2014 Global Real Estate Strategy and Research Compendium

2014 Global Real Estate Strategy and Research Compendium FOR INSTITUTIONAL INVESTOR USE ONLY. Not for use with or distribution to the general public.

Table of Contents It s all relative: Assessing global real estate investment opportunities January 9, 2014 Creative destruction: Generational shift in the U.S. office sector March 14, 2014 Awaiting the cranes: Supply discipline and office market performance July 31, 2014 3 10 16 Cap rates rising: Well maybe next year... 22 September 12, 2014 Counting cranes: Supply discipline and apartment market performance September 22, 2014 REITs and real estate: Complementary through good times and bad October 28, 2014 Chasing yield? Target and non-target market performance in the current recovery November 11, 2014 26 33 41 2 2014 Global Real Estate Strategy and Research Compendium

TIAA-CREF Asset Management It s Documeent all relative: title on one or two Assessing lines Gustan global real Book estate 24pt investment opportunities TIAA-CREF Global Real Estate Strategy & Research Martha Peyton, Ph.D. Managing Director Edward F. Pierzak, Ph.D. Managing Director Timothy Francis Senior Director Real estate investors are increasingly seeking to construct global property portfolios. Reasons for going global include, but are not limited to, the pursuit of higher absolute returns, portfolio diversification, and an expansion of the investment opportunity set. Constructing global property portfolios is more difficult than constructing home country portfolios because country risk is different, data is not always available, and the opportunity to purchase institutional investor quality real estate is not always abundant. These factors influence potential risk-adjusted returns from global property, but they are difficult and sometimes impossible to measure. Without adequate return measurement, investors have difficulty formulating property bids with confidence. Evidence of strong economic growth, expansion of the middle class, and accelerating development support exciting headlines in many countries, but such data is not robust enough to support the calculation of risk-adjusted returns across countries. In this paper, we describe an analytic process that uses available data to identify countries with relatively equivalent country risk and abundant liquidity. This equalization provides a reasonable basis for calibrating relative risk-adjusted returns among these countries, so that investors can bid on property with confidence. We further show that these countries include the vast bulk of global investmentquality real estate. Outside of these countries, investors need to devise strategies to assess and buffer against risk because it cannot be robustly priced. Such strategies can include fund investments rather than direct property purchases and joint ventures with local real estate entities. Building global property portfolios Property investors share the common goal of all investors: to maximize risk-adjusted returns. The return part of the goal is easy to define and measure; the risk part is tricky. Real estate investors typically control risk through discounted cash flow analysis of prospective acquisitions in the context of local market supply and demand, as well as interest rate expectations. Careful property management is another phase of risk control, especially with regard to spending on capital improvements. On a portfolio level, investors control risk by diversifying across property types and locations and avoiding concentrated bets on very large deals. This works very well when property investors focus on their home countries. When they venture abroad, this same approach can be woefully inadequate because country location matters and it matters above all else. Country location determines the rights of property owners and the regulatory requirements surrounding transactions and property management. It determines the potential for political stability or unrest and for physical security or lack thereof. It also determines the economic foundation for property performance and the financial backdrop for liquidity. For foreign investors, these elements may differ significantly from their home country characteristics and require very explicit consideration before property investments can be comfortably undertaken. We have learned 3 2014 Global Real Estate Strategy and Research Compendium HOME

It s all relative: Assessing global real estate investment opportunities this lesson well in our experience as global investors. Unfortunately, real estate research does not offer clear empirical evidence that country matters above all else. But, there is research using global equity market data that does show the significance of country location. Country effects/factors have a significant influence on equity returns; in fact, country factors have been found to have a stronger influence on stock performance than industry factors. 1 In more recent years, the ongoing integration of the global financial markets has been associated with diminishing importance of country for developed nations, but ongoing significance of country factors for emerging markets. 2 Investment managers who embrace these results are likely to select countries first and then choose stocks within those countries to construct portfolios. Applying this conclusion to real estate investing is straightforward because publicly-traded real estate stocks are included in the research described above and private real estate ownership and operation is essentially the same business as that of the publicly-traded real estate firms. As such, it is affected by the common factors that differentiate countries including: rule of law (especially with regard to property ownership and enforcement of contracts), regulatory requirements, capital market liquidity, political risk, and physical security. Screen testing Our goal is to establish a screening process that will identify countries that have relatively homogeneous country risk characteristics which are roughly in line with our home country, the U.S. The U.S. is generally accepted as a global benchmark, as is the U.K., and U.S.-U.K. country risk measures are roughly aligned. We employ a four-stage screening process that examines country rule of law, sovereign risk, transparency, and direct real estate liquidity. The process effectively acts as a funnel that sifts out countries with materially different baseline risk characteristics. After filtering out countries with material differences, real estate investments can be examined based on the characteristics of the real estate itself and investment decision-making can thereby focus on potential returns from the real estate. Other countries need to be treated differently in that country risks need to be addressed explicitly before making real estate decisions. Each screen focuses on a factor that is vital to real estate investors. For example, legal systems form the basis of property ownership and dispute resolution, so rule of law and its implementation are critical components to the real estate investment process. Perception and reality of corruption are similarly important, as is the culture that promotes or discourages them. Next, sovereign risk addresses the ability of a country s government to meet its obligations and it also offers a window into a country s economic and financial stability. Then, market transparency can greatly simplify the real estate investment process; opaqueness can pose significant hurdles. Finally, ample liquidity is one of the essential components of our market selection process; we believe it is equally important in country selection. Take 1: Identify countries with solid rule of law The Rule of Law Index (RLI) and Corruption Perceptions Index (CPI) are two indices that attempt to capture and compare the effectiveness of legal systems and perceptions of corruption in government across countries. The RLI was designed by The World Justice Project; it measures the extent to which countries adhere to the rule of law in practice. 3 The CPI is published by Transparency International and measures the perceived levels of public sector corruption in 176 countries and territories around the world. For both indices, higher scores reflect better conditions. Country scores for the two indices are highly correlated; the correlation coefficient exceeds 0.9. Using the U.S. as a benchmark, we find that 21 countries have RLI and/or CPI metrics that are close to or better than those metrics for the U.S. These countries and their RLI and CPI scores are listed in Exhibit 1. 4 Exhibit 1 Rule of Law Index (RLI) and Corruption Perceptions Index (CPI) Country RLI CPI Sweden 0.88 88 Denmark 0.88 90 Norway 0.87 85 Finland 0.87 90 Netherlands 0.84 84 New Zealand 0.83 90 Australia 0.82 85 Austria 0.80 69 Singapore 0.79 87 Japan 0.79 74 Germany 0.79 79 Canada 0.78 84 United Kingdom 0.78 74 Hong Kong 0.76 77 France 0.76 71 Belgium 0.74 75 Spain 0.73 65 South Korea 0.73 56 Poland 0.73 58 United States 0.72 73 Switzerland N/A 86 Sources: TIAA-CREF, World Justice Project (unweighted average of sub-factors); Transparency International, as of 2012 2013. 4 2014 Global Real Estate Strategy and Research Compendium HOME

