2021 TIAA Real Estate Account Outlook

The year 2020 was certainly a challenging year. Portfolio Manager, Randy Giraldo shares why we believe there is reason for optimism in 2021 and how the TIAA Real Estate Account is well positioned for the future.

2021 Outlook for the TIAA Real Estate Account

After a challenging 2020, the prospects for the U.S. economy and the commercial real estate market have begun to improve.

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Throughout 2020, the world experienced an unprecedented global health crisis and resulting economic crisis that hasn't been seen in over 100 years. The economic impact will be felt for years to come and recovery is expected to be uneven across sectors. However, by the end of the year, there were several reasons for optimism, including: election uncertainty subsiding, federal law makers passing a second round of stimulus, and better than expected COVID-19 vaccine news.

Commercial real estate, relative to other asset classes, experienced greater adverse effects by the ongoing pandemic but we continue to be optimistic about the future of real estate. Our discussion will focus on three items: First, work from home implications for the office sector. Second, the TIAA Real Estate Account's property diversification. And third, the future Outlook for commercial real estate in 2021.

With traditional office workers continuing to work remotely as we began 2021, the relevancy of the physical office space has come into question. A recent survey of 50,000 office workers, conducted by Cushman & Wakefield in November, found that 73% of them "want remote working policies expanded and a shift to balancing office, home and third places." While the long-term impacts of office demand are unknown, the general consensus is that workers will demand greater flexibility, ultimately driving a reduction in demand for physical office space. This trend will be somewhat offset by the need for more space per office employee.

Most tenants have chosen a "wait and see" approach to near-term lease expirations. As leases expired in 2020, U.S. tenants of the Real Estate Account have generally signed short-term extensions instead of locking in long-term deals.

The next few years will likely be challenging for the office sector overall, but certain characteristics of the Account, and the sector in general, provide reason for optimism. The broad diversification of the Account's office portfolio across a number of markets and industries, largely mitigate geographic concentration and tenant risk.

Another important point is there are numerous sub-sectors within the broader office market. For example, the Life Sciences sub-sector, a mix of office and laboratory space, has experienced rapid growth in recent years and was a strong performer in commercial real estate markets in 2020. The TIAA Real Estate Account has approximately $1.1 billion invested in the Life Sciences sub-sector as of September 30, 2020. That's approximately 12% of the office portfolio. Notable tenants include Biogen, Eli Lilly and Fibrogen.

The Medical Office sub-sector is another area of opportunity for the Account. In the fourth quarter, the Account established a joint venture with Healthcare Realty, a leading real estate investment trust in the sub-sector, with the purpose of acquiring a diverse portfolio of assets over the next few years.

One of the main benefits of office investments is their long lease terms. Unlike apartments, which typically have 1-year durations, office leases tend to have terms ranging from 5 to 10 years. The weighted average lease term of the Account's office portfolio is 5.9 years as of September 30, 2020. This helps secure cash flow during periods of uncertainty and disruption. Factoring in the credit quality of the tenant portfolio, rent collections reached 95%+ for the Account's office portfolio through the first nine months of 2020. The Account has a very manageable office lease expiration schedule through the end of 2025.

In summary, while we do anticipate some further weakness in the U.S. office market, we believe that the diversity of the Account's holdings and long-dated leases will keep the Account well positioned for the future.

Now let's discuss the TIAA Real Estate Account's property diversification. While stories around office and mall properties dominated news headlines in recent months, it's important to understand the property composition of the TIAA Real Estate Account and how its assets are positioned to withstand the current economic environment.

Over the last 10 years the composition of investable real estate has changed significantly. There has been tremendous growth in non-traditional "alternative" asset types, broadly defined as anything other than the traditional main four property types - office, retail, industrial and multifamily. Private real estate lags behind the public REIT market in this regard.

REITs are constantly rewarded or punished by the capital markets based on forward-looking prospects. Therefore, their overall composition changes more rapidly than that of private funds. We believe that the optimal composition of real estate portfolios going forward looks more like the REIT market. The TIAA Real Estate Account is ahead of its peers in this transformation. Over the past several years, the Account has diversified into alternative property types.

