Baron Real Estate Fund: Navigating Growth, Seizing Opportunities
Exceptional Third Quarter Performance and Sustained High Rankings
During the third quarter of 2025, the Baron Real Estate Fund (Institutional Shares) recorded a significant 10.25% increase. This impressive growth outpaced the MSCI US REIT Index, which saw a 4.49% rise, and the MSCI USA IMI Extended Real Estate Index, which climbed by 5.65%. The fund's consistent outperformance is further highlighted by its top rankings over various multi-year periods and its prestigious 5-Star Overall Morningstar Rating.
Insights from Industry Leaders Shape Our Positive Market View
We remain confident in the future of public real estate and the Baron Real Estate Fund. This optimism is reinforced by positive statements from prominent real estate executives. For example, Jon Gray of Blackstone Inc. noted that the real estate market is nearing a \"tipping point\" for upward movement. Hamid Moghadam of Prologis, Inc. observed strong leasing activity and improving customer sentiment, indicating a favorable setup for growth in the logistics sector. Bob Sulentic of CBRE Group, Inc. projected new earnings peaks despite a prior downturn. Doug Yearley, Jr. of Toll Brothers, Inc. expressed a healing economy and a return of buyers, particularly in the luxury housing market. Chris Nascetta of Hilton Worldwide Holdings Inc. highlighted strong brands and a growing development pipeline. Lastly, Andy Florance of CoStar Group, Inc. pointed to robust performance across all business segments due to strategic investments and innovative product development.
The Real Estate Cycle: A Turning Point for Value Acquisition
Our analysis aligns with Blackstone Real Estate's view that the market is at a critical juncture. Property values have adjusted, new supply in key sectors like apartments and warehouses is at a decade-low, and a recovery is just beginning. This presents an opportune moment to acquire high-quality assets at a discount to their replacement cost.
Compelling Investment Rationale for Real Estate
Despite previous challenges from higher interest rates, refinancing pressures, and post-pandemic effects, we believe the real estate sector is at a positive inflection point. Many past concerns are now considered \"old news\" or exaggerated, creating attractive investment opportunities at compelling valuations. Demand conditions are largely favorable, driven by well-located properties and secular trends such as e-commerce, residential affordability, an aging population, increased travel, and data consumption. Competitive supply remains low due to modest new construction and high development costs, making existing asset acquisition more appealing than new construction. Balance sheets are generally robust with lower leverage compared to private markets, and debt capital is readily available. Furthermore, substantial private capital is seeking real estate ownership, providing an \"embedded put\" that may limit downside valuation. Public real estate has largely been repriced for a higher cost of capital, making current valuations attractive.
Strategic Investment Themes Guiding Portfolio Decisions
The fund continues to focus on several high-conviction investment themes. These include Real Estate Investment Trusts (REITs), characterized by strong demand relative to supply, solid balance sheets, growing dividends, inflation protection, and attractive valuations. Residential-related real estate, encompassing homebuilders and building product companies, benefits from structural underinvestment in housing and both cyclical and secular tailwinds. Travel-related real estate, including casinos, gaming operators, hotels, and leisure companies, is driven by shifting consumer preferences towards experiences and favorable demographic trends. Commercial real estate services companies, like CBRE and JLL, gain from outsourcing, institutionalization, and market share expansion. Real estate-focused alternative asset managers, such as Blackstone and Brookfield, capitalize on secular growth in alternative assets and global scale. Finally, property technology companies, exemplified by CoStar Group, leverage the convergence of real estate and technology to drive revenue and reduce costs.
A Flexible Approach to Real Estate Investment
The Baron Real Estate Fund offers a compelling mutual fund option due to its adaptable investment strategy. This approach allows the fund to invest across a diverse range of real estate companies, including REITs and other real estate-related businesses. We anticipate that this flexibility will become even more valuable in the evolving real estate landscape, necessitating sophisticated analysis to identify prime opportunities.
