Zephyr18
Dear Baron Real Estate Income Fund Shareholder
We are pleased to report that on its 7th anniversary, Baron Real Estate Income Fund® (MUTF:BRIIX, the Fund) delivered the #1 ranked 2024 performance among all real estate funds.
Looking back over its 7-year period since inception on December 29, 2017, through December 31, 2024, the Fund’s cumulative return of 89.30% (Institutional Shares) was more than double that of the MSCI US REIT Index (the REIT Index), which increased 36.42%.
As of December 31, 2024, the Fund has maintained high rankings from Morningstar for its performance:
- #4 ranked real estate fund for its 5-year performance period
- #4 ranked real estate fund ranking since the Fund’s inception on December 29, 2017
Notably, the only real estate fund that is ranked higher than the Fund for the trailing 5-year and since inception periods is the other real estate fund that we manage, the Baron Real Estate Fund®, which has three share classes.
Please refer to “Our current top-of-mind thoughts” section in this letter. There, we reflect on the past 7 years and discuss our optimistic expectations for the next 7 years.
For the full year, the Fund increased 17.36%, significantly outperforming the REIT Index, which appreciated 7.49%.
The fourth quarter of 2024 was challenging, however, as a sharp rise in the U.S. 10-year treasury yield from 3.8% to 4.6% weighed on several real estate shares in addition to concerns that restrictions on immigration, the possibility of raising or imposing new tariffs, still high federal deficits, and an acceleration in economic growth may result in an uptick in inflation and even higher interest rates. In the most recent quarter, the Fund increased 0.95%, significantly outperforming the REIT Index, which decreased 6.39%.
We will address the following topics in this letter:
- Our current top-of-mind thoughts
- Portfolio composition
- Top contributors and detractors to performance
- Recent activity
- Concluding thoughts on the prospects for real estate and the Fund
Table I. Performance Annualized for periods ended December 31, 2024
| Baron Real Estate Income Fund Retail Shares1,2 | Baron Real Estate Income Fund Institutional Shares1,2 | MSCI US REIT Index1 | S&P 500 Index1 | |
| Three Months3 | 0.91% | 0.95% | (6.39)% | 2.41% |
| One Year | 17.16% | 17.36% | 7.49% | 25.02% |
| Three Years | (0.81)% | (0.56)% | (3.43)% | 8.94% |
| Five Years | 9.00% | 9.28% | 3.10% | 14.53% |
| Since Inception (December 29, 2017) | 9.31% | 9.55% | 4.54% | 13.83% |
| Since Inception (December 29, 2017) (Cumulative)3 | 86.49% | 89.30% | 36.42% | 147.70% |
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As of 12/31/2024, the Morningstar Real Estate Category consisted of 220, 210, 194, and 196 share classes for the 1-, 3-, 5-year, and since inception (12/29/2017) periods. Morningstar ranked Baron Real Estate Income Fund Institutional Share Class in the 1st, 5th, 2nd, and 2nd percentiles for the 1-, 3-, 5-year, and since inception periods, respectively. On an absolute basis, Morningstar ranked Baron Real Estate Income Fund Institutional Share Class as the 2nd, 11th, 5th, and 4th best performing share class in its Category, for the 1-, 3-, 5-year, and since inception periods, respectively. As of 12/31/2024, Morningstar ranked Baron Real Estate Income Fund R6 Share Class in the 1st, 5th, 2nd, and 3rd percentiles for the 1-, 3-, 5-year, and since inception periods, respectively. On an absolute basis, Morningstar ranked Baron Real Estate Income Fund R6 Share Class as the 1st, 10th, 4th, and 5th best performing share class in its Category, for the 1-, 3-, 5-year, and since inception periods, respectively. Since inception rankings include all share classes of funds in the Morningstar Real Estate Category. Performance for all share classes date back to the inception date of the oldest share class of each fund based on Morningstar’s performance calculation methodology. Morningstar calculates the Morningstar Real Estate Category Average performance and rankings using its Fractional Weighting methodology. Morningstar rankings are based on total returns and do not include sales charges. Total returns do account for management, administrative, and 12b-1 fees and other costs automatically deducted from fund assets. Since inception rankings include all share classes of funds in the Morningstar Real Estate Category. Performance for all share classes date back to the inception date of the oldest share class of each fund based on Morningstar’s performance calculation methodology. © 2025 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its affiliates or content providers; (2) may not be copied, adapted or distributed; (3) is not warranted to be accurate, complete or timely; and (4) does not constitute advice of any kind, whether investment, tax, legal or otherwise. User is solely responsible for ensuring that any use of this information complies with all laws, regulations and restrictions applicable to it. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. MORNINGSTAR IS NOT RESPONSIBLE FOR ANY DELETION, DAMAGE, LOSS OR FAILURE TO STORE ANY PRODUCT OUTPUT, COMPANY CONTENT OR OTHER CONTENT. Performance listed in the above table is net of annual operating expenses. The gross annual expense ratio for the Retail Shares and Institutional Shares as of December 31, 2023 was 1.32% and 0.96%, respectively, but the net annual expense ratio was 1.05% and 0.80% (net of the Adviser’s fee waivers), respectively. 