It s all relative: Assessing global real estate investment opportunities Take 2: Identify countries with low sovereign risk Within the group of 21 countries, we next examine sovereign risk using Moody s sovereign credit ratings. Sovereign ratings are designed to measure the risk that a country will default on its debt. That risk is associated with relative economic strength and the effectiveness of government in managing its debt and economy. High sovereign risk points to a variety of deficiencies that threaten capacity to repay sovereign debt, including too much debt, weak growth prospects, and/or incompetent government. We limit our focus to countries with sovereign ratings of Aa1 and better. Among the 21 countries that passed the rule of law screen, 19 have ratings that meet this criterion. Exhibit 2 lists the Moody s government bond ratings for all 21 countries; the 19 countries with Aa1 or better Moody s ratings are shaded in blue. Exhibit 2 Moody s sovereign credit ratings (local currency) Country Sweden Denmark Norway Finland Netherlands New Zealand Australia Austria Singapore Japan Germany Canada United Kingdom Hong Kong France Belgium Spain South Korea Poland United States Switzerland Credit rating Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aa3 Aaa Aaa Aa1 Aa1 Aa1 Aa3 Baa3 Aa3 A2 Aaa Aaa Source: Moody s, as of September 22, 2013. Take 3: Identify countries with transparent real estate markets Jones Lang LaSalle s Global Real Estate Transparency Index (GRETI) is derived from a biennial survey and provides market transparency scores for 97 markets around the world. The index is a composite of measures, encompassing real estate performance measurement and fundamental market data, governance of publicly-listed real estate companies, regulatory and legal factors, and the ease of real estate transactions. The survey places markets into one of five tiers. Level 1 contains highly transparent markets; Level 5 markets are deemed opaque. The 19 countries identified in the rule of law and sovereign risk screens are fully contained in Level 1 (highly transparent) and Level 2 (transparent) markets with the exception of South Korea; it is a Level 3 (semi-transparent) market. Given the significant overlap, the GRETI effectively acts as confirmation of the importance of the rule of law and sovereign risk screens. We limit our investment interest to Level 1 and 2 markets. These markets are shown in Exhibit 3 along with their composite transparency scores; lower scores indicate more transparency. The 18 markets shaded in blue are those that passed our rule of law, sovereign risk, and transparency screens. Exhibit 3 Global Real Estate Transparency Index (2012) Level 1: High transparency Level 2: transparent Country Composite score Country Composite score United States 1.26 Hong Kong 1.76 United Kingdom 1.33 Germany 1.80 Australia 1.36 Singapore 1.85 Netherlands 1.38 Denmark 1.86 New Zealand 1.48 Ireland 1.96 Canada 1.56 Spain 2.06 France 1.57 Belgium 2.07 Finland 1.57 Norway 2.08 Sweden 1.66 Poland 2.11 Switzerland 1.67 Italy 2.16 South Africa 2.18 Austria 2.22 Malaysia 2.32 Czech Republic 2.34 Japan 2.39 Hungary 2.53 Brazil Tier 1 Cities 2.54 Portugal 2.54 Source: Jones Lang LaSalle, as of June 2012. In less transparent markets, data for performance measurement and tracking real estate fundamentals is less commonly available and generally less robust; publiclytraded real estate companies are scarce or non-existent; regulatory and legal systems are more difficult to navigate; and transactions are more costly. To offer a flavor of the 5 2014 Global Real Estate Strategy and Research Compendium HOME