Diverse Portfolio Composition Across Real Estate Categories
Our portfolio strategically allocates investments across REITs and various non-REIT real estate-related categories, with percentages determined by thorough research and bottom-up opportunity assessment. REITs constitute 27.2% of net assets, while non-REITs account for 71.0%, including significant allocations to building products/services, real estate service companies, real estate operating companies, and homebuilders/land developers. Remaining allocations are distributed among hotels & leisure, casinos & gaming operators, data centers, and infrastructure-related sectors, with a small portion in cash and cash equivalents.
Focused Investment Themes for Long-Term Growth
Our long-term investment strategy centers on six high-conviction real estate categories. These encompass REITs, residential-related real estate, travel-related real estate, commercial real estate services companies, real estate-focused alternative asset managers, and property technology companies, all chosen for their strong growth potential and strategic market positions.
REITs: Resilience and Growth in a Changing Landscape
Despite fluctuating demand in some sectors, most REITs maintain high occupancy rates and exhibit robust demand in specific segments. Anticipated limited new competitive supply over the next few years, coupled with an expected uptick in transaction activity, positions public REITs for accretive external growth. Many balance sheets are strong, and several REITs offer advantages such as inflation protection, contracted cash flows, and growing dividends. We have identified numerous REITs trading at historically low valuations, poised for double-digit returns through growth, dividends, and valuation expansion. As of September 30, 2025, REITs represented 27.2% of the Fund's net assets, diversified across various categories including health care, data center, office, industrial, wireless tower, mall, other, multi-family, single-family rental, and mortgage REITs.
Residential Real Estate: Cautious Near-Term, Bullish Long-Term Outlook
While we remain optimistic about the long-term prospects for residential real estate, we exercise near-term caution. The housing market faces challenges from a prolonged slowdown in supply growth, rising home prices, and elevated mortgage rates, leading to affordability issues. The Trump administration's focus on addressing housing affordability, potentially through standardizing building codes or reducing closing costs, indicates growing awareness. However, we believe stimulating demand by lowering mortgage rates would be more effective than solely focusing on increasing supply. Despite these headwinds, we maintain long-term confidence due to structural underinvestment in housing, strong demographic needs, and a combination of cyclical and secular tailwinds. These include pent-up demand, low inventory, a healthy consumer, flexible work arrangements favoring suburban living, and a preference for newly built homes. As of September 30, 2025, residential-related real estate companies comprised 29.1% of the Fund's net assets, distributed among building products/services, homebuilders, and home centers.
Travel-Related Real Estate: Benefiting from Shifting Consumer Preferences
Although recent travel trends have shown some moderation, we believe several factors will drive multi-year growth for travel-related real estate companies. These include a consumer shift towards experiences over goods, a growing middle class, and favorable demographic trends such as increased disposable income for millennials and work-from-home flexibility. Additionally, private equity investments in this sector could unlock value that public markets may be overlooking. As of September 30, 2025, travel-related real estate companies accounted for 13.1% of the Fund's net assets, primarily in hotels & leisure and casinos & gaming operators.
Commercial Real Estate Services: Structural and Secular Tailwinds
Leading commercial real estate service providers like CBRE Group, Inc. and Jones Lang LaSalle Incorporated are well-positioned to benefit from ongoing structural and secular trends. These include the increasing outsourcing and institutionalization of commercial real estate functions, along with opportunities to expand market share within a fragmented industry. We anticipate a rebound in commercial real estate sales and leasing, potentially driving annual earnings per share growth exceeding 20% for these companies in the coming years.
Alternative Asset Managers in Real Estate: Growth and Market Share Gains
Prominent real estate-focused alternative asset managers, such as Blackstone Inc. and Brookfield Corporation, are poised to expand their market share within a growing sector. Their impressive investment track records and global scale enable them to capitalize on the increasing demand for alternative assets. These firms consistently deliver attractive relative and absolute returns, offering perceived lower volatility compared to other investment options.
