Market

TIAA-CREF Asset Management

Real Estate Quarterly HighlightsThird Quarter 2011


Outlook For Real Estate Investment PerformancePositive Forces include the healthy ongoing recovery in NCREIF-NPI property values, improving commercial property fundamentals, nine consecutive quarters of GDP growth, continuing low Treasury yields and available financing for property purchases but not yet for new construction.

§§ The pace of U.S. economic growth improved during the third quarter to 2.5% compared with less than 1% during the first half of the year. Bright spots include the ongoing strong pace of business investment in equipment and software and a pickup in household spending during 3Q11. Business investment spending is supporting strong corporate profits growth with domestic profits of non-financial corporations increasing 80% in 2Q11 vs. 20% in 1Q11. However, profits of financial corporations declined sharply. Third quarter profits data have not yet been reported.

§§ Non-agricultural employment grew by 80,000 in October and 158,000 in September but the unemployment rate remains stuck at 9.0%. Private sector employment growth was even stronger with a September-October gain of almost 300,000 offsetting a 57,000 decline in government employment. These jobs numbers are not strong but they are an improvement compared with 2010. Through October, 1.256 million jobs have been added versus 940,000 in all of 2010.

§§ Personal consumption expenditure (PCE) spending grew at a 2.4% pace in 3Q11, reversing the troubling 0.7% rate of increase in 2Q11. Spending on durable goods jumped 4.1% following a 5.3% decline in the second quarter; spending on services increased at a 3.0% rate. Except for the dip in 2Q11, PCE spending has been healthy throughout 2010 and 2011.

Negative Forces include the ongoing drag on growth from domestic forces, including anemic job growth, a moribund housing market, and shrinking government spending at all levels, and global forces, particularly the Euro-zone debt crisis which has undermined business and consumer confidence.

§§ Global financial markets were roiled by sharply higher volatility in 3Q11 reflecting the combined effects of S&P’s downgrade of the U.S. to AA+ from AAA in the aftermath of the political drama surrounding a routine vote to raise the debt ceiling. The episode highlighted the long-term structural deficit issues that the U.S. faces juxtaposed against the ongoing turmoil in the Euro-zone over government debt. By the end of October, markets reversed a portion of the damage but stock values remain lower and bond spreads were wider for the year to date. The Euro-zone crisis remains the chief threat to the global economy.

§§ Rocky financial markets and economic uncertainty did not go unnoticed among investors in U.S. commercial real estate. Transactions in 3Q were down 14% from 2Q. At the same time, valuation cap rates continued to tighten though the decline at the longer-end of the Treasury curve might be disguising a moderation in risk appetite.

§§ Prospects for some near-term fiscal policy stimulus for the U.S. economy have faded despite the roll-out of the President’s package of proposals in early September. Congress remains in stalemate, leaving monetary policy as the only treatment for the dragging recovery. Odds of a new recession to begin sometime over the next 12 months are holding at about 30% and reflect both the fragility of the domestic economy and the threat of a shock from the Euro-zone.

Introduction


U.S. commercial real estate investment performance was only minimally affected by the financial markets turmoil and economic growth uncertainties that grabbed headlines in the third quarter. NCREIF-NPI total return clocked in at 16.1% for the four quarters ending September with the income component at 6.3% and the capital appreciation component at 9.4%. While stunning, these results are backward looking by virtue of the appraisal methodologies that produce them. More timely information is contained in the subset of NCREIF-NPI properties that changes hands each quarter. For these properties, cap rates widened slightly in 3Q to 6.55% from 6.51% the prior quarter. More importantly, the cap rate spread versus the 10-year Treasury widened significantly to 415 bps from 332 bps in 2Q. Another effect of the turmoil is perhaps the easing in property sales volume which dropped 14% in 3Q from 2Q’s volume. Finally, pricing of REIT stocks suggests that the values of the underlying properties reached a plateau in the spring bringing them to within 10% of prior peaks, but with little change since; this is according to the REIT specialty firm Green Street Advisors.

What is not seen in these various metrics for commercial real estate is the intense volatility that has pervaded stock and bond markets. The Russell 3000 U.S. stock index ended October down only 2% from last year’s close, however, its standard deviation jumped from 16 percentage points for the January-through-July period to 28 percentage points for August-through-October. The absence of heightened volatility does not mean that commercial real estate is immune from the economic and financial uncertainties roiling the more liquid markets. It does mean that commercial real estate investors are less exposed to the minute-by-minute psychological stresses that flow from public market trading. The ongoing weak U.S. economic recovery is prolonging the recovery of occupancy and NOI in industrial and office property types. The heightened risk of weaker or even negative economic growth in 2012 will further slow the pace of recovery in commercial real estate, especially the lagging office sector. The better outcome envisioned in the Blue Chip consensus outlook for 2.1% GDP growth in 2012 is still a weak foundation for commercial real estate recovery; the saving feature is the ongoing minimal construction activity that allows even weak economic growth to restore space market equilibrium. Recent indicators are supporting the consensus outlook; retailers are said to be expecting solid gains in holiday sales with tight inventories pointing to a profitable season; S&P corporate earnings for the third quarter are beating estimates and pointing to ongoing capacity for business investment spending; job openings reported in the official “JOLTS” survey are at the highest level since August 2008 before the financial crash suggesting that strong corporate earnings are finally bolstering hiring plans.

