Baron Real Estate Fund (BREIX)

Portfolio Management

Jeffrey Kolitch

Fund Manager since 2009

View All Commentary by Jeffrey

Fund Description

Baron Real Estate Fund invests in securities of real estate and real estate related companies of all sizes.


Fund Resources

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Portfolio Commentary

Institutional Performance

Review and Outlook (for quarter ended 9/30/2015)

The generally unimpeded six-year rally in the stock market, most real estate securities, and Baron Real Estate Fund hit a speed bump in the third quarter. Investor concerns included uncertainty over China’s economic growth prospects, the devaluation of the yuan, weak oil and commodity prices, uncertainty over the timing of a Fed rate hike, and stretched valuations for certain segments of the market.

REITs was the only real estate category to contribute. Business conditions were generally strong for our REIT companies, and we think they may continue to benefit from low interest rates, occupancy growth and increased rents at a time of limited new construction activity, improved balance sheets, access to low cost capital, and accretive investment opportunities. We are mindful, however, that many of the Fund's non-REIT companies’ valuations are more compelling. Also, REITs may be more vulnerable to an eventual rise in interest rates than non-REIT real estate stocks.

The categories that detracted the most included hotels & leisure, building products/services, and senior housing operators & health care facilities. Hotel & leisure declined due to concerns over the possibilities of a global economic slowdown, the end of the lodging cycle, increased inventory, and/or pricing pressure from new competitors such as Airbnb, as well as difficult year-over-year growth comparisons and weaker-than-expected financial results and forecasts by several companies. We maintain conviction in our hotel & leisure holdings given solid demand forecasts, generally low supply forecasts, company-specific initiatives that may unlock shareholder value, the growing likelihood of mergers & acquisition activity, and attractive valuations. Weak performance of the building products/services category was primarily driven by a sharp drop in the stock price of top detractor CaesarStone Sdot-Yam Ltd. The senior housing operators & health care facilities sub-category was negatively impacted by the stock price decline of the second biggest detractor, Brookdale Senior Living Inc.

We believe many real estate valuations have become more attractive following the recent decline in the markets. Business conditions for commercial and residential real estate are generally appealing. Demand is outstripping supply, credit has improved, balance sheets are solid, interest rates are low, and valuations are reasonable. We think many categories of real estate are on the cusp of entering the growth phase of the real estate recovery. We are bullish on long-term prospects for housing due to improving household formation and employment, pent-up demand, low inventories, favorable mortgage rates, and reasonable prices. We believe the relative lack of real estate construction activity combined with low interest rates following the 2008-09 credit crisis and economic downturn portend a longer lasting real estate recovery cycle than most prior cycles of five to seven years.

We are hopeful that the Fund's investments will continue to report solid business results, favorable business outlooks, and possible initiatives to increase shareholder value such as strategic acquisitions or corporate reorganizations.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 9/30/2015)
  • Equinix, Inc. is a network neutral global operator of state-of-the-art data centers. Shares performed well in Q3 and year-to-date as Equinix completed its REIT transformation, reduced its cost of capital, and bid for a large European competitor. We continue to like the growth prospects for Equinix’s business and believe that management has a clear and sensible plan to keep growing at a faster pace than its peers while improving business efficiencies.

  • Shares of hotel REIT Strategic Hotels & Resorts, Inc. were a contributor in the quarter as Blackstone agreed to acquire the company for $14.25 per share.

  • AvalonBay Communities, Inc. saw its stock price rise during Q3. AvalonBay is a REIT that focuses on high quality apartment communities in high barrier-to-entry U.S. coastal markets. Strong performance was driven by strong Q2 results and a preannouncement of better than expected results for Q3.

Detractors (for quarter ended 9/30/2015)
  • CaesarStone Sdot-Yam Ltd. is a leading global manufacturer of quartz surfaces for kitchens and bathrooms. Shares fell sharply in August after the company reduced its full-year revenue guidance on the second quarter earnings call. A negative report by a short seller of the stock also weighed on the stock price. We believe investors overreacted to both events and remain positive on our investment in CaesarStone, as earnings growth accelerates from successful new product launches and quartz market share gains vs. other countertop materials.