It s all relative: Assessing global real estate investment opportunities constituency of the less transparent markets, Level 3 (semi-transparent) markets include the BRIC countries excluding the first tier cities in Brazil which are Level 2. Level 4 (low transparency) and Level 5 (opaque) markets tend to include smaller, poorer countries with weaker rule of law and greater sovereign risks. Take 4: Identify countries with ample liquidity The final screen examines real estate market liquidity in each country. Of the 18 countries in our group, 11 have average annual transaction volumes in excess of US$5 billion. While this level of transaction volume is admittedly an arbitrary cutoff, it does represent a rather natural breakpoint in the actual data. Exhibit 4 lists Real Capital Analytics average annual transaction volumes for each of our 18 identified countries for the period from 2007 to mid-2013. Countries with average annual transaction volumes in excess of US$5 billion are shaded in blue. These 11 countries account for approximately 80% of total average annual transaction volume. Exhibit 4 also shows the percent of transaction activity that is accounted for by non-domestic investors. This measure can be interpreted as the degree of market penetration of international investors. Conversely, it also reflects the extent to which non-domestic investors might be discouraged by country-specific transaction costs. The data in Exhibit 4 is not ideal because the vendor does not have access to and therefore cannot report all transactions everywhere. In countries where transactions are dominated by local entities, data may be unreported. Countries with material non-domestic transactions might have better reporting, as well as stronger transaction activity. As a result, interpreting the data is tricky and requires integration with other data sources to derive conclusions. In particular, countries with few non-domestic transactions might have small stocks of high quality properties that are attractive to cross-border investors. Or, properties might be relatively abundant but closely held by domestic institutional investors with deep capital resources. The bottom line here is that countries with relatively more transactions overall and more transactions involving non-domestic entities signal more accessible opportunity. The signal is valuable due in no small part to the high costs of exploring cross-border property investing. Making the cut So, at the end of our screen tests, 11 countries make the cut. They include the United States, United Kingdom, Australia, Netherlands, Canada, France, Sweden, Hong Kong, Germany, Singapore, and Japan. Having been run through casting, these target countries can be viewed as possessing similar baseline risk characteristics. As a result, core real estate investment opportunities across these areas can be assessed on a more level field of comparison, and investors can be more confident in their attempts to gauge relative value across these countries. The identification of target countries is only the first step in solving the global real estate relative value puzzle. Having established a more level playing field, our next steps mirror the analysis we perform for identifying target markets in the U.S. These steps include analysis of each country s economic and real estate cycles, both historically and prospectively. Once the macro environment of each country is understood, we step our analysis down to the local real Exhibit 4 2007 to mid-2013 commercial real estate average annual transaction volume (US$B) and non-domestic purchaser percentage (%) Country Transaction volume Non-domestic purchaser % Country Transaction volume Non-domestic purchaser % United States 129.1 11% Hong Kong 9.7 15% United Kingdom 47.8 46% Germany 30.9 56% Australia 14.9 36% Singapore 6.1 27% Netherlands 7.6 44% Denmark 2.7 33% New Zealand 0.9 45% Belgium 2.5 58% Canada 13.4 10% Norway 4.2 26% France 21.1 46% Austria 2.0 50% Finland 2.7 65% Japan 26.1 20% Sweden 10.3 33% Switzerland 1.5 43% Source: Real Capital Analytics, as of September 2013. 6 2014 Global Real Estate Strategy and Research Compendium HOME

It s all relative: Assessing global real estate investment opportunities estate market level where we examine historical and forward-looking real estate market performance and property supply and demand fundamentals. Liquidity is important too on a local market level and we find that among our 11 country targets, transactions are typically focused on one or two major cities. 5 The ultimate result of the process is an assessment on the real estate investment prospects of each country and market by property type that is similar to a stock analyst s call indicating a bullish, neutral, or bearish view on a stock. Exhibit 5 highlights some of the country and local market factors that are examined in our global market selection process. While the process described above appears to be as straightforward as selecting target markets in the U.S., it is very much more complicated. Challenges begin with identifying data sources for the indicators shown in the table. The macro-economic and country-level demographic data are the most available and most consistent. The World Bank and International Monetary Fund are good sources, available online for historical information and some forecasts as well. Local market economic and demographic data is more difficult to obtain and analysts commonly resort to purchasing databases that gather and report data from the local sources in a consistent fashion. Real estate market performance data is challenging as well. The global standard is a measurement service provided by Investment Property Databank (IPD), a subsidiary of MSCI Inc. IPD collects property level performance data from investors around the world who are interested in the performance analysis and benchmarking services that IPD offers. IPD combines the data to create local market and country level indices which are available to data providers and others on a subscription basis. The challenge in using this data is to understand that coverage by market and by country varies and that the measurement standards across countries are not identical, and in some cases there can be major inconsistencies. Data for real estate market fundamentals is also challenging. It is similarly available from third-party providers on a subscription basis, but here too, definitions across countries may not be absolutely consistent. A good example involves the differences in lease protocols that make rent growth data difficult to compare. Additionally, data will be based on very different degrees of coverage across markets. Some vendors are leasing brokers using their own databases; other vendors combine databases from multiple sources. Data derived from weaker coverage is less reliable than that derived from sources with a solid grasp of the local market. Exhibit 5 Global market selection process: Country and local market factors Country factors Economic indicators GDP growth: Historical & forecast Employment growth: Historical & forecast Inflation rates: Historical & forecast Confidence in fiscal & monetary policy Demographic indicators Population growth: Historical & forecast Dependency ratio: Historical & forecast Birth rates Immigration flows Real estate performance indicators Total return: Historical Total return volatility: Historical Liquidity: Historical Local market factors Economic indicators GMP growth: Historical & forecast Employment growth: Historical & forecast Industry composition Demographic indicators Population growth: Historical & forecast Trade-area demographics for retail Real estate performance indicators Total return: Historical Total return volatility: Historical Property sector liquidity: Historical Property sector fundamentals: Stock, construction, & absorption Rent levels/growth & occupancy Source: TIAA-CREF 7 2014 Global Real Estate Strategy and Research Compendium HOME