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 Adviser waives and/ or reimburses certain Fund expenses pursuant to a contract expiring on August 29, 2035, unless renewed for another 11-year term and 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. For performance information current to the most recent month end, visit BaronCapitalGroup.com or call 1-800-99-BARON. (1)The MSCI US REIT Index Net (USD) is designed to measure the performance of all equity REITs in the U.S. equity market, except for specialty equity REITs that do not generate a majority of their revenue and income from real estate rental and leasing operations. The S&P 500 Index measures the performance of 500 widely held large-cap U.S. companies. MSCI is the source and owner of the trademarks, service marks and copyrights related to the MSCI Indexes. The MSCI US REIT Index and the Fund include reinvestment of dividends, net of foreign withholding taxes, while the S&P 500 Index includes reinvestment of dividends before taxes. Reinvestment of dividends positively impacts performance results. The indexes are unmanaged. Index performance is not Fund performance. Investors cannot invest directly in an index.(2)The performance data in the table does not reflect the deduction of taxes that a shareholder would pay on Fund distributions or redemption of Fund shares.(3)Not annualized. |
Our Current Top-of-Mind Thoughts
7-year review – reflections on the past
Since its launch on December 29, 2017, the key factor that positioned the Fund for success relative to more traditional active and passively managed REIT funds is that we embraced and structured a more expansive and diversified real estate income fund.
Though REITs tend to be at least 75% to 80% of net assets (versus most REIT funds that tend to invest approximately 100% in REITs), the Fund has the capacity to invest up to 20% to 25% in non-REITs, primarily dividend paying real estate companies. Further, unlike many of our peers, the Fund is willing to invest in REITs that are not in the REIT Index. The Fund primarily invests in U.S. real estate equity income securities, but it may also invest in international real estate companies and other real estate income vehicles such as real estate debt and preferred securities.
Further, we felt that the Fund’s flexibility would improve the likelihood that it could navigate exogenous events – e.g., a global pandemic, spikes in interest rates, commercial real estate crisis fears – better than its competition, including most active, passive, semi-liquid, and private real estate peers.
In a comparison of U.S. listed REIT returns versus U.S. non-listed or private real estate funds, Green Street, a highly regarded third-party REIT research firm, published a report on November 25, 2024, that compares the trailing 15-year annualized total returns of listed US REITs versus non-listed or private real estate funds (through June 2024). According to Green Street, U.S. listed REITs generated an annualized return of 11.5%, far exceeding the 7.4% annualized return of U.S. non-listed real estate funds.
We believe the Fund’s cumulative 7-year return through December 31, 2024, also exceeds the performance of most if not all U.S. non-listed or private real estate funds in addition to outperforming actively managed REIT funds, passive/ETF real estate funds, and semi-liquid non-traded REITs.
The next 7 years – we are even more optimistic
Looking forward, we believe the merits of our more comprehensive, flexible, and actively managed investment approach will shine even brighter.
A rapidly evolving real estate universe that requires more discerning analysis (there are more “winners” and “losers”), the prospects for a structurally higher interest rate environment, and several other items that may impact real estate including the onset of AI, the rise in geopolitical tensions, immigration, shelter, tariff, and other investment considerations should favor more flexible and liquid real estate investment strategies that cast a wider real estate investment net. We believe we have developed the right real estate income product for long-term success.
Our highly differentiated real estate income fund enjoys, in our opinion, attractive attributes compared to actively managed REIT funds, passive/ETF real estate funds, non-traded REITs, and private real estate.
The Fund versus actively managed REIT funds
- The Fund’s flexibility allows it to invest approximately 20% to 25% of net assets in non-REIT real estate companies (also with a dividend yield prioritization). At times, these companies may present superior growth, income, and/or share price appreciation potential.
- Many REIT funds limit their REIT investments to companies that are included in their comparative REIT benchmark. Our key focus is identifying compelling REITs and other real estate income companies with attractive share price appreciation potential – regardless of whether the company is part of the REIT benchmark.
- The Fund may invest in real estate debt and preferred securities and international real estate companies.
The Fund versus passive/ETF real estate funds
- More discerning than passive/ETF real estate funds that must own the entire index (both the “good” and “bad” real estate companies).