  • Shares of senior housing company Brookdale Senior Living Inc. fell in Q3 on concerns over the integration with Emeritus, lagging occupancy, and a possible increase in senior housing supply. Investors appear less optimistic that management will pursue actions to unlock shareholder value, such as the sale of the company or a spin-off of owned real estate. Absent such a transaction, we still believe Brookdale will benefit from positive demographics, deeper senior housing penetration, and favorable supply/demand balance.

  • Shares of timeshare resort company Diamond Resorts International, Inc. fell in Q3 due to investor concerns over the potential supply threat from vacation rental website Airbnb and regulations by the Consumer Financial Protection Bureau that could potentially affect timeshare financing. However, neither of these issues appeared to have an impact on sales, and we do not anticipate any future impact. We believe it is possible that Airbnb could become a distribution outlet for timeshare sales by Diamond Resorts.

Quarterly Attribution Analysis (for quarter ended 9/30/2015)

When reviewing performance attribution on our portfolio, please be aware that we construct the portfolio from the bottom up, one stock at a time. Each stock is included in the portfolio if it meets our rigorous investment criteria. To help manage risk, we are aware of our sector and security weights, but we do not include a holding to achieve a target sector allocation or to approximate an index. Our exposure to any given sector is purely a result of our stock selection process.

Baron Real Estate Fund declined 9.91% in the third quarter, yet trailed the MSCI USA IMI Extended Real Estate Index by 704 basis points due to stock selection and relative real estate category weights.

Outperformance of the Fund’s only holding in the casinos & gaming real estate category, MGM Resorts International, and average cash exposure of 3.6% in a down market contributed to relative results. Within casinos & gaming, outperformance of MGM was somewhat offset by slightly larger exposure to this lagging category, which fell 22% in the index. Shares of MGM performed well after the company announced a $300 million profit improvement plan to cut costs and improve revenue efficiencies by 2017. The sale of Las Vegas Sands Corp. and Wynn Resorts Ltd. in the first half of the year also aided relative performance after these stocks fell 27.0% and 46.0%, respectively, in the index during the quarter. Favorable stock selection in REITs owing mostly to the outperformance of Strategic Hotels & Resorts, Inc., Equinix, Inc., and Douglas Emmett, Inc. also contributed, but was overshadowed by meaningfully lower exposure to this category. REITs finished up slightly in the index during the quarter, bolstered by the Federal Reserve’s decision to not raise interest rates at its mid-September meeting.

Underperformance of investments within the building products/services, hotels & leisure, and senior housing operators & health care facilities categories and larger exposure to lagging real estate service companies detracted the most from relative results. Within building products/services, underperformance of CaesarStone Sdot-Yam Ltd., the largest detractor on an absolute basis, and Summit Materials, Inc., a company formed to acquire and expand heavy-side building materials businesses hampered relative results. Summit’s shares declined as a result of more tempered expectations around the pace of future acquisitions. Its higher-than-average leverage exacerbated the impact to the stock price. Notably lower exposure to strong performing home improvement retailers Home Depot, Inc. and Lowe's Companies, Inc., which account for 13% of the index’s exposure to the category, also hurt relative results. Within hotels & leisure, cruise line investments added value, but this positive effect was more than offset by the underperformance of its hotels & timeshare companies, led by Diamond Resorts International, Inc., Hilton Worldwide Holdings, Inc., and Hyatt Hotels Corp. Diamond Resorts was the third largest detractor from absolute performance, while shares of Hilton and Hyatt fell due to concerns over the possible end of the lodging cycle fueled by several pre-announced 3Q earnings and weaker-than-expected trends in indicated revenue per available room. Weakness in senior housing operators & health care facilities was mainly due to underperformance of Brookdale Senior Living, Inc. and Capital Senior Living Corp. Brookdale was the second largest detractor on an absolute basis, while shares of Capital Senior fell on concerns that an acceleration in new construction of senior living facilities will potentially limit owners’ abilities to raise rental rates in the future.

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The prospective performance of the companies discussed herein is based on our internal analysis and reflect our opinions only. We cannot promise future returns and our opinions are a reflection of our best judgement at the time of publication. Our views are not intended as recommendations or investment advice to any person and are subject to change at any time based on market and other conditions and Baron has no obligation to update them. Investing in the stock market is always risky. Current and future portfolio holdings in the Fund are subject to risk.

Source: FactSet PA.