It s all relative: Assessing global real estate investment opportunities Even after assembling and analyzing the data described above, non-local investors need to decide whether they are confident enough to invest directly in property outside their home country. Confidence to invest directly involves not only confidence in the data and analysis, but also confidence in securing and overseeing property management from afar. However, we believe the filtering exercise above greatly assists in ruling out those countries where, on a standalone basis, foreign investors should be particularly cautious. Not making the cut But, what about countries that did not make the cut? These countries possess risks that are different from our target countries. In many instances, these risks are difficult to measure and stem from structural features that can change only very slowly through time, if at all. For these countries, any interest in investing should logically start with a strategy for dealing with country risk. For real estate, common strategies include limiting investment to funds with strong local roots and/or securing local investment partners. These strategies assume that funds and local partners have the expertise and clout to serve as a buffer against country risk. Moreover, since country risk often means an absence of data necessary for evaluating property prospects, funds and local partners may also be assumed to provide enough on-the-ground insight and capital-at-risk to price relative value among real estate opportunities within their local country. Partners are unlikely to provide the data infrastructure required to benchmark either property-level performance or their own performance. Similarly for local markets within the target countries that have weak liquidity, investors might also seek intermediaries to buffer against risk. For example, logistics properties scattered outside of the major cities might have better liquidity if contained in a multiproperty, multi-location portfolio in joint venture with a REIT or real estate specialty company. It is tempting to assume that the higher country risk identified here can be priced by simply incorporating the sovereign spread (i.e., the difference between a U.S. Treasury and a specific non-u.s. government bond) into real estate pricing. This method does result in some compensation assigned to country risk, but it falls short of covering the extra risk that is specific to real estate investing. Investors in sovereign bonds assume the risk of sovereign default. They do not assume the risk of purchasing, operating, and selling property in an environment with compromised rule of law, corruption, transparency, and/or liquidity. Measuring the impact of these risks on return would require an extensive database of reliable, consistent property performance data that simply does not exist. The currency conundrum We leave the currency question for last. As real estate investors, we focus on the role that property plays in our larger portfolios. That role is distorted if our metrics do not isolate property investment performance separately from currency performance. Property investment is rational only when property performance meets the risk-return requirements of the portfolio manager. If performance is related to currency appreciation or depreciation rather than property returns, the portfolio manager would have been better off investing in currency itself, which has low transaction costs and high liquidity. In standalone real estate portfolios, managers are limited to property investments and their choice is to hedge the currency risk or assume it. In this regime, managers are investing in two separate asset classes, property and currency. Their analysis should treat each separately, while their performance will be judged on the combined portfolio performance. Closing words Our approach to global real estate investing involves careful screening to identify target countries using several measures of country risk. The screening is designed to group together countries with relatively equivalent country risk to our home country, the U.S. This allows examination of real estate investments to focus on real estate characteristics rather than country risk characteristics. Investments in countries with more country risk are best approached, in our judgment, through local intermediaries who can serve as a country risk buffer. As a sidebar, our approach also suggests that currency risk be considered independent of the real estate to avoid using real estate as a vehicle for currency bets. 8 2014 Global Real Estate Strategy and Research Compendium HOME

1 See Richard Grinold, Andrew Rudd, and Dan Stefek, Global Factors: Fact or Fiction?, The Journal of Portfolio Management, Fall 1989, and Steven L. Heston and K. Geert Rouwenhorst, Industry and Country Effects in International Stock Returns, The Journal of Portfolio Management, Spring 1995. 2 See Jianguo Chen, Andrea Bennett, and Ting Zheng, Sector Effects in Developed vs. Emerging Markets, Financial Analysts Journal, November/ December 2006. 3 A composite score is calculated by taking the simple average of the sub-factor scores. 4 The paper adopts a broader meaning for the word country, as not all of the areas listed in Exhibit 1 are countries, e.g., Hong Kong. This broader definition is used throughout the paper. 5 The exception here pertains to investments in retail properties which we believe are trade-area dependent rather than dependent on the larger city or metro area location. Retail investment requires detailed analysis of trade-area population and its spending patterns, as well as analysis of the strength of tenant retailers. Real estate securities are subject to various risks, including fluctuations in property values, higher expenses or lower income than expected, and potential environmental problems and liability. 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. Past performance does not guarantee future results. 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 adviser and wholly owned subsidiary of Teachers Insurance and Annuity Association (TIAA). TIAA, TIAA-CREF, Teachers Insurance and Annuity Association, TIAA-CREF Asset Management and FINANCIAL SERVICES FOR THE GREATER GOOD are registered trademarks of Teachers Insurance and Annuity Association. 2013 Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF), 730 Third Avenue, New York, NY 10017 C13279 184925_374125 (12/13) 9 2014 Global Real Estate Strategy and Research Compendium HOME

March 2014 TIAA-CREF Asset Management Documeent title on one or two Creative lines in destruction: Gustan Book 24pt Generational shift in the U.S. office sector TIAA-CREF Global Real Estate Strategy & Research Martha Peyton, Ph.D. Managing Director Edward F. Pierzak, Ph.D. Managing Director Office demand is shifting toward creative space which is designed to appeal to the tastes of young millennials, especially those with tech skills. The shift in demand is creating opportunity that offsets some of the drag associated with slow office employment growth, densification in use of office space, and the overhang of space in less desirable locations. Investing in creative office space is challenging because it requires an understanding of the technological, generational and locational forces that drive it. Our assessment of those forces is summarized here. The investment strategies that we are pursuing for the near term act on the shifts we identify. They include rebalancing of our office holdings to weed out properties that are losing competitiveness in favor of those that are better positioned to withstand the creative destruction now underway. Others are well advised to follow suit. In a pickle Office property investments have been the weakest sector in the commercial real estate recovery that began in 2010. Total returns for the NCREIF Property Index show that apartment, industrial and retail property types have all outperformed office over the last four years. This situation has left office investors in a pickle. To date, the slow recovery in the office sector nationally has been driven by a variety of largely negative forces. The most significant is the weakening in the importance of both finance and law. Employment in both sectors has grown little since 1990, as compared to growth in business and professional services. Additionally, all office tenants are squeezing employees into less space by eliminating libraries, file cabinets and excess equipment. On a macro-economic level, employers are also squeezing maximum productivity out of existing staff before adding to it. None of these forces appear to be easing. Office developers are reacting to these weak prospects by limiting the flow of new office construction. That parsimony is welcomed by office investors, but it is not enough to revitalize investment returns in the sector. The more powerful force will come from a slow weeding out of noncompetitive properties from the institutional-quality office stock. 10 2014 Global Real Estate Strategy and Research Compendium HOME