- Many of the companies held in a passive/ETF real estate fund have unappealing long-term growth prospects, are located in geographic markets with excess real estate inventory, are saddled with poorly constructed balance sheets, and/or have leases with rents that are likely to decline as in-place leases expire and are marked to market at current market rents.
- Our actively managed Fund has a greater ability to pick our spots, emphasize companies with attractive long-term prospects, and pivot away from real estate categories, geographies, balance sheets, and leases that are likely to face long-term cash flow pressures.
- Since the launch of the Fund 7 years ago on December 29, 2017, the Fund has increased 89.30% cumulatively (net of fees) which is more than double the performance of the largest real estate passive/ETF strategy, the Vanguard Real Estate ETF (VNQ), which increased 40.33%.
The Fund versus non-publicly traded REIT funds and private real estate
- Though public and private real estate investment products can be complementary, we believe our Fund offers several compelling advantages versus non-publicly traded REIT funds and private real estate.
- Our Fund tends to offer more liquidity, diversification, valuation transparency, superior capital structures, and lower fees. Further, our Fund’s long-term performance exceeds the performance of several non-traded REIT and private real estate alternatives.
- Regarding the topic of volatility and liquidity, there is a narrative among some fans of private real estate that private real estate is preferred over public real estate because it is not as volatile. We have long held the view that that argument is flawed. In our opinion, volatility should only be measured based on the sales price that one is able to exit the investment. If a real estate investment is locked up in a private vehicle, it may feel less volatile in a given day but may ultimately be more volatile than a public real estate investment when liquidity is ultimately achieved. Notably, in the 2024 Institutional Real Estate Allocations Monitor, 67% of institutions cited the advantages of liquidity as a primary consideration for investing in REITs (up from 46% in 2023). We believe the restrictions on liquidity for non-traded REITs and private real estate contributed to this notable uptick in the desire for liquidity.
2025 preliminary outlook for real estate and the Fund – we remain bullish, but with guarded optimism
As we peer into 2025, we are positive on the prospects for REITs, non-REIT real estate, and the Fund. We are mindful, however, that the possibility of higher-than-expected interest rates may limit widespread opportunities for improvements in valuations. Nonetheless, we have identified several attractively valued REITs and non-REIT real estate companies and believe our active and discerning approach to portfolio management will result in a double-digit annual return as we have done the last two years.
The time has come
In the 2025 year-end Emerging Trends in Real Estate report published by PwC and the Urban Land Institute, we agree with the opening excerpts from chapter one’s “The Time Has Come”:
- “We are on the cusp of the next upturn in the real estate cycle, and now is the time to be thinking about planning, laying the groundwork for the next two to three years of growth.”
- “The skies are finally clearing over commercial real estate markets, even if some dark clouds still linger.”
The above commentary aligns with our views. Business prospects are, in most cases, improving, the demand versus supply outlook is generally attractive, most balance sheets are strong, the banking system is well capitalized, much of public real estate has repriced for a higher cost of capital, many real estate share prices have lagged the broader market, and there is the possibility that the Federal Reserve may lower interest rates in 2025 should inflation continue to moderate.
Pillars of total return
We are optimistic that we will be able to generate a double-digit return in 2025.
The three pillars of total return include:
- Growth: We are positive about growth prospects for several categories of real estate as organic demand, in many cases, is strong, and several companies now have a “green light” to issue equity and pursue accretive external growth opportunities.
- Dividends: Most real estate dividends are well covered and should continue to grow in 2025.
- Valuation multiples: The path of long-term interest rates will affect the degree to which a company’s valuation multiple may improve. We are sanguine, though, that our team will continue to identify several companies that have the potential to improve their valuation multiples.
For further thoughts on our 2025 preliminary outlook, please see “Concluding thoughts on the prospects for real estate and the fund” later in this letter.
Portfolio Composition
As of December 31,2024, we invested the Fund’s net assets as follows: REITs (75.9%), non-REIT real estate companies (17.9%), and cash (6.2%). We currently have investments in 11 REIT categories. Our exposure to REIT and non-REIT real estate categories is based on our research and assessment of opportunities in each category on a bottom-up basis (See Table II below).
Table II. Fund investments in REIT categories as of December 31, 2024
| Percent of Net Assets (%) | |||
|---|---|---|---|
| REITs | 75.9 | ||
| Data Center REITs | 16.2 | ||
| Health Care REITs | 15.6 | ||
| Multi-Family REITs | 14.4 | ||
| Mall REITs | 9.3 | ||
| Office REITs | 9.2 | ||
| Hotel REITs | 3.7 | ||
| Triple Net REITs | 2.2 | ||
| Single-Family Rental REITs | 2.2 | ||
| Shopping Center REITs | 2.0 | ||
| Other REITs | 0.6 | ||
| Timber REITs | 0.5 | ||
| Non-REIT Real Estate Companies | 17.9 | ||
| Cash and Cash Equivalents | 6.2 | ||
| Total | 100.0* | ||
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* Individual weights may not sum to the displayed total due to rounding.