With over 9% of its net asset value in non-traditional property types, the TIAA Real Estate Account compares favorably to similar private real estate funds with an approximately 5% allocation to alternative property types.

Traditional commercial real estate is still the bulk of the Account's net assets, and performance has varied by sector type during 2020. It's worth noting that several sectors have proven resilient throughout the current downturn.

First, at approximately 17% of real estate investments, as of September 30, 2020, the Industrial sector has delivered property appreciation and provided stable income in a period of great uncertainty. Rising e-commerce retail sales have been a strong tailwind for the sector as consumers have been forced to do more online shopping.

Second, the apartments sector has provided stable income in 2020, with rents in the United States declining only 3% year-over-year through September, according to CB Richard Ellis. As of September 30, 2020, rent collections for the Account's portfolio have tracked with the broader industry at approximately 95%, slightly below historical rates of 96-98%. Apartments comprise approximately 26% of the Account's real estate investments.

Next, the "necessity"-based Grocery Anchored Retail sector has proven the most resilient retail subtype during the ongoing pandemic. Even though online grocery shopping saw exponential growth in 2020, those sales are estimated to be less than 15% of overall grocery sales by many experts.

Next, shopping centers anchored by Walmart, Target, Costco, Home Depot and Lowes have performed relatively well for the "Big Box" Retail sector compared to other retail properties.

The asset allocations discussed, together with the alternative property types, constitute $13.4 billion of net assets (or 56% of net asset value) for the Account. Together with the resilient characteristics presented earlier regarding the Account's office assets, we're optimistic the portfolio is built to withstand the current economic crisis and exit this period on solid footing.

So what is the future outlook for commercial real estate in 2021? After a challenging 2020, the prospects for the U.S. economy and the commercial real estate market have begun to improve. Many of the obstacles and uncertainties present in the middle of the year have been resolved.

Let's start with the political landscape. The elections are behind us and we have greater clarity regarding economic policy. Further, the government was able to pass a second round of stimulus in an effort to provide much needed economic aid to small businesses, distressed corporations and families. Additionally, Proposition 15 in California was voted down, ensuring commercial property tax increases do not exceed 2% annually.

Moving on to the vaccine and COVID-19, with reported efficacies of 95%, the Moderna and Pfizer vaccines have exceeded expectations. As states began mass distribution in the first half of 2021, experts believe that widespread immunity could be possible before year-end. Cases are expected to peak in early 2021, then drop steadily as a result of the vaccination efforts.

Moving on to monetary and economic policy, the Federal Reserve has signaled that it will keep rates near zero at least through 2023 in order to allow the economy to fully recover. Historically, there has been a statistically significant positive correlation between interest rates and capitalization rates, a common metric of real estate value. The spread between the 10-year Treasury yield and the average NCREIF capitalization has widened recently. With treasury yields expected to remain low, it is possible that capitalization rates decline, driving real estate valuations higher.

In 2020, the combination of stimulus, economic uncertainty and inability to physically consume certain types of goods and services (for example, events, travel, experiential, retail) led to a historically high savings rate. As government-mandated restrictions ease and health fears subside, we expect spending to bounce back in the second half of 2021.

And now moving on to real estate fundamentals, new construction was largely paused at the onset of the pandemic in March of 2020 as real estate firms' appetite for development risk diminished. This interruption in supply bodes well for owners of existing real estate as competition for tenants eases just as demand recovers.

While 2020 was certainly a challenging year, we believe there is reason for optimism in 2021. The Account is well positioned for the future. Given its strong balance sheet and broad portfolio diversification, it has the unique ability to make strategic asset allocation decisions during this unprecedented time. In 2021, the Account will seek to further improve diversification by selling lower productivity assets and acquiring assets in preparation for what we believe is a bright future. We thank you for your trust and support and we will continue to provide the high-quality management and service that you deserve.
Special Report

2021 TIAA Real Estate Account Outlook

Read the full report.