Creative destruction: Generational shift in the U.S. office sector Separating the winners from the losers At the same time, some positive forces are emerging within the office sector that will affect the competitiveness of properties. These uplifting forces are associated with the demographic shift as Gen Y (also called millennials ) steadily increases as a proportion of both the workforce and consumers. The shift to Gen Y is associated with (1) the strong growth in technology- related jobs since the bottom of the recession, (2) the demand for creative office space designed to appeal to Gen Y techie employees who fill those jobs, (3) the economies associated with that kind of space design because it requires less space per employee, (4) the concentration of growth in tech jobs and creative office space on locations that are more urban and amenity rich, and (5) the increasing technology content of almost everything which further enhances the importance of tech-related activities and those with techie skills. These are the forces pushing the economy and office property forward. The key for office investors is to identify properties where these positive forces dominate. In the sections that follow, we attempt to untangle the positive and negative forces to help investors identify office opportunities with better prospects for attractive returns. Generational shift Technology today is focused on a combination of new industries such as social media, new devices such as smartphones and tablets, and new ways of doing things such as mobile shopping and streaming media. All these elements, in turn, are driven by young people who are the strongest users of technology, and, an increasingly important segment of the workforce that produces it. These younger workers are part of the generation referred to as millennials or Gen Y. It is the largest cohort since the baby boom and includes those born in the years leading up to the millennium who are now between 15 and 34 years old. The 84 million millennials outnumber even the massive boomer cohort which totals 82 million. Millennials now constitute 35% of the U.S. labor force and 52% of the population over 16 which is defined as eligible for the labor force. As younger millennials mature and older boomers retire, millennials will become an increasingly larger portion of the labor force. Exhibit 1: U.S. population by age cohort 2012 100 80 Thousands 60 40 20 0 Under 15 Millennials 15-34 Gen X 35-44 Boomers 45-64 65+ Source: U.S. Census Bureau 11 2014 Global Real Estate Strategy and Research Compendium HOME

Creative destruction: Generational shift in the U.S. office sector Tech s turf In 2008, nine U.S. metro areas were identified as having at least 80,000 jobs each in occupations in the computer and mathematical science category which contains the bulk of tech sector activities. At that time, these occupations accounted for 4.5% of the nonagricultural jobs in these tech-heavy metro areas. Within these metros, the most recent occupational survey shows an 8.4% jump in this job category between 2008 and 2012 despite the Great Recession. This increase brought the concentration of tech to 4.9% in 2012 in the nine metros. It is likely that the 2013 update due for release later this year will show a further increase in tech concentration. Exhibit 2: Metro area concentrations of computer and math jobs 300 W 2008 W 2012 Thousands 200 100 0 New York Washington, Los D.C. Angeles Chicago Boston Dallas Seattle San Francisco San Jose Source: Bureau of Labor Statistics Not only has tech been growing in these nine metro areas, but overall employment growth there has outpaced the remainder of the nation. The most recent employment data for November 2013 shows that the job total for these nine metros is slightly above its January 2008 level, indicating that the negative effects of the Great Recession have been more than made up. The remainder of the U.S. has not fully recovered and remains 1.45 million jobs beneath the January 2008 level. The strength of the tech sector can be seen in the office sector. According to a CBRE Econometric Advisors special report, 1 the tech sector accounted for the largest volume of office leasing in 2Q2013 at 13% of the total. Leasing activity in tech outpaced the more traditional leaders, finance and law, which accounted for 11% and 6% of leasing, respectively. This activity has not been limited to downtown CBDs, but rather tracked the pattern of urban-suburban tech concentrations within the nine metros. Furthermore, the tech-heavy metros are also leading the way with respect to price performance. According to the Moody s/rca CPPI index, 2 six of the nine tech-heavy metros identified above are deemed major markets; Seattle, Dallas, and San Jose are the exceptions. In the major markets, the index shows that downtown office property values recovered more than their entire property value decline suffered during the Great Recession as of November 2013. Values are on average 8.2% above their prior peaks, the best performance across all of the CPPI segments except for major market apartments. Outside the major markets, downtown office values have restored only 57.5% of the prior peak values. 12 2014 Global Real Estate Strategy and Research Compendium HOME