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Notable changes to the Fund’s portfolio from the end of the third quarter:
- Increased the Fund’s exposure to multi-family REITs from 8.4% to 14.4% due to affordability advantages versus for-sale housing, a favorable supply outlook over the next three years, and reasonable valuations versus private market valuations.
- Increased the Fund’s exposure to office REITs from 5.7% to 9.2% with the addition of Kilroy Realty Corporation (KRC). Please see “top net purchases” for a discussion about the company.
- Increased the Fund’s exposure to mall REITs from 5.9% to 9.3% as the fundamental backdrop for high-quality mall and outlet real estate remains favorable.
- Eliminated the Fund’s exposure to industrial REITs due to demand normalizing to pre-pandemic levels (elongated corporate decision making), moderating rent growth in certain geographic markets, inventory de-stocking, and pricey headline valuations relative to other REIT categories.
- Exited the Fund’s modest exposure to wireless tower REITs due to underwhelming near-term growth prospects.
- We increased the Fund’s cash and cash equivalents from 1.6% to 6.2%. We are optimistic we will be able to redeploy the capital in compelling investment opportunities in 2025.
REITs
We believe REITs can generate double-digit returns in 2025 through a combination of growth, dividends, and some room for valuations to expand for certain REITs.
Though demand remains tempered for some real estate segments (e.g., self-storage and industrial), most REITs enjoy occupancies of more than 90%, and there are several segments of real estate where demand remains strong (data centers, senior housing, multi-family, retail malls, and shopping centers). Limited new competitive supply is forecasted in the next few years. The transaction market has picked up and we expect several publicly traded REITs, who now have the “green light”, to issue equity for accretive external growth. We expect private equity to continue to acquire discounted public REITs. Most balance sheets are in good shape. Several REITs benefit from some combination of all or some of the following favorable characteristics including inflation-protection, contracted cash flows, and an ability to increase dividends. We have identified several REITs that are cheap relative to history and private market valuations.
Summary REIT and Non-REIT Category Commentary
Data Center REITs (16.2%)
- We maintain conviction in the multi-year favorable prospects for data centers. Data center landlords such as Equinix, Inc. (EQIX) and Digital Realty Trust, Inc. (DLR) are benefiting from record low vacancy, demand outpacing supply, more constrained power availability, and rising rental rates. Several secular demand vectors, which are currently broadening, are contributing to robust fundamentals for data center space globally. They include the outsourcing of information technology infrastructure, increased cloud computing adoption, the ongoing growth in mobile data and internet traffic, and AI as a new wave of data center demand. Put simply, each year data continues to grow exponentially, and all of this data needs to be processed, transmitted, and stored—supporting increased demand for data center space. In addition, while it is still early innings, we believe AI could not only provide a source of incremental demand but also further accelerate existing secular trends by driving increased prioritization and additional investment in digital transformation among enterprises. Aside from positions in Equinix and Digital Realty, the Fund also has a position in Iron Mountain Incorporated (IRM), which we consider a data center REIT even though GICS classifies the company in other specialized REITs (shown as Other REITs in Table II).
Health Care REITs (15.6%)
- We maintain a favorable view of the multi-year prospects for senior housing and remain bullish on the outlook for Welltower Inc. (WELL), Ventas, Inc. (VTR), and American Healthcare REIT, Inc. (AHR) We believe senior housing real estate is likely to benefit from favorable cyclical and secular growth opportunities in the next few years. Fundamentals are improving (rent increases and occupancy gains) against a backdrop of muted supply growth due to punitive financing and construction costs. The long-term demand outlook is favorable, driven in part by an aging population (baby boomers and the growth of the 80-plus population), which is expected to accelerate in the years ahead. Expense pressures (labor shortages/other costs) are abating, and we believe highly accretive acquisition opportunities may surface, particularly for Welltower given its cost of capital advantage. The Fund also maintains an investment in Healthpeak Properties, Inc. (DOC)
Multi-Family REITs (14.4%)
- We remain optimistic due to the rental affordability advantages versus for-sale housing (move-outs to buy remain low), an attractive supply outlook in 2025 to 2027, the benefits of a partial inflation hedge given annual leases, and still modest discounts to private market valuations.