An essential component of a diversified portfolio1

Real estate is a fundamental building block of investment portfolios, helping protect against stock market uncertainty, rising interest rates and inflation.
Why private real estate infographic

An easy way to provide employees with real estate exposure

The TIAA Real Estate Account is a variable annuity designed to maximize the benefits of real estate investing with the option for income for life in retirement.

Privately owned commercial real estate

Emphasis on high-quality, income-producing properties.

Guaranteed liquidity

A liquidity guarantee backed by the TIAA General Account.

Retirement income
for life

Participants can convert some or all of their investment into income for life in retirement.*
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1The TIAA Real Estate Account is truly diversified within the larger asset class of commercial real estate. An investment in REA, when combined with other appropriate investments in different asset classes, can help an investor achieve portfolio diversification. Diversification is a technique to help reduce risk. It is not guaranteed to protect against loss.
2Returns are largely unaffected by movements in stock or bond markets since returns are generated by rental income and changes in property values. For the 10-year period ended December 31, 2020, REA correlation to the S&P 500 Index and Barclay’s Aggregate Bond Index was -0.08 and 0.00, respectively. Over this same period, correlation between the FTSE Nareit All Equity REIT Index and the S&P 500 Index was 0.75. You cannot invest directly in any index. Index returns do not reflect a deduction for fees and expenses.
3Direct real estate has delivered higher risk-adjusted returns than bonds since the account’s inception in 1995. As of December 31, 2020, the REA since-inception Sharpe ratio (a measure of risk-adjusted return) was 1.1, while the Bloomberg Barclays U.S. Aggregate Bond index was 0.9 over the same period. The REA inception date is 10/2/1995. You cannot invest directly in any index. Index returns do not reflect a deduction for fees and expenses. Past performance does not guarantee future results.
*Other payout options are available. Any guarantees under annuities issued by Teachers Insurance and Annuity Association of America are subject to its’ claims-paying ability. Payments from the TIAA Real Estate Account will rise or fall based on investment performance.
The TIAA Real Estate Account is a variable annuity product and an insurance separate account of TIAA.
Withdrawals of earnings are subject to ordinary income tax, plus a possible federal 10% penalty if you make a withdrawal before age 59 ½. Transfers out of the account to another TIAA or to a CREF account or into another investment option can be executed at any time, but are limited to once per calendar quarter, although some plans may allow systematic transfers that result in more than one transfer per calendar quarter, and certain other limited exceptions to this restriction apply.
The real estate industry is subject to various risks including fluctuations in underlying property values, expenses and income, and potential environmental liabilities.
In general, the value of the TIAA Real Estate Account will fluctuate based on the underlying value of the direct real estate or real estate-related securities in which it invests. The risks associated with investing in the Real Estate Account include the risks associated with real estate ownership including among other things fluctuations in underlying property values, higher expenses or lower income than expected, risks associated with borrowing and potential environmental problems and liability, as well as risks associated with participant flows and conflicts of interest. For more complete discussion of these and other risks, please consult the prospectus.
You should consider the investment objectives, risks, charge and expense carefully before investing. Please call 877-518-9161 or to go to TIAA.org/prospectuses  for current product and fund prospectuses that contain this and other information. Please read prospectuses carefully before investing.
Past performance does not guarantee future results.
The TIAA Real Estate Account is an insurance separate account of Teachers Insurance and Annuity Association of America, New York, NY. TIAA-CREF Individual & Institutional Services, LLC, Member FINRA, distributes securities products.
For its stability, claims-paying ability and overall financial strength, Teachers Insurance and Annuity Association of America (TIAA) is a member of one of only three insurance groups in the United States to currently hold the highest rating available to U.S. insurers from three of the four leading insurance company rating agencies: A.M. Best (A++ as of 7/20), Fitch (AAA as of 11/20) and Standard & Poor's (AA+ as of 8/20), and the second highest possible rating from Moody's Investors Service (Aa1 as of 9/20). There is no guarantee that current ratings will be maintained. The financial strength ratings represent a company's ability to meet policyholders' obligations and do not apply to variable annuities or any other product or service not fully backed by TIAA's claims-paying ability. The ratings also do not apply to the safety or the performance of the variable accounts, which will fluctuate in value.