Creative destruction: Generational shift in the U.S. office sector What s in it for me? For office investors, it is important to understand the needs and preferences of the rising tech workforce who populate office space and their employers who sign the leases on that space. For employers, the boom in tech is very much about finding and keeping skilled employees. Fifty-eight percent of corporate CEOs are either somewhat or extremely concerned with the availability of employees with key skills according to a recent survey. 3 Young techies are in high demand from both emerging industries and traditional industries, along with the attraction of entrepreneurship. Supply of skilled techies is perceived to be tight with some analysts projecting a talent gap. 4 On top of strong demand and tight supply, young employees with sought-after skills are footloose. A recent Gallup survey reports that 47% of them expressed interest in switching jobs over the coming year, the highest percent among all age cohorts. 5 Employers are noticing; PwC reports that their youngest generation of professionals were leaving in growing numbers after just a few years. 6 In light of their concern with finding and keeping skilled millennial employees, employers are taking note of the workplace environment that is most satisfying to millennials. Their preferences lean toward office space that is quite different from traditional design and configuration. Some are calling it creative space. The value proposition in creative space Creative space is not simply about taking down the partitions surrounding cubicles. It is more complex than just open space with a patina of grunge. Creative space is best defined as a part of a flexible work environment that offers employees a variety of spaces to accommodate various activities. The design firm Gensler defines these activities as focus, collaborate, learn, and socialize. 7 Focus work and individual learning are commonly done in an open space environment with benches, tables, or low-walled cubes. Employees often listen to music through ear buds to encourage focus, loud talking is discouraged. Conference rooms are readily available for collaboration and group learning which are also encouraged by availability of attractive common spaces including kitchens, dining areas and recreation spaces. Small private spaces are available for conversation and telephone calls. Academic research supports this multi-use configuration showing that people communicate three times more often in a multi-space area 8 The final characteristic of creative space is its design esthetic which is reminiscent of converted urban industrial lofts. Big windows, abundant natural light, high ceilings, big open space, and rather raw-looking finish complete the look. Millennials grew up with abundant fast-changing technology: video games, computers, cell phones, smartphones, tablets, etc. As a result, creative space suits millennials because it facilitates the way they use technology. Their smartphones, tablets and lightweight laptops allow them to move around while they work. They are not tied down to a single desk and chair. They use paper minimally which also facilitates mobility. They eschew hierarchy which is symbolized by work environments where space equals rank. They use technology to communicate. A 2013 survey shows that 66% of younger millennials (16 to 24 years old) said they send texts instead of making phone calls, because it s easier. Millennials are said to view telephone calls as an interruption and are anecdotally referred to as phone-phobic. They also appear to favor texting over face-to-face communication. This style of communication accommodates open-space offices and minimizes the need for the small private spaces used for conversation and phone calls. 13 2014 Global Real Estate Strategy and Research Compendium HOME

Creative destruction: Generational shift in the U.S. office sector The appetite for creative office space is most pronounced in the metro areas with concentrations of tech employment. Leading-edge tech companies and smaller tech startups were the first adopters. They prefer edgier sub-market locations such as SOMA in San Francisco, the seaport in Boston, and Midtown South in Manhattan. These submarkets offer abundant older office and industrial properties with potential for conversion into creative space. More traditional companies are nibbling at creative space for their tech-heavy activities in order to attract and retain staff. Their efforts involve renovation of more traditional office space to incorporate elements of creative design. The secret sauce of creative space is that it actually economizes on the use of space. CBRE data show that office space per employee has been dropping since 2009 when it peaked at 196 square feet per employee to 182 in 2013. 9 Gensler predicts that such densification could reach as low as 100 square feet per employee as creative design spreads. 10 The opportunity to use less space is an enormous quantifiable benefit of creative design than will likely encourage adoption even for employers with less interest in satisfying the design esthetic of millennials. Exhibit 3: Occupied office space per employee 200 190 Square feet 180 170 160 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 Source: CBRE-EA as of 4Q 2013 Bottom line There is solid evidence of a generational shift underway with huge implications for the investment performance of office property. The components of the shift include the increasing role of tech in economic growth, the increasing role of millennials in manning that sector and as a proportion of the labor force generally, the perceived shortage of skilled workers and sensitivity of employers to retention, and the preference of skilled millennials for a creative space office environment. Over and beyond the generational shift, creative space design squeezes more employees into less space which is a quantifiable benefit for employers. These opportunities will be especially precious because other forces are shrinking prospects for office investors. The bottom line for investors is that the shift toward creative space is creating opportunities to offset some of the drag associated with slow office employment growth, densification in use of office space, and the overhang of space in less desirable locations, both in CBDs and suburbs. Investing in creative office space is challenging because it requires an understanding of technological, generational and locational forces that drive it. Over the long term, addressing the challenge should prove to be worthwhile. 14 2014 Global Real Estate Strategy and Research Compendium HOME

Creative destruction: Generational shift in the U.S. office sector We are acting on the emerging generational shift toward creative space by adjusting the investment strategy for the office portion of our portfolios. The first step is restructuring portfolios away from office properties that are in locations that do not appeal to millennials. Out-of-favor locations are likely to include more isolated neighborhoods that lack access to public transportation and cool amenities. Some will be in downtowns, others suburban. The second step is adding investment in office properties that can benefit from the generational shift. These will include properties in submarkets with relatively strong job growth especially jobs requiring tech skills that will draw millennials. But, the characteristics of these properties might be off-putting to some. Older buildings that would be shunned in the past can be particularly attractive and amenable to creative office retrofitting. The third step is to embrace leasing opportunities that transform space through creative design and use that space to demonstrate expertise to prospective tenants. This will likely require higher tenant allowances than traditional space design but should be worth it. The efficacy of this strategy is supported by the pattern of investment performance in the tech-heavy metro areas. Those markets are leading the way; investors are well advised to take notice and take action. 1 CBRE, Econometric Advisors, U.S. Tech Sector Dominates Office Leasing, September 9, 2013. 2 Moody s/rca CPPI, January 2014. 3 PwC, The Talent Challenge 2013. 4 McKinsey Global Institute, Big Data: The Next Frontier for innovation, competition, and productivity, June 2011. 5 Gallup Inc., State of the American Workplace, 2013. 6 PwC, NextGen: A Global Generational Study, 2013. 7 Gensler, 2013 U.S. Workplace Survey, Key Findings. 8 R. Boutellier, et. al., Impact of Office Layout on Communication in a Science-Driven Business, R&D Management, September 2008. 9 CBRE EA, Is The Demand for U.S. Office Space Shifting, October 28, 2013. 10 Gensler, 2013 U.S. Workplace Survey, Key Findings. Real estate securities are subject to various risks, including fluctuations in property values, higher expenses or lower income than expected, and potential environmental problems and liability. 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. Past performance does not guarantee future results. 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 adviser and wholly owned subsidiary of Teachers Insurance and Annuity Association (TIAA). TIAA, TIAA-CREF, Teachers Insurance and Annuity Association, TIAA-CREF Asset Management and FINANCIAL SERVICES FOR THE GREATER GOOD are registered trademarks of Teachers Insurance and Annuity Association. 2014 Teachers Insurance and Annuity Association of America-College Retirement Equities Fund (TIAA-CREF), 730 Third Avenue, New York, NY 10017 C15327 184925_410404 (03/14) 15 2014 Global Real Estate Strategy and Research Compendium HOME