Mall REITs (9.3%)
- We are optimistic about the prospects for the Fund’s investments in mall REITs The Macerich Company (MAC) and Simon Property Group, Inc. (SPG) The fundamental backdrop for high-quality mall and outlet real estate remains favorable. Tenant demand remains robust. There is a shortage of desirable retail space (occupancy is high and there is a dearth of new mall developments). The favorable demand/supply imbalance is enabling landlords to raise rents. Valuations are attractive. We remain optimistic about the two-to-three-year prospects for Macerich following the announcement of a new highly regarded CEO (Jackson Hsieh) who we believe will unlock value (sell non-core properties and repay debt).
Office REITs (9.2%)
- While we have remained generally cautious on office real estate for several years in light of both cyclical and secular headwinds that we expected would persist, we have also identified certain geographic markets (New York City) and certain well-located, modern office properties (New York City and parts of the West Coast) that we believe are poised to gain market share and outperform as market conditions improved.
- We believe certain office REIT valuations screen inexpensive versus the private market value of its real estate portfolio, the replacement cost of its portfolio, and relative to publicly traded peers.
Hotel REITs (3.7%)
- Recent travel trends have been mixed – leisure demand is moderating, and business travel is mixed in certain cities. On the other hand, group and convention travel remain strong. We remain long-term bullish about the prospects for hotel REITs and other travel-related real estate companies. Several factors are likely to contribute to multi-year tailwinds including a favorable shift in consumer preferences, a growing middle class, and other encouraging demographic trends. We maintain an allocation to select travel-related real estate including hotel REITs because we believe the long-term investment case for travel is compelling, valuations are appealing as many hotel REITs are currently valued at 25% to 50% discounts to net asset value, and we believe hotel REITs could be targeted by private equity firms for purchase.
Triple Net REITs (2.2%)
- We remain optimistic about the long-term prospects for triple-net REIT Agree Realty Corporation. (ADC) Investment merits include its high-quality retail real estate portfolio and tenant base, the company’s investment grade portfolio, a cost of capital advantage to pursue accretive acquisitions, an opportunity to triple the size of the current portfolio and Agree Realty is a founder-led firm with shareholder interests aligned. We believe Agree Realty could be an outsized beneficiary of a decline in interest rates given its reliance on acquisitions to drive earnings growth and the long duration nature of cash flows.
Single-Family Rental REITS (2.2%)
- Near term we have remained cautious in part due to the onset of elevated supply in a few key geographic markets.
- We remain long-term bullish due to favorable demand/supply prospects (homeownership affordability challenges, a desire for flexibility and not to be burdened by mortgages, and limited supply of homes for rent in most geographic markets) which should lead to strong long-term growth prospects and an ability of landlords to increase rents.
Shopping Center REITs (2.0%)
- We remain optimistic about the prospects for Brixmor Property Group Inc. (BRX) Shopping centers are seeing strong tenant demand for space, limited store closures/bankruptcies, tenants that are broadly healthy, and positive rent growth. Private equity interest in shopping centers would suggest that certain shopping center REITs are undervalued in the public market.
Non-REIT Real Estate Companies (17.9%)
- We emphasize REITs but have the flexibility to invest in non-REIT real estate companies. We tend to limit these to no more than approximately 25% of the Fund’s net assets. At times, some of our non-REIT real estate holdings may present superior growth, dividend, valuation, and share price appreciation potential than some REITs. We remain optimistic about the Fund’s prospects for its non-REIT real estate holdings.
Top Contributors to Performance
Table III. Top contributors to performance for the quarter ended December 31, 2024
| Quarter End Market Cap ($ billions) | Contribution to Return (%) | |
|---|---|---|
| GDS Holdings Limited | 4.6 | 0.81 |
| Equinix, Inc. | 91.0 | 0.62 |
| Digital Realty Trust, Inc. | 60.0 | 0.53 |
| Vornado Realty Trust | 8.0 | 0.49 |
| The Macerich Company | 4.5 | 0.46 |
Shares of GDS Holdings Limited (GDS) continued to perform well during the quarter, delivering returns into the mid-teens. We traveled to Asia in December to tour the company’s newly developed data center campus in Malaysia, spend additional time with GDS International’s executive team, and conduct competitor/market due diligence by meeting with the management teams of several global competitors based in Singapore. We also had the opportunity to meet the management team of the largest utility in Malaysia providing power to GDS and competitors, which provided valuable insight on the developing market. We also traveled to Hong Kong to meet, once again, with CEO/founder William Huang and CFO Daniel Newman while touring one of the company’s urban data centers with the local operating team. We came away with more confidence regarding the demand visibility and growth that GDS can capture in this region due to its first mover and other competitive advantages. In addition, we believe GDS will be able to secure additional high-demand power capacity in Southeast Asia and other international markets, which will elongate the growth profile of the company and is not currently appreciated by the broader investment community.