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Real Estate Investment Quarterly Highlights: Third Quarter 2011 is prepared by TIAA-CREF Asset Management and represents the views of TIAA-CREF’s Global Real Estate Group as of November 2011. These views may change in response to changing economic and market conditions. Past performance is not indicative of future results. The material is for informational purposes only and should not be regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons. Data is as of 9/30/2011 unless noted otherwise.

Real estate investing risks include fluctuations in property values, higher expenses or lower income than expected, higher interest rates which affect leveraged investments, and potential environmental problems and liability.

TIAA-CREF Asset Management provides investment advice and portfolio management services to the TIAA-CREF group of companies through the following entities: Teachers Advisors, Inc., TIAA-CREF Investment Management, LLC, and Teachers Insurance and Annuity Association® (TIAA®). Teachers Advisors, Inc., is a registered investment advisor and wholly owned subsidiary of Teachers Insurance and Annuity Association (TIAA).

© 2011 Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF), 730 Third Avenue, New York, NY 10017

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Conclusions

Economic and Real Estate Cycles


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Total Returns ModerateThe NCREIF Property Index (NPI) for the four quarter period ending September 2011 posted a 16.1% total return vs. 16.7% for the prior period ending June 2011. Income returns edged down to 6.3% versus 6.4% previously. Capital returns were 9.4% compared to 9.8% previously. While returns were still healthy, the dip is a reflection of the moderation in economic activity and the slower improvement in real estate market fundamentals during the quarter.

Valuation and Transaction Cap Rates Decline Further AgainCap rates implied in NCREIF-NPI property valuations declined for the sixth consecutive quarter to an average of 6.07% for the four quarters ending September 2011 vs. 6.24% for the prior four quarter period. Value-weighted cap rates fell to 5.57% vs. 5.79% previously. Both are indicative of investor appetite for top quality properties. Value- and equal-weighted cap rates are still 50+ basis points above their 3Q08 lows, but the spread is narrowing each quarter. Transactional cap rates averaged 6.5% in 3Q11 but are 100+ bps higher than their 2Q07 low.

All Markets are “Back in Black”Total returns were positive in all 102 markets tracked for the four quarter period ending September 2011, with 81 markets posting double digit returns. One quarter of all markets performed above the national average with top performers including several Western markets: Tacoma, Riverside, San Francisco, Napa and San Jose, all with total returns in excess of 20%. Cleveland and Palm Bay were laggards once again, and were joined by Manchester and Santa Cruz, the weakest performer.

Transactional Volumes Remain HealthyTransactional volume totaled $50 billion in 3Q11, up 38% from the prior year but down 14% from 2Q11. However, year-to-date 2011 volume already exceeds 2010 totals. The moderation in sales was attributable to concerns about the slowing U.S. and global economies and uncertainty resulting from the European debt crisis. Still, cap rates declined 25 basis points for apartments and suburban office and held firm for other property types according to Real Capital Analytics. Investors remained focused on New York, LA, DC, San Francisco et al., but interest in secondary and tertiary markets has picked up.

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RCA Transactions

Sources: CBRE-Econometric Advisors, NCREIF, RCA, Bloomberg and TIAA Research

U.S. Real Estate Performance Overview

NCREIF Returns for All Property Types

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Russell 3000 ML-Developed Mkts Blmbrg-Emrg Mkts

Stocks Down vs. 2Q with High VolatilityGlobal stock markets retreated in the third quarter following S&P’s downgrade of U.S. sovereign debt from AAA to AA+. The move had virtually no negative impact on the U.S.’s capacity to sell bonds but served as symbolic punishment for the political drama that surrounded a routine Congressional vote on raising the debt ceiling and the political paralysis surrounding all economic policy. When combined with the daily ups and downs related to the Euro-zone crisis and the prospect that China’s growth rate might be moderating, the markets just couldn’t keep it together. The Russell 3000 dropped 16% in 3Q but then added back 11% in October. Developed non-U.S. markets dropped 29% but added back 13%. Emerging markets dropped 23% and added back 13%. Through October, the Russell had only a 2% drop compared with the 13% and 15% drops for developed non-U.S. and emerging markets, respectively. But, more important is the doubling in stock market volatility since August.