June 2014 TIAA-CREF Asset Management Documeent title on one or two Awaiting lines in the Gustan cranes: Book 24pt Supply discipline and office market performance TIAA-CREF Global Real Estate Strategy & Research Martha Peyton, Ph.D. Managing Director Edward F. Pierzak, Ph.D. Managing Director Fabiana Lotito Senior Director The recovery in US commercial real estate that began in 2010 has been helped along by a very constrained pace of construction. Of the four main property types, only the apartment sector is generating supply inflows in line with historical norms. But, as vacancy rates continue declining, accompanied by increasingly strong credit availability, the stage is set for an upswing in commercial construction. The specter of cranes on the horizon cannot be far off. For investors, the key question is the potential impact on property investment performance as construction returns. With this in mind, this report examines the concept of supply discipline for US office markets and its relationship with total return performance. The analysis shows that the discipline associated with the best investment performance is composed of a combination of strong demand growth that produces significant absolute rent growth and just enough new construction to preserve that rent growth. Market Discipline Commercial real estate investors are likely to agree that supply-disciplined markets are preferable locations to markets without supply discipline. Yet, when pressed to offer a technique for identifying supply-disciplined markets, many are unable to do so, as their assessments are often based on experience and intuition. In essence, investors know a supply-disciplined market when they see one, but they have difficulty defining the concept in a technical sense. So, what constitutes a supply-disciplined property market? A simple definition is a market where new construction has historically responded in a lesser, yet aligned, manner to demand. This alignment can be measured technically using a metric from introductory economics called the price elasticity of supply (PES). 1 PES measures the responsiveness, or elasticity, of a quantity supplied to a change in price. It is simply calculated as the percent change in quantity supplied divided by the percent change in price. This concept can be easily adaptable to the supply response in individual property markets. For PES values less than 1, a change in price produces a lesser change in supply. In these situations, supply is considered inelastic; a condition consistent with supply-disciplined markets. For PES values greater than 1, supply is considered elastic; a likely situation for markets that lack supply discipline. 16 2014 Global Real Estate Strategy and Research Compendium HOME

Awaiting the Cranes: Supply Discipline & Office Market Performance For the analysis described in this report, we focus on the office sector and calculate each office market s PES by dividing its average annual percent change in stock by its average annual percent change in rent. 2 The analysis includes only the nineteen metro markets with full twenty calendar-year histories (1994 to 2013) for both CBRE Econometric Advisors (CBRE-EA) and National Council of Real Estate Investment Fiduciaries (NCREIF) data. 3 Figure 1 displays the PES values for the nineteen US office markets. The chart also shows two horizontal lines that serve as breakpoints and allow for the assignment of each market into one of three groups. Markets with PES values less than that of the US (roughly 0.5) were assigned to the low PES group and those with values near or greater than 1 were assigned to the high PES group; all other markets were placed in the moderate PES group. 4 Office Market Price Elasticity of Supply (1994 to 2013) Figure 1 3.0% 2.5% 16% 2.0% 1.5% 1.0% 0.5% PES=1.0 13% US PES 0.5 Low PES Moderate PES High PES 0.0% New York Houston New Houston York Los San Angeles Francisco Oakland Boston Denver Washington DallasChicago San Orange D.C. Diego Philadelphia County Austin Minneapolis Seattle St. Sacramento Louis Atlanta Los Angeles San Francisco Oakland Boston Denver Dallas Washington D.C. Chicago San Diego Orange County Philadelphia Austin Minneapolis Seattle St. Louis Sacramento Atlanta Sources: CBRE-EA, as of 4Q13; TIAA-CREF Perusing the list of markets in each PES group reveals few surprises; the results are very much consistent with investor expectations for each of the markets. The low PES markets include localities where new office construction is generally difficult for one or more reasons. For example, limited site availability and long development approval processes are clearly factors in both New York and San Francisco. In contrast, Atlanta, which is in the high PES group, is physically unconstrained and relatively friendly to developers. Washington, DC lies somewhere between these two extremes; it is physically constrained within the District itself, but close-in suburbs with excellent public transportation do offer substitute locations where building is easier. The one market with an unexpected PES result is Houston. Real estate practitioners with long memories will recall vacancy rates above 30% in Houston during the oil-bust years in the late 1980s. Easy credit, plenty of open land, and an absence of zoning restrictions all contributed to overbuilding even as demand waned. But, over the last 20 years, office construction in Houston has moderated with an average addition to stock of approximately 1% per year versus the national pace of roughly 1.3%. Could it be that Houston has become supply disciplined? A closer look at the annual data reveals that Houston s average annual supply growth over the last twenty years may be a statistical anomaly because virtually no new office supply was delivered in the market for the first five years of the analysis, 1994 to 1998. Yet, even after accounting for this dearth of development activity, Houston would continue to be categorized as a low PES office market. 17 2014 Global Real Estate Strategy and Research Compendium HOME