We remain optimistic about the company’s growth prospects over the next several years, which can be bucketed into: i) its Asia ex-China data center business (GDS International or GDSI); and ii) its mainland China data center business (GDS Holdings or GDSH).
Bottom line:We see a path for the business to be worth $45 to $55 a share in two to three years versus approximately mid-$20s at the recent market price.
GDS International (Asia ex-China): We see cash flow for GDSI growing from less than $50 million today to over $500 million over the next three years! We value GDS’ ownership stake at $15 per share after accounting for the growth capital it has secured from renowned U.S. and global investors. Blackstone’s recent $16 billion acquisition of Southeast Asia based data center operator AirTrunk at 25 times cash flow is still at a substantial premium to where GDS is raising growth capital today, which provides an important valuation marker for a potential IPO of this business over the next 12 to 15 months. During the quarter, GDSI raised over $1 billion of additional Series B capital to fund its highly compelling and pre-leased growth from several well-known investors including Coatue, Baupost, Ken Griffin, and Soft Bank that valued the international segment at approximately $3.5 billion or 75% higher on a per-share basis to GDS compared with its Series A capital raise back in March.
GDS Holdings (China): We believe the China data center business is at the doorstep of a growth inflection and see cash flow growing from about $700 million today to $1 billion over the next three years. We value the China business at $30 to $40 a share on what we believe is a conservative cash flow multiple and remain encouraged that there will be several catalysts to further surface value (e.g., a transaction to place certain stabilized assets into a listed REIT vehicle in the next few months).
In the most recent quarter, the shares of Equinix, Inc., the premier global operator of network-dense, carrier-neutral data centers, performed well following solid third quarter results. We continue to be optimistic about the long-term growth prospects for the company due to its interconnection focus among a highly curated customer ecosystem, irreplaceable global footprint, strong demand and pricing power, favorable supply backdrop, and evolving incremental demand vectors such as AI. Equinix has multiple levers to drive outsized bottom-line growth with operating leverage. Equinix should compound its earnings per share at approximately 10% over the next few years and we believe the prospects for outsized shareholder returns remain compelling from here given the superior secular growth prospects combined with a discounted valuation.
In the most recent quarter, the shares of data center REIT Digital Realty Trust, Inc. continued to appreciate due to strong quarterly new leasing results, strong pricing power on new and renewal leases, an improved capital structure, and an evolving AI demand growth opportunity for its data center facilities.
Digital Realty is a global provider of data center services to enterprises, cloud service providers, network providers, financial services, media, and other customers. Our team traveled to Digital Realty’s headquarters in Texas earlier this year to meet with the CEO Andy Power. We remain optimistic about Digital Realty’s continued ability to perform well due to improving growth and pricing power, the company’s existing and newly developed data center capacity in supply constrained markets, its fully secured future pipeline of power and key infrastructure components, and management’s greater focus on delivering bottom-line growth while balancing investing for the future.
Top Detractors from Performance
Table IV. Top detractors from performance for the quarter ended December 31, 2024
| Quarter End Market Cap orMarket Cap When Sold ($ billions) | Contribution to Return (%) | |
|---|---|---|
| Ventas, Inc. | 24.7 | -0.34 |
| Iron Mountain Incorporated | 30.8 | -0.31 |
| American Tower Corporation | 92.3 | -0.28 |
| Lennar Corporation | 42.0 | -0.24 |
| Prologis, Inc. | 93.9 | -0.22 |
In the most recent quarter, the shares of Ventas, Inc., a health care REIT that owns a $30 billion portfolio of senior housing, medical office, hospitals, and life science properties, declined alongside the broader REIT market. We remain optimistic about the company’s prospects. We believe Ventas’ senior housing operations will continue to inflect positively in the years to come given the favorable supply/demand backdrop and increasing growth of the 80-plus year-old population. The company owns high-quality real estate and benefits from a compelling occupancy recovery story within senior housing.
Shares of Iron Mountain Incorporated lagged during the quarter after outsized absolute and relative year-to-date performance. Iron Mountain offers records storage management along with an evolving fast-growing data center segment. We recently met with CFO Barry Hytinen in our offices and came away encouraged by the company’s prospects to grow overall cash flow by approximately 10% and by high single digits on a per share basis over the next several years. Growth is underpinned by predictable and stable growth in its core records management business while outsized growth is driven by its data center business, which has visibility to more than the triple operational capacity from today’s in-place base. We actively managed our position, and took some near-term tax losses but remain encouraged by the company’s growth prospects and may revisit position sizing in the future.
