Dear Baron Real Estate Fund Shareholder:
Our 15th Anniversary: We are pleased to report that on Baron Real Estate Fund’s® (the Fund) 15th anniversary, the Fund has achieved the #1 real estate ranking for the 15-year period ended December 31, 2024.
According to Morningstar, the Fund has received special recognition for its achievements as follows:
• #1 real estate fund ranking for each of its 15-, 10-, and 5-year performance periods• Highest 5-Star Morningstar Rating for each of its 10-, 5-, and 3-year performance periods• Highest 5-Star Overall Morningstar Rating™
Please refer to “Our current top-of-mind thoughts” section in this letter. There, we reflect on the past 15 years and discuss our optimistic expectations for the next 15 years.
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As of 12/31/2024, the Morningstar Real Estate Category consisted of 220, 210, 194, 146, and 110 share classes for the 1-, 3-, 5-, 10-, and 15-year or since inception (12/31/2009) periods. Morningstar ranked Baron Real Estate Fund Institutional Share Class in the 9th, 2nd, 1st, 1st, and 1st percentiles, respectively. On an absolute basis, Morningstar ranked Baron Real Estate Fund Institutional Share Class as the 16th, 6th, 1st, 1st, and 1st best performing share class in its Category, for the 1-, 3-, 5-, 10-, and 15-year or since inception periods, respectively. 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. Baron Real Estate Fund Institutional Share Class was rated 5 stars overall, 5 stars for the trailing 3 years, 5 stars for the trailing 5 years, and 5 stars for the trailing 10 years ended 12/31/2024. There were 210 share classes, 194 share classes, and 146 share classes for the 3-, 5-and 10-year periods. These Morningstar Ratings are for the Institutional Share Class only; other classes may have different performance characteristics. The Morningstar Rating™ for funds, or “star rating”, is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product’s monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods. © 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. |
For the full year, the Fund increased 12.46% (Institutional Shares), outperforming the MSCI US REIT Index (the REIT Index), which increased 7.49%, and performing similarly to the MSCI USA IMI Extended Real Estate Index (the MSCI Real Estate Index), which increased 12.70%.
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 decreased 2.98%, outperforming both the REIT Index, which declined 6.39%, and the MSCI Real Estate Index, which fell 4.69%.
We will address the following topics in this letter:
- Our current top-of-mind thoughts
- Portfolio composition and key investment themes
- 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 Fund Retail Shares1,2 | Baron Real Estate Fund Institutional Shares1,2 | MSCI USA IMI Extended Real Estate Index1 | MSCI US REIT Index1 | S&P 500 Index1 | |
|---|---|---|---|---|---|
| Three Months3 | (3.05)% | (2.98)% | (4.69)% | (6.39)% | 2.41% |
| One Year | 12.19% | 12.46% | 12.70% | 7.49% | 25.02% |
| Three Years | (0.04)% | 0.21% | 1.85% | (3.43)% | 8.94% |
| Five Years | 12.25% | 12.54% | 8.50% | 3.10% | 14.53% |
| Ten Years | 9.35% | 9.64% | 8.61% | 4.38% | 13.10% |
| Fifteen Years and Since Inception (December 31, 2009) (Annualized) | 13.39% | 13.68% | 11.18% | 8.03% | 13.88% |
| Fifteen Years and Since Inception (December 31, 2009) (Cumulative)3 | 558.55% | 584.08% | 390.13% | 218.41% | 602.68% |
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Performance listed in the above table is net of annual operating expenses. Annual expense ratio for the Retail Shares and Institutional Shares as of December 31, 2023 was 1.31% and 1.06%, 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 may waive or reimburse 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 USA IMI Extended Real Estate Index Net (USD) is a custom index calculated by MSCI for, and as requested by, BAMCO, Inc. The index includes real estate and real estate-related GICS classification securities. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI. 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 Indexes 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
15-year anniversary – reflections on the past
Since its launch on December 31, 2009, the key factor that positioned the Fund for success is that we formulated an investment creed that we believed had the potential to produce superior results over the long term versus our competitors.
Unlike our peers who tend to limit their real estate investment to REITs, we embraced and structured a more expansive, balanced, and diversified real estate-related fund, not a REIT-only fund.
In addition to our investments in REITs, the Fund has also invested in a broader group of non-REIT real estate-related categories, including hotel and leisure companies, real estate services companies, homebuilders, building product and services companies, casino and gaming operators, data center and tower operators, and real estate operating companies.