Proptech: The Fusion of Real Estate and Technology
The intersection of real estate and technology, known as proptech, is creating a dynamic new category within the industry. This digitization of real estate represents an exciting and promising development. We believe we are in the early stages of a technology-driven investment cycle, focusing on data and digital solutions that enable real estate-related businesses to generate additional revenue streams and reduce operational costs. CoStar Group, Inc., a leading provider of information, analytics, and marketing services to the real estate industry, is strategically positioned to capitalize on this burgeoning trend.
Data Center Operators: Long-Term Growth Potential
Shares of data center operator GDS Holdings Limited are considered attractively valued, offering compelling long-term growth prospects. As of September 30, 2025, other real estate-related companies, including the investment themes mentioned above, comprised 28.7% of the Fund's net assets. This category includes commercial real estate services companies, real estate-focused alternative asset managers, property technology companies, data center operators, and a minor exposure to infrastructure-related firms.
Key Contributors and Detractors to Performance
In the third quarter, Wynn Resorts, Limited significantly boosted performance with a 37.3% increase in shares, driven by strong Q2 results in Macau and Las Vegas. Jones Lang LaSalle Incorporated also contributed positively, supported by robust financial reporting and broad business strength. CRH public limited company performed well following strong quarterly results and a positive Investor Day. Conversely, American Tower Corporation experienced a pullback due to a slight delay in U.S. billings and concerns over customer contractual commitments. Airbnb, Inc. detracted from performance despite strong Q2 results, as market concerns focused on expected growth deceleration and potential negative impacts on cash flow margins. Floor & Decor Holdings, Inc. also detracted from performance following a sharp share price correction, prompting the initiation of a new position.
Recent Portfolio Adjustments and Strategic Acquisitions
During the third quarter, a new REIT position was established in Iron Mountain Incorporated, based on its compelling valuation and long-term growth potential in records management and data centers. The fund also began acquiring shares of AAON, Inc., a provider of HVAC and data center cooling solutions, following a significant share price decline believed to be an overreaction to guidance. Additionally, shares of Floor & Decor Holdings, Inc. were purchased after a sharp correction, identified as an attractive opportunity due to its competitive advantages, growth drivers, and appealing valuation. Minor trims were made in CoStar Group, Inc. and Vornado Realty Trust after strong share price performance, while the position in Independence Realty Trust, Inc. was exited to reallocate capital to more promising multi-year opportunities.
Positive Outlook for Real Estate and Fund Performance
While no single event is expected to trigger a sudden surge, several positive factors are converging to accelerate growth and reignite interest in public real estate. Business conditions are stable with signs of improvement, and limited competitive new supply is anticipated, potentially leading to better-than-expected cash flow growth. Real estate credit markets are robust, liquid, and experiencing compressing credit spreads. Although interest rates are not forecasted, a Federal Reserve interest rate cut could initiate an easing cycle, benefiting asset prices, business confidence, activity, and potentially reducing mortgage rates, making stocks more appealing than cash. We remain focused on identifying competitively advantaged real estate companies capable of generating strong cash flow growth. As 2026 approaches, we believe the real estate sector and the Baron Real Estate Fund are at an encouraging juncture. Solid business fundamentals are expected to exceed forecasts, driving robust growth and a potential expansion in real estate values, ultimately leading to compelling total shareholder returns through growth, dividends, and improved valuations.
Leading Holdings in the Portfolio
The top 10 holdings of the Fund include prominent companies such as Jones Lang LaSalle Incorporated, Brookfield Corporation, CBRE Group, Inc., Welltower Inc., Toll Brothers, Inc., Wynn Resorts, Limited, CRH public limited company, Blackstone Inc., Equinix, Inc., and American Tower Corporation. These selections reflect a diversified approach across various real estate sectors, aiming for strong investment value and a substantial percentage of net assets.