The shares of American Tower Corporation, a global operator of over 200,000 wireless towers, declined alongside the other publicly traded wireless tower REITs in the fourth quarter in part due to the sensitivity of these businesses to higher interest rates and our expectation for the continuation of uninspiring growth prospects in the year ahead. We exited our position in the fourth quarter. Nonetheless, our fundamental conviction regarding the secular growth of mobile data, evolving network needs and the idiosyncratic growth prospects for American Tower remain unchanged and we may look to acquire additional shares in the future.
Recent Activity
Table V. Top net purchases for the quarter ended December 31, 2024
| Quarter End Market Cap ($ billions) | Net Amount Purchased ($ millions) | |
|---|---|---|
| Kilroy Realty Corporation | 4.8 | 6.4 |
| Equity Residential | 27.2 | 6.0 |
| Independence Realty Trust, Inc. | 4.5 | 5.0 |
| Simon Property Group, Inc. | 56.2 | 4.2 |
| American Healthcare REIT, Inc. | 4.4 | 3.5 |
During the fourth quarter, we initiated a position in Kilroy Realty Corporation, a REIT that owns a portfolio of high-quality office properties concentrated in U.S. West Coast markets including San Francisco, San Diego, Los Angeles, and Seattle. The company also owns one property in Austin, Texas.
While we have remained generally cautious on office real estate for several years in light of both cyclical and secular headwinds that we expected would persist, we also have acknowledged that certain well-located, modern office properties were poised to gain market share and outperform as market conditions improved. We would categorize Kilroy’s portfolio as falling into this latter bucket.
We are optimistic about our investment in Kilroy for several reasons:
- Although office fundamentals remain challenged in certain of Kilroy’s markets (most notably in the greater San Francisco Bay area), we have begun to see several encouraging signs that lead us to believe that office fundamentals are bottoming and beginning to improve. These signs include stable or rising utilization of office space and more return-to-office mandates, improving levels of leasing activity and tenant interest, declining levels of vacant sublease space, more confident corporate decision making, and stabilizing market rents and concessions.
- The ongoing proliferation of the AI industry should benefit Kilroy in the future since approximately half of Kilroy’s portfolio is located in the greater San Francisco Bay Area. The Bay Area commands the highestproportion of AI-related venture capital investment in the country. Management estimates that AI-related leasing accounts for approximately 10% of Kilroy’s leasing activity in San Francisco and could trend materially higher over time.
- The prospects for Kilroy’s recently delivered Kilroy Oyster Point development project in South San Francisco appear to be improving. This legacy development project was completed without leasing pre-commitments; however, tenant interest levels have been improving recently. Management is optimistic that a new lease can be signed in the coming months. We believe that a new lease announcement would be well received by investors.
- Kilroy’s new management team is focused on capital recycling. CEO Angela Aman joined Kilroy in January 2024 and was most recently CFO at Brixmor Property Group. We think very highly of Angela and the team that she has been building around her. We are excited about the company’s renewed focus on value-enhancing capital recycling, which is different from the company’s long history as a developer. Management expects to moderate spending on development, monetize non-core land assets, and pursue select acquisitions. The company’s balance sheet is in good shape, with low leverage and a strong liquidity position.
- We believe Kilroy’s valuation screens inexpensive versus the private market value of its real estate portfolio, the replacement cost of its portfolio, and relative to publicly traded peers.
We increased the Fund’s exposure to two multi-family REIT owners/ operators Equity Residential (EQR) and Independence Realty Trust, Inc. (IRT) during the fourth quarter due to more favorable valuation levels, a continued robust demand outlook across their respective markets, and other idiosyncratic considerations.
Equity Residential owns approximately 80,000 apartment homes primarily in coastal markets. We believe this portfolio offers superior growth prospects due to: i) favorable supply/demand dynamics; ii) a high-earning, well-employed resident profile with attractive rent-to-income ratios allowing for future pricing power; iii) an undersupply of housing in the U.S. with above-average cost of ownership versus renting in their respective markets; iv) a meaningful discount to its underlying net asset value; and v) a low levered balance sheet to present attractive opportunities for accretive external growth (e.g. Equity Residential acquired a 3,500 unit apartment portfolio in Dallas, Denver, and Atlanta back in August for $1 billion).
IRT owns 33,000 apartment units that cater to a more affordable income demographic. We believe the return prospects for the stock continue to be attractive given the company’s discounted public market valuation relative to both recent private market transactions and publicly traded peers that have communities in overlapping markets, its “value-add” program that provides superior growth prospects versus peers, and abating supply deliveries in its markets that should enhance pricing power. Furthermore, we believe the broader market is under-appreciating the company’s additional cash flow growth from the lease-up of its two recently completed development projects that is not reflected in its current earnings.
