OUTLOOK FOR 2008
While
commercial real estate fundamentals have remained positive to date despite the
capital markets turmoil of recent months, Management expects these fundamentals
to weaken to some degree in the months ahead as a result of a weak economic
growth environment. There is little disagreement among economic forecasters
with regard to the first half of 2008; expectations of very weak, if not
negative, growth are unanimous. Some forecasters are expecting mildly negative
GDP growth during the first half while others are expecting weakly positive
growth. While the difference might well determine whether this period is
actually
deemed to be a “recession”, the impact on commercial real estate
will probably not differ much one way or the other. The larger question is
whether economic growth will rebound materially in the second half of the year.
Here, management shares the view among more optimistic forecasters which calls
for a rebound to positive, but still sub-par growth in the third and fourth
quarters largely as a result of the Federal Reserve’s interest rate cuts that
began in September. This view is shared by the Federal Open Market Committee
which is the policy setting arm of the Federal Reserve. As reported by Chairman
Bernanke in his February 2008 Semiannual Monetary Policy Report to Congress,
the FOMC members believe that GDP growth in 2008 will amount to 1.3% to 2.0%
with a rebound “close to or a little above its longer-term trend” in 2009 and
2010. They also expect inflation will be “moderate” from its 2007 pace.
With
slow growth or mild recession in the first half of 2008, followed by only a
weak rebound in the second half, growth in tenant demand for office, industrial
and retail space will likely slip, rent growth will likely slow or flatten out,
and vacancy rates will probably inch up. The degree of commercial real estate
market weakening will be mitigated by the generally balanced conditions that
currently prevail in many if not most metro area markets. In addition, the
credit market constraints now in play, combined with the weaker demand outlook,
will likely constrain new commercial real estate construction activity into
2009. Constrained additions to supply along with the expected strengthening in
economic growth will set the stage for a repair of fundamentals in 2009.
Commercial
real estate pricing in the near term will be largely determined by a
combination of factors including the level and uncertainty associated with
Treasury rates and inflation, and the general pricing of risk across all asset
types. Assuming that the period of economic weakness is short-lived, Treasury
rates should achieve a cycle low in the first half of the year and then slowly
rebound as the economy recovers, with transitory volatility as inflation
expectations ebb and flow. Low Treasury rates should cushion the impact of
wider cap rate spreads which, for commercial real estate, are approaching their
long-term norms. Additionally, pricing pressures have so far been concentrated
on properties that are in less attractive locations or have less attractive
investment characteristics. Management believes that such distinctions will
continue in light of the ongoing strong investor demand for the most attractive
properties. Nonetheless, in light of less available and more expensive
commercial mortgage debt, it is possible that the number of investors pursuing
commercial real estate will be smaller in 2008 than in prior years,
contributing to some easing of pricing pressure across the quality spectrum.
There is some evidence of this in the reduction in transaction volume in recent
months relative to volumes in the prior three years. At the same time, management
believes the quality of commercial mortgage credit is holding up well;
delinquency rates remain very low and distressed sales of commercial property
are not, at this point, prevalent.
52 Prospectus § TIAA Real
Estate Account
Note this assumption in the above - Assuming that the period of economic weakness is short-lived!
Ray
