Review and Outlook

as of 12/31/23

Following a three-month downturn, the markets went on a bull run in the last two months of the year. Improving inflation data coupled with dovish comments from the Federal Reserve spurred an “everything rally” in which real estate fully participated. In a significant shift from its earlier stance, the Fed suggested it was planning three interest rates cuts over 2024. The end of “higher for longer” rate concerns was a tailwind for real estate equities, as the market views this category as a beneficiary of lower rates. Despite low unemployment and robust consumer spending – typically viewed as inflation drivers -- inflation continued to trend lower, with the annual rate dropping to 3.4% in December. Investor fears of a recession were replaced by optimism that the Fed had successfully orchestrated a “soft landing,” generating further cause for cheer on top of the prospect that the Fed would soon start cutting interest rates.

Baron Real Estate Fund increased in the quarter. Holdings within the homebuilders & land developers, REITs, and real estate service companies categories contributed the most. No category detracted. Homebuilders & land developers had a strong quarter, with the top three contributors to performance all within the category. Appreciation within REITs was led by industrial warehouse REIT Prologis, Inc., whose shares increased on positive operating and financial results. All three real estate service companies advanced, led by CoStar Group, Inc. Shares of this marketing and data analytics provider to the real estate industry increased on multiple expansion.

The last few years have been unusually challenging for real estate. Much of real estate has had to absorb a hurricane of headwinds including COVID-19, the most aggressive Federal Reserve rate tightening campaign in decades, a spike in mortgage rates from 3% to 8%, fears of a commercial real estate crisis, a tightening of credit availability, multi-decade high inflation, and supply chain challenges. We are encouraged by the strong performance of real estate equities in the most recent quarter and believe many of the challenges of the last few years are subsiding. Though we expect market volatility at various points in the year ahead, we believe brighter prospects for real estate are on the horizon. We also believe the narrative about a commercial real estate crisis is hyperbole and unlikely to materialize. Public real estate generally enjoys favorable demand versus supply prospects, maintains conservatively capitalized balance sheets, and has access to credit.

We have assembled what we think is a portfolio of competitively advantaged real estate companies with compelling long-term growth and share price appreciation potential. We have structured the portfolio to capitalize on high conviction investment themes. Valuations and return prospects are attractive. We believe the benefits of our broader and more flexible approach, which allows us to invest in both REITs and non-REIT real estate-related companies, will shine even brighter in the years ahead.

Top Contributors/Detractors to Performance

as of 12/31/23

Contributors

  • Toll Brothers, Inc. is a leading U.S. homebuilder specializing in the luxury and "affordable luxury" segments. Positive performance was helped by a pronounced decline in mortgage rates, which made new home purchases more affordable. Share prices gains were also driven by strong operating and financial results, as the company continued to benefit from resilient demand for new housing, market share gains against smaller and less well-capitalized competitors, and healthy profitability margins and returns on capital. We remain shareholders. New single-family home construction activity in the U.S. remains below the levels needed to meet current and pent-up demand following a decade of under-building. In our view, Toll is a differentiated homebuilder with a niche focus on high-end homes and an excellent management team with high inside ownership. We think Toll Brothers is well positioned to benefit from housing growth through its sizable land bank, healthy balance sheet, and market share gains against smaller players.
  • D.R. Horton, Inc. is the nation's largest homebuilder. A pronounced decline in mortgage rates during the fourth quarter, which made new home purchases more affordable, helped boost the share price. Strong performance was also driven by robust operating and financial results, as the company continued to benefit from resilient demand for new housing, market share gains against smaller and less well-capitalized competitors, and healthy profit margins and returns on capital. We retain conviction. New single-family home construction activity in the U.S. remains below the levels needed to meet current and pent-up demand following a decade of under-building. As the largest homebuilder, D.R. Horton is well positioned to benefit from end-market growth and market share gains. The company is also driving improved returns on capital via margin expansion and improved capital efficiency.
  • ​Lennar Corporation is one the largest homebuilders in the U.S. Positive performance was helped by a pronounced decline in mortgage rates during the fourth quarter, which made new home purchases more affordable. Shares were also boosted by strong operating and financial results, as the company continued to benefit from resilient demand for new housing, market share gains against smaller and less well-capitalized competitors, and healthy profit margins and returns on capital. We retain conviction. New single-family home construction activity in the U.S. remains below the levels needed to meet current and pent-up demand following a decade of under-building. As one of the largest homebuilders, Lennar is well positioned to benefit from end market growth and market share gains.

Detractors

  • Public Storage Incorporated is the largest self-storage REIT. The company detracted from performance in the fourth quarter due to an industry-wide softening in pricing power and demand from new customers following two years of outsized growth. We retain conviction in the longer-term business prospects for Public Storage and the self-storage industry in general, given continued resilience of existing storage customers, and we expect rents for new customers to soon stabilize.
  • Wynn Resorts, Limited, a global owner and operator of casinos in Macau, Las Vegas, and Boston, detracted from performance due to Macau's continued slow recovery following the lifting of COVID-related restrictions. We retain conviction. Macau's recovery remains on track, in our view, and we believe should come close to or exceed pre-COVID EBITDA levels in 2024, leading to earnings and cash flow growth which Wynn can use to pay down debt and invest in improvements at its casinos. The company's Macau assets trade at significant discount to pre-COVID levels and we believe should return to more appropriate valuation multiples in the coming years as investors see the growth and durability of these earnings streams.
  • Shares of timeshare company Marriott Vacations Worldwide Corporation fell in the quarter, driven by soft sales of timeshare units due to higher interest rates and the slow ramp of a new product offering. A default rate that was higher than the company had anticipated forced it to take a charge to increase its reserves, pressuring earnings and cash flow. We remain investors. The company has a strong balance sheet with a well-covered 3% dividend. It continues to use cash flow to buy back its shares, and management has personally bought stock at much higher levels than current prices.

Investors should consider the investment objectives, risks, and charges and expenses of the investment carefully before investing. The prospectus and summary prospectuses contain this and other information about the Funds. You may obtain them from the Funds’ distributor, Baron Capital, Inc., by calling 1-800-99BARON or visiting www.BaronFunds.com. Please read them carefully before investing.

The performance data quoted represents past performance. Past performance is no guarantee of future results. The investment return and principal value of an investment will fluctuate; an investor's shares, when redeemed, may be worth more or less than their original cost. The Fund’s transfer agency expenses may be reduced by expense offsets from an unaffiliated transfer agent, without which performance would have been lower. Current performance may be lower or higher than the performance data quoted.

Risks:All investments are subject to risk and may lose value.

The discussion of market trends is not intended as advice to any person regarding the advisability of investing in any particular security. The views expressed on this page reflect those of the respective writer. Some of our comments are based on management expectations and are considered “forward-looking statements.” Actual future results, however, may prove to be different from our expectations. Our views are a reflection of our best judgment at the time and are subject to change at any time based on market and other conditions and Baron has no obligation to update them

Portfolio holdings are subject to change. Current and future portfolio holdings are subject to risk.

The index performance is not fund performance; one cannot invest directly into an index.