Table VI. Top net sales for the quarter ended December 31, 2024
| Quarter End Market Cap orMarket Cap When Sold ($ billions) | Net Amount Sold ($ millions) | |
|---|---|---|
| Prologis, Inc. | 93.9 | 6.0 |
| American Tower Corporation | 92.3 | 5.0 |
| Rexford Industrial Realty, Inc. | 10.1 | 3.6 |
| First Industrial Realty Trust, Inc. | 6.6 | 3.0 |
| Toll Brothers, Inc. | 14.0 | 2.8 |
In the most recent quarter, we exited the Fund’s investments in industrial REITs Prologis, Inc. (PLD) and Rexford Industrial Realty, Inc. (REXR) because demand continues to normalize to pre-pandemic levels (elongated corporate decision making), rents continue to moderate in several geographic markets, and headline valuations remain pricey relative to other REIT categories.
We exited the Fund’s investment in American Tower Corporation, a global operator of over 200,000 wireless towers, in part due to the sensitivity of wireless tower REITs to higher interest rates and our expectation for the continuation of uninspiring growth prospects in the year ahead. Nonetheless, our fundamental conviction regarding the secular growth of mobile data, evolving network needs and the idiosyncratic growth prospects for American Tower remain unchanged and we may look to acquire additional shares in the future.
Concluding Thoughts on the Prospects for Real Estate and the Fund
2025 Outlook
As cited earlier in this letter, we are optimistic about the prospects for real estate and the Fund in 2025.
Though daily market volatility is likely to be high as the sequencing of the new administration’s policies are announced (e.g., less immigration versus less regulation; higher tariffs versus lower taxes), we believe the key driver for a year of solid market performance is that the fundamental backdrop for earnings growth is expected to be strong. Demand conditions are mostly favorable against a backdrop of muted new real estate supply. While some headline valuations screen rich, we believe there are several attractively valued real estate opportunities beneath the surface. Our biggest concern is a resurgence in inflation which would limit the potential for improvements in valuations. We will, of course, be monitoring this closely.
7-Year Review
The prior 7 years have been filled with rapid changes to the real estate landscape and outlook, a global pandemic, the most aggressive Federal Reserve interest rate hiking period in decades, and several other items that have forced us to be flexible and kept us on our toes. Our team works hard to embrace our mantra of being dispassionate research analysts rather than emotional cheerleaders. With all of this in mind, we are proud that we have been able to deliver the 2nd best performing real estate fund over this 7-year period (second only to the other real estate fund that we manage, the Baron Real Estate Fund).
As we look ahead, we are even more energized about the prospects for the Fund in the next 7 years. We believe the merits of our more comprehensive, flexible, liquid, and actively managed investment approach will shine even brighter in the years ahead. We believe we have developed the right real estate product for long-term success.
Our Team
I smile when I think about our core real estate team – assistant portfolio manager David Kirshenbaum and George Taras, David Berk, and David Baron. They are an outstanding group. They are smart and highly competitive. They have developed a deep knowledge of real estate. Their dedicated work ethic is impressive. And, on a personal note, they are fabulous people. I am the winner to have such an outstanding team.
I and our team remain fully committed and energized to continue to deliver outstanding long-term results.
Table VII. Top 10 holdings as of December 31, 2024
| Quarter End MarketCap ($ billions) | Quarter End InvestmentValue ($ millions) | Percent of Net Assets (%) | |
|---|---|---|---|
| Equinix, Inc. | 91.0 | 18.8 | 10.2 |
| Welltower Inc. | 78.5 | 15.2 | 8.3 |
| Equity Residential | 27.2 | 11.8 | 6.4 |
| Digital Realty Trust, Inc. | 60.0 | 10.9 | 5.9 |
| Vornado Realty Trust | 8.0 | 10.6 | 5.8 |
| GDS Holdings Limited | 4.6 | 10.5 | 5.7 |
| The Macerich Company | 4.5 | 10.0 | 5.4 |
| Brookfield Corporation | 94.6 | 8.3 | 4.5 |
| Ventas, Inc. | 24.7 | 8.1 | 4.4 |
| Independence Realty Trust, Inc. | 4.5 | 8.0 | 4.3 |
I would also like to thank you, our current and prospective shareholders, and express heartfelt gratitude for your past and continuing support.
I proudly remain a major shareholder of the Baron Real Estate Income Fund.
Sincerely,
Jeffrey Kolitch | Portfolio Manager
|
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 Adviser waives and/or reimburses or may waive or reimburse certain Funds expenses pursuant to a contract expiring on August 29, 2035, unless renewed for another 11-year term and the Funds’ 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. For performance information current to the most recent month end, visit BaronCapitalGroup.com or call 1-800-99-BARON. 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 1-800-99-BARON or visiting BaronCapitalGroup.com. Please read them carefully before investing. Risks: All investments are subject to risk and may lose value. |
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