Credit Spreads Rock ‘n Roll TooSpread widening during the third quarter affected all credit grades rather proportionally, with a rough 50% increase in spreads between June 30 and September 30. In October, high yield B-corporate spreads reversed and tightened more than proportionally ending the month at 715 bps versus 571 bps on June 30. Investment grade BBB-corporates ended October at 273 bps versus 203 bps in June and emerging markets spreads settled at 624 bps versus 466 bps in June. Spread widening over these weeks certainly points to a more cautious risk appetite among investors. However, the degree of spread widening has so far been minor when compared with the spread explosion in 2008-09, as shown in the credit spreads chart.

Treasury Twist is a Golden OldieThe FOMC responded to the market turmoil and the first half’s weak U.S. economic growth by reviving the 1960’s “twist” policy which is aimed at pushing down the longer end of the Treasury curve by buying longer-dated Treasury securities. So far, that effort has been associated with a significant drop in the 10-year Treasury from 3.16% on June 30 to a low of 1.72% on September 22. The 10-year Treasury rate has been trading in the 2% +/- range since then. The 30-year Treasury rate has dropped similarly from 4.37% on June 30 to around 3% currently. By these measures, “operation new twist” has succeeded but it is impossible to say how much of the decline might be due to safe haven flows out of riskier investments and how much lower Treasury rates might really be benefiting the U.S. economy.

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Financial Markets Overview

Data Through 10/31

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Apartment Properties Continue to Lead Apartment properties posted the highest total return among the major property types for the sixth consecutive quarter at 18.6% for the four quarter period ending September 2011. However, returns were down from 21.4% for the prior four quarter period. Income return was 5.6% vs. 5.7% previously. Capital appreciation was the strongest among the major property types at 12.5%. Sector returns have slowed from their torrid pace due to more moderate but healthy capital appreciation.

Valuation Cap Rates Decline AgainCap rates implied in NPI apartment valuations averaged 5.52% for the four quarters ending September 2011 vs. 5.55% for the prior four quarter period. The modest quarterly decline in cap rates may be suggesting that the bottom is near as spreads to low cost Government Sponsored Enterprise financing narrow. Sales volume increased 31% compared with 3Q10 but slipped 3% vs. 2Q11 totals. Still, cap rates fell 25 basis points. Sector NOI grew a whopping 11.7% following a 9.3% increase in the prior four quarters. Occupancy gains, healthy rent growth, and minimal concessions are driving NOI growth.

Apartment Market Fundamentals Remain Solid U.S. apartment vacancies declined to 5.0% in 3Q11 vs. 5.8% in 3Q10. (Year-over-year comparisons are used in the apartment sector to account for leasing seasonality.) Apartment vacancy rates declined in 56 of the 63 markets tracked by CBRE-EA with most markets sporting vacancy rates that are below the national average. Apartment markets have benefited from a decline in the homeownership rate as a result of the housing debacle coupled with growth in demand as a result of modest job growth.

Development Ramping UpConstruction is rebounding off the lows recorded in 2009-2010 with completions in September running at a 210,000 unit annual pace vs. 100,000 earlier in the year. During the boom, 350,000+ units were delivered. The pace is likely to continue as multifamily starts were running at a 230,000 annual pace in September. Sector prospects remain promising through 2012 as it will take time for new projects to be completed.

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Apartment Construction


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Apartment Market Overview

Current Vacancy Below U.S. Current Vacancy Above U.S. U.S.

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Industrial Sector Jumps to Second PlaceIndustrial property total returns averaged 15.4% for the four quarter period ending September 2011 vs. 14.7% for the prior four quarter period. Industrial property moved to second place in terms of performance, inching ahead of office and retail. Income returns were 6.7% vs. 6.9% for the prior four quarters. Capital returns jumped to 8.3% from 7.5% previously. Fundamentals have improved slowly with further gains expected provided the economy continues on its slow growth trajectory.

Cap Rates Decline; NOI Nearly StableImplied cap rates in industrial property valuations declined to 6.10% for the four quarters ending in September 2011 from 6.33% in the prior four quarter period. For the 3rd quarter alone, valuation caps were at 6.0% which is reflective of investor’s renewed interest in the sector. NOI growth declined another 1.1.%, the eleventh consecutive quarterly decline, but NOI appears to be stabilizing. Looking ahead, NOI is poised for future growth as occupancies increase and leases signed at the 2008-09 market bottom begin to expire.

Industrial Vacancies ModerateThe U.S. industrial vacancy rate declined to 13.7% in 3Q11 from 13.9% in 2Q11. Vacancies declined in 44 out of 58 markets tracked by CBRE-EA. The vacancy rate in Riverside CA, a bellwether port market, fell 350 basis points. The continuing improvement in market conditions has been gradual, coming as a result of nine consecutive quarters of GDP growth, a 5% increase in industrial production during 3Q, and a rebound in global trade flows.