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 U.S. 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 15-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.
For example, employing our more expansive and actively managed real estate investment approach, the Fund produced a cumulative return of 584%, far exceeding the REIT Index’s cumulative return of 218% for the 15-year period ending December 31, 2024.
The next 15 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 product for long-term success.
Our highly differentiated real estate 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
- Larger investment universe than actively managed REIT funds (340 real estate-related companies in the MSCI Real Estate Index versus only 118 REITs in the REIT Index).
- Less reliant on the debt markets than REIT funds (REITs must pay out at least 90% of taxable income in dividends annually).
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 15 years ago on December 31, 2009, the Fund has increased 584% cumulatively (net of fees), more than double the performance of the largest real estate passive/ETF strategy, the Vanguard Real Estate ETF (VNQ), which increased 258%.
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, we believe 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 each 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 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 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 in the past. Note there is no guarantee that this goal will be met.
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 as we have done in the past 15 years. Note there is no guarantee that this goal will be met.
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 and Key Investment Themes
We currently have investments in REITs, plus seven additional non-REIT real estate-related categories. Our percentage allocations to these categories vary, and they are 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 real estate-related categories as of December 31, 2024
| Percent of Net Assets (%) | |
|---|---|
| REITs | 30.6 |
| Non-REITs | 62.2 |
| Real Estate Operating Companies | 12.8 |
| Real Estate Service Companies | 12.6 |
| Building Products/Services | 10.6 |
| Hotels & Leisure | 9.4 |
| Homebuilders & Land Developers | 7.9 |
| Data Centers | 4.9 |
| Casinos & Gaming Operators | 4.0 |
| Cash and Cash Equivalents | 7.2 |
| Total | 100.0* |
* Individual weights may not sum to the displayed total due to rounding.
Investment Themes
We continue to prioritize seven long-term high-conviction investment themes or real estate categories:
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REITs
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Residential-related real estate
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Travel-related real estate
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Real asset-focused alternative asset managers
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Commercial real estate services companies
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Property technology companies
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Data center operators
Notable changes to the Fund’s real estate category exposures from the end of the third quarter:
- Following two years of exceptional share price performance, we decreased the Fund’s allocation to homebuilders & land developers from 18.9% to 7.9%. We also decreased the Fund’s building products/ services exposure from 14.1% to 10.6%. An explanation for the decrease can be found in our “residential-related” real estate commentary below.
- We increased the Fund’s exposure to real estate operating companies from 10.1% to 12.8%, reflecting our optimism for the prospects for real estate alternative asset managers.
- We decreased the Fund’s exposure to casino & gaming operators from 8.8% to 4.0% following disappointing third quarter results and redirected a portion of the capital to hotels & leisure where we increased the Fund’s exposure from 5.2% to 9.4%.
- We increased the Fund’s cash and cash equivalents from 1.0% to 7.2%. 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.
As of December 31, 2024, we had investments in six REIT categories representing 30.6% of the Fund’s net assets. Please see Table III below.
Table III.
REITs as of December 31, 2024
| Percent of Net Assets (%) | |
|---|---|
| Data Center REITs | 12.9 |
| Office REITs | 6.2 |
| Health Care REITs | 4.4 |
| Multi-Family REITs | 4.2 |
| Mall REITs | 2.5 |
| Other REITs | 0.4 |
| Total | 30.6* |
* Individual weights may not sum to the displayed total due to rounding.
Residential-related real estate
We have become near-term cautious yet remain long-term bullish.
Following two years of spectacular performance for homebuilders (from September 30, 2022 through September 30, 2024, Toll Brothers, Inc. (TOL), D.R. Horton, Inc. (DHI), and Lennar Corporation (LEN) increased 269%, 184%, and 155%, respectively), we chose to decrease the Fund’s exposure from 17.6% to 7.2%. Homebuilder valuations for our investments had approached near peak valuations from prior cycles (at or above 2 times tangible book value). We also have concerns that the recent 100 basis point increase in interest rates will further crimp housing affordability. This could lead to flattening home prices and elevated homebuilder incentives to entice buyers to purchase a home. Further, the new administration policy decisions around tariffs, immigration, and deportation may increase the cost for labor and materials. The issues cited above may lead to pressure on homebuilder gross margins in 2025.
The shares of several homebuilders and residential-related building product/ services companies foreshadowed some of these concerns in the fourth quarter and valuations are becoming more compelling. We are monitoring developments closely and may look to acquire additional shares in 2025.
