Review and Outlook

as of 03/31/24

Investors entered the new year optimistic that a soft landing was in store for the economy, in which a recession would be avoided, inflation would continue to dissipate, and the Fed would start cutting interest rates in March. The economy has not only avoided recession, but it has been stronger than market forecasts. Meanwhile, inflation has again turned sticky, and Fed rate cuts have been delayed to at least June. The return to “higher for longer” rate concerns was a headwind for real estate equities, as the market views this category as a beneficiary of lower rates.

Against this backdrop, Baron Real Estate Income Fund increased. Investments within the non-REIT real estate companies, data center REITs, and mall REITs categories contributed the most. Holdings within wireless tower REITs, self-storage REITs, and industrial REITs categories detracted the most. Toll Brothers, Inc. and Wynn Resort, Limited, the top and second largest contributors, respectively, led gains within non-REIT real estate companies. Gains in both holdings within data center REITs boosted that category’s performance. Third largest contributor Simon Property Group, Inc. drove appreciation within mall REITs. Top detractor American Tower Corporation drove declines within wireless tower REITs, while second largest detractor drove weak performance within self-storage REITs. Industrial warehouse REIT Rexford Industrial Realty, Inc. led declines within industrial REITs.

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 that prioritizes a full array of REITs but also invests in non-REIT income-oriented real estate companies will shine even brighter in an evolving real estate landscape.

Top Contributors/Detractors to Performance

as of 03/31/24

Contributors

  • Toll Brothers, Inc. is a leading U.S. homebuilder. Positive performance was driven by continued signs of resilience and improvement in the U.S. homebuilding industry, strong results, and management's rosy business outlook. New single-family home construction activity in the U.S. remains below the levels needed to meet demand following a decade of under-building. Toll is a differentiated homebuilder with a niche focus on high-end homes and an excellent management team. 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.
  • Wynn Resorts, Limited owns casinos in Las Vegas, Boston, and Macau. Shares increased on quarterly results across its portfolio that beat consensus. Its Macau asset showed signs of rebounding to pre-pandemic levels while its Las Vegas and Boston assets continued to take share. We remain shareholders, given Wynn's strong growth prospects, including a UAE casino slated to open in early 2027 as well as modest growth in existing properties. With its Macau asset trading at a significant discount to its pre-pandemic historical level, we believe Wynn's valuation remains attractive.
  • Simon Property Group, Inc. is the largest U.S. mall and outlet REIT. Positive performance was driven by strong fundamentals for high-quality mall and outlet real estate. Simon continues to focus on maximizing shareholder value through monetizing non-core investments, pursuing accretive redevelopment projects, and considering acquisition opportunities. Simon's size and balance sheet strength should ensure it will stay a dominant force in the U.S. mall business, where scale matters, and in the outlet business (50% market share).

Detractors

  • American Tower Corporation is a REIT that owns and operates 220,000 cell phone towers, with 40,000 in the U.S. and 180,000 internationally. The stock gave up some gains following a rebound in the prior quarter, as shares of higher valued companies were impacted by the increase in interest rates during the first quarter. In addition, uncertainty around the timing and ultimate financial impact of American Tower’s sale of its India business, combined with lower overall spending by wireless carriers, weighed on shares. We remain investors given durable demand drivers in data growth and video, accelerating growth, and the company’s ability to grow its portfolio and return excess capital to shareholders.
  • Extra Space Storage Inc. is a REIT that owns one of the largest self-storage portfolios in the U.S. Shares detracted from performance during the first quarter due to ongoing business challenges in the self-storage industry. We remain optimistic about Extra Space’s long-term growth prospects given the overall quality of its self-storage portfolio and synergies associated with the company's 2023 merger with Life Storage.
  • ​Boston Properties, Inc. is a REIT that owns a portfolio of high-quality office buildings across many major U.S. cities. Shares detracted from performance during the first quarter after the company reported weak full-year guidance. While we believe the stock is trading at a discounted valuation that, in part, reflects near-term business challenges, we have this position under review.

Quarterly Attribution Analysis (Institutional Shares)

as of 03/31/24

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.

as of 03/31/24

Baron Real Estate Income Fund (Institutional Shares) rose 1.96% in the first quarter, outperforming the MSCI US REIT Index by 258 basis points due to differences in REIT category exposures.

Non-REIT real estate companies contributed 240-plus basis points of relative gains, accounting for most of the outperformance in the period. Strength in the category was broad based, led by double-digit gains from homebuilder Toll Brothers, Inc. and casino operator Wynn Resorts, Limited. Toll Brothers was the top contributor in response to continued signs of resilience and improvement in the U.S. homebuilding industry, strong financial results, and management's rosy business outlook. Wynn’s shares increased on quarterly results across its portfolio that beat Street expectations. The company’s Macau asset showed signs of rebounding to pre-pandemic levels while its Las Vegas and Boston assets continued to take share. Other standouts in the category were pure-play timeshare company Marriott Vacations Worldwide Corporation, homebuilder Lennar Corporation, home improvement retailer Lowe's Companies, Inc., and alternative investment management firm Brookfield Asset Management Ltd.

The Fund also benefited from solid stock selection in health care REITs, negligible exposure to lagging triple net and shopping center REITs, and higher exposure to better performing single-family rental and data centers REITs. Performance in health care REITs was bolstered by Welltower Inc., a leading operator of senior housing, life science buildings, and medical offices. Welltower’s shares rose on solid cash flow growth in the company’s senior housing portfolio, driven by strong rent and occupancy growth, an attractive full-year outlook, robust demand from new residents, and ample capital deployment opportunities sourced by management. Stock selection in the category was further enhanced by the Fund’s limited exposure to Ventas, Inc., whose shares fell sharply in the period after the company provided a disappointing full-year growth outlook due to upcoming lease expirations that have a high probability of not getting renewed.

Somewhat offsetting the above was poor stock selection in office REITs coupled with unique exposure to wireless tower REITs and lower exposure to better performing other REITs, which together were a 90-plus basis point drag on performance. Weakness in office REITs was due to disappointing performance from Boston Properties, Inc., an owner of high-quality office buildings across many major U.S. cities. The company’s shares declined due to disappointing growth prospects for 2024. While we believe the stock is trading at a discounted valuation that, in part, reflects near-term business challenges, we have this position under review.

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.