Industrial Construction Stuck at Historic Lows Industrial construction is projected to total less than 25 msf in 2011 and a measly 35 msf in 2012. Forecasts from CBRE-EA indicate that construction is not expected to recover meaningfully until 2014-2015. In most markets construction is not economically feasible until rents rise another 15-20%. While minimal construction is expected, CBRE-EA is projecting absorption to pick up measurably starting in 2012. An extended lull in construction coupled with a pickup in absorption would work down the overhang of space relatively quickly.

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U.S.3Q11: 13.7%3Q10: 14.5%

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94–10 8.0 1.3 5.0

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Industrial Market Overview


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Office Sector Returns Maintain StrengthOffice properties recorded a 15.3% total return for the four quarter period ending September 2011 vs. 15.5% for the prior four quarter period. As with other sectors, income return slipped, but was still solid at 6.2% vs. 6.5% previously. The dip in income return was largely attributable to growth in property values as capital returns increased another 8.7% following the 8.7% increase in the prior four quarter period.

Valuation and Transaction Cap Rates DropOffice cap rates implied by NPI valuations fell to 6.20% for the four quarters ended September 2011 vs. 6.43% in the prior period. According to Real Capital Analytics, transaction cap rates were stable during the quarter at an average of 7% overall, with CBD cap rates remaining stable while suburban office cap rates declined by 25 basis points. The decline in cap rates comes despite seven consecutive quarters of NOI declines, including a 1.3% drop in 3Q11. However, rents have stabilized in most markets and are growing slowly in others, and investors are anticipating rent growth in the future.

U.S. Office Vacancy Rate is UnchangedThe national vacancy rate held steady at 16.2% in 3Q11. Vacancies had declined for four consecutive quarters but anecdotal reports are that the uncertain economic environment caused companies to delay leasing and hiring decisions. Nonetheless, vacancies declined in 34 of the 57 markets tracked by CBRE-EA. While announced layoffs at banks and financial firms in response to upcoming regulatory changes have the potential to push vacancies higher, professional and business service firms continue to add jobs. Bright spots include New York (9%), San Francisco (12%) and Boston (13%).

Office Pipeline Falls Close to Historic LowsOffice construction is projected to total 10 msf in 2011 and 2012, which approach the historic lows of 1993-1994, but there are now 4 million more office jobs. Green Street Advisors notes that the construction slowdown is “reminiscent of the mid-1990’s lull… which preceded a period of strongly improving fundamentals in the late-1990’s. However, a repeat of strong demand growth from that time seems unlikely.” Still, absorption has been positive for six consecutive quarters, and CBRE-EA expects absorption to exceed construction by 75 msf over the 2112-2114 period.

NCREIF Office Returns

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Cap Rate (%)

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94–10 7.8 2.9 5.0

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06/11 6.4 -3.1 3.2

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Rolling 4Q Avgs

Office Market Overview






Retail Property Returns Maintain Strength Retail properties posted a healthy 15.3% total return for the four quarters ending September 2011 vs. 15.1% for the prior four quarter period. The retail sector was tied for third place with office property among the four major property types. Income return for the current period was a healthy 6.7% vs. 6.9% previously. Similarly, capital returns increased to 8.2% from 7.8% previously.

Retail Valuation Cap Rates Drop AgainCap rates for retail property as implied by NPI valuations averaged 6.64% for the four quarters ending September 2011 vs. 6.80% previously. Transaction cap rates were 7.5% on average but much tighter for higher quality assets, and particularly grocery-anchored centers in major markets, according to Real Capital Analytics. NOI growth was 1.6% vs. 3.4% in 2Q11 but NOI growth has now been positive for five consecutive quarters.

Retail Vacancies Remain ElevatedNeighborhood and community center strip center vacancies averaged 13.2% in 3Q vs. 13.3% in 2Q. Vacancies have remained at 13% since 2010 due to anemic consumer spending and the construction boom of 2005-2008 which left an overhang of space. The recovery remains slow as vacancies increased in 37 of the 60 markets tracked by CBRE-EA. Retailers remain under pressure as Gap announced plans to close 20% of its stores and Syms/Filene’s Basement will liquidate. However, the pickup in consumer spending in 3Q was encouraging as retailers enter the all important holiday season.

Retail Construction Stays at Historic LowsNeighborhood and community center construction is expected to total a mere 7 msf in 2011 and remain significantly below historic norms over the next 3-5 years. Construction will remain constrained due to difficulty in obtaining construction financing and retailers’ reluctance to open new stores given current economic conditions. Consumer spending is expected to remain very anemic in the “new normal” environment as households rebuild balance sheets.

NCREIF Retail Returns

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Retail Market Overview




Documents

Real Estate Quarterly Highlights Third Quarter 2011...The NCREIF Property Index (NPI) for the four quarter period ending September 2011 posted a 16.1% total return vs. 16.7% for the