Awaiting the Cranes: Supply Discipline & Office Market Performance Discipline Pays Conventional wisdom suggests that investing in supply-disciplined property markets pays. But, does it? To answer this question, we examined the relationships between low, moderate, and high PES market portfolios and total return. Using NCREIF data from 1994 to 2013, average annual total return performance for each office market was compared to overall office sector performance and total return spreads were calculated for each market. Positive spreads indicated portfolio outperformance; negative spreads underperformance. Portfolio spreads were then calculated for each of the PES groups by taking the simple average of each group s individual market spreads. Figure 2 displays the average annual total return spreads for the low, moderate, and high PES market portfolios. Office Market Price Elasticity of Supply & Total Return Spreads (1994 to 2013) Figure 2 Average Annual Total Return Spreads (bps) 150 100 50 0-50 -100-150 13% 96 Low PES 4% -11 Moderate PES -103 High PES Sources: CBRE-EA, as of 4Q13; NCREIF, as of 4Q13; TIAA-CREF It is not possible to invest in an index. Performance for indices does not reflect investment fees or transactions costs. The results reveal a pecking order across the varying degrees of supply discipline. As expected, the low PES, or supply-disciplined, market portfolio had the best performance; its average annual total return spread was nearly 100 basis points. The high PES, or supply-undisciplined, market portfolio had the worst performance, underperforming by an average of roughly 100 basis points. The moderate PES market portfolio underperformed, but the average result was near zero, suggesting performance comparable to that of the broad office sector. The results indicate that, on average, supply-disciplined markets have historically outperformed; markets that lack supply discipline have underperformed. Tell Me More But, this categorization alone is not a basis for making investment judgments because not all markets within a particular PES group offer equivalent attractiveness. For example, with its historically limited supply and modest rent growth, Hartford, CT would be considered a low PES market. 5 But, despite its low PES value, Hartford lacks broad appeal for real estate investors. Its supply discipline is not enough to compensate for its shortcomings which constrain the demand for office space. 18 2014 Global Real Estate Strategy and Research Compendium HOME

Awaiting the Cranes: Supply Discipline & Office Market Performance Differences across markets are illustrated in Figure 3. For the low PES portfolio, all of the total return spreads were positive, indicating market outperformance, but portfolio performance was primarily driven by New York and San Francisco. For the high PES portfolio, market performance was consistently bad with the exception of the high growth markets, Austin and Seattle. For the moderate PES group, markets were equally split between outperformers and underperformers. In all, there were 6 markets that can be viewed as significant chronic underperformers: Philadelphia, Chicago, Sacramento, St. Louis, Atlanta, and Minneapolis. All of these markets underperformed the broad office sector, on average, by more than 150 basis points per year over the last 20 years. Individual Office Market Average Annual Total Return Spreads (1994 to 2013) Figure 3 300 200 100 0-100 255 Low PES 159 31 24 13% 9 131 128 Moderate PES 103 51-9 -88 190 49 High PES -200-174 -230-300 New York New San York Francisco Oakland Los Angeles Houston Orange Boston Washington County San Diego Denver D.C. Dallas Philadelphia Seattle Austin Sacramento St. Louis Atlanta Minneapolis Chicago San Francisco Oakland Los Angeles Houston Boston Orange County Washington D.C. San Diego Denver Dallas Philadelphia Chicago Seattle -188-192 -194 Austin Sacramento St. Louis -283 Atlanta Minneapolis Sources: CBRE-EA, as of 4Q13; NCREIF, as of 4Q13; TIAA-CREF With chronic underperformers in both the moderate and high PES groups, there is obviously more to the market supply discipline story that needs explaining. To explore this view, Figure 4 plots the components of the PES calculation, average annual change in stock and average annual change in rent, for individual office markets. Each market is identified along with its average annual total return spread in basis points over the last twenty calendar years. The scatter plot also displays the lines that correspond to the breakpoints for the groups. The purple line shows all points where PES values equal 1; the blue line shows all points where PES values equal the US value, roughly 0.5. 19 2014 Global Real Estate Strategy and Research Compendium HOME

Awaiting the Cranes: Supply Discipline & Office Market Performance Average Annual Percentage Change in Stock & Rent (1994 to 2013) Figure 4 Average Annual Change in Rent 5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% NY; +255 LA; +24 Hou; +9 CHI; -230 SF; +159 OAK; +31 BOS; +131 MIN; -283 Low PES OC; +128 PHI; -174 DEN; -9 DAL; -88 STL; -192 DC; +103 SD; +51 SEA; +190 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% Average Annual Change in Stock Moderate PES US PES 0.5 SAC; -188 ATL; -194 AUS; +49 High PES PES=1.0 Sources: CBRE-EA, as of 4Q13; NCREIF, as of 4Q13; TIAA-CREF The complexity of the chart requires very careful examination which is rewarded with a clear conclusion. Supply discipline is not only about the relative response of supply to changes in rent as in the PES measure, it is also about the absolute response of supply to absolute changes in rent. The metro markets enclosed in the oval are the 6 chronic underperforming office markets; they include both moderate and high PES markets. In these markets, supply responded to rent changes that were too weak to produce outperformance in total return. In contrast, both Seattle and Austin are high PES markets where supply has been very responsive to rent changes, but those rent changes have been strong enough to propel outperformance. These observations suggest that investors need to consider both supply discipline and the absolute magnitude of expected rent changes in their market selection processes. The latter encompasses all the factors that influence local economic vitality and demand for space. 20 2014 Global Real Estate Strategy and Research Compendium HOME