Importantly, we maintain our long-term optimism for residential real estate. A multi-decade structural underinvestment in the construction of residential real estate relative to the demographic needs of our country bodes well for long-term housing construction activity, sales, rentals, pricing, and repair and remodel activity. Cyclical tailwinds (pent-up demand, low inventory levels, and a still healthy consumer) and secular tailwinds (flexible work arrangements that favor suburban living, a desire to own newly built homes rather than existing homes which, on average, are more than 40 years old, and the lock-in effect for existing homeowners to remain in their homes due to the move higher in mortgage rates) should aid the new home market for several years. The strategic pivot by several homebuilders to a more land- light business model, the utilization of lower leverage, improved capital allocation, and the prioritization of scale advantages may lead to higher valuations for homebuilders over time.
As of December 31, 2024, residential-related real estate companies represented 18.5% of the Fund’s net assets. Please see Table IV below.
Table IV.
Residential-related real estate companies as of December 31, 2024
| Percent of Net Assets (%) | |
|---|---|
| Building Products/Services | 9.1 |
| Homebuilders | 7.2 |
| Home Centers | 2.2 |
| Total | 18.5* |
* Individual weights may not sum to the displayed total due to rounding.
Travel-related real estate
Several factors are likely to contribute to multi-year tailwinds for travel-related real estate companies including a favorable shift in consumer preferences (demand for experiences/services such as travel over goods), a growing middle class, and other encouraging demographic trends (more disposable income for the millennial cohort due to delays in household formation and work-from-home arrangements which allow for an increase in travel bookings); healthy balance sheets; and private equity’s long history of investing in travel-related companies.
As of December 31, 2024, travel-related real estate companies represented 13.4% of the Fund’s net assets. Please see Table V below.
Table V.
Travel-related real estate as of December 31, 2024
| Percent of Net Assets (%) | |
|---|---|
| Hotels & Leisure | 9.4 |
| Casinos & Gaming Operators | 4.0 |
| Total | 13.4* |
* Individual weights may not sum to the displayed total due to rounding.
Real estate-focused alternative asset managers
Leading real estate-focused asset managers Blackstone Inc. (BX) and Brookfield Corporation (BN) have an opportunity to increase market share due to impressive investment track records and global scale advantages. They are positioned to benefit from a secular growth opportunity for alternative assets due to long track records of generating attractive relative and absolute returns with what is perceived, in some cases, as less volatility than several other investment options.
Commercial real estate services companies
Leading commercial real estate services companies CBRE Group, Inc. (CBRE) and Jones Lang LaSalle Incorporated (JLL) should benefit from structural and secular tailwinds: the outsourcing of commercial real estate, the institutionalization of commercial real estate, and opportunities to increase market share in a highly fragmented market. Looking forward, we believe we are in the early days of a rebound in commercial real estate sales and leasing activity. We believe CBRE and JLL may generate annual earnings per share growth of more than 20% in the next few years.
Data center operators
In the most recent quarter, we acquired additional shares in data center operator GDS Holdings Limited (GDS)(OTCPK:GDHLF). We believe the shares are attractively valued and offer compelling long-term growth prospects. Please see “Top contributors to performance for the quarter ended December 31, 2024” for more on GDS.
Property technology companies
The collision of real estate and technology has led to a new category within real estate–real estate technology, also referred to as proptech. The emergence of proptech and the digitization of real estate is an exciting and promising new development for real estate. We believe we are in the early innings of a technology-driven investment cycle centered on data and digitization that allows real estate-related businesses to drive incremental revenue streams and lower costs.
CoStar Group, Inc. (CSGP), the leading provider of information, analytics, and marketing services to the real estate industry, is positioned to capitalize on this burgeoning secular growth trend.
As of December 31, 2024, other real estate-related companies (which includes the four investment themes mentioned directly above) represented 30.2% of the Fund’s net assets. Please see Table VI below.
Table VI.
Other real estate-related companies as of December 31, 2024
| Percent of Net Assets (%) | |
|---|---|
| Real Estate-Focused Alternative Asset Managers | 12.8 |
| Commercial Real Estate Services Companies | 9.8 |
| Data Center Operators | 4.9 |
| Property Technology Companies | 2.8 |
| Total | 30.2* |
* Individual weights may not sum to the displayed total due to rounding.
Top Contributors and Detractors to Performance
Table VII.
Top contributors to performance for the quarter ended December 31, 2024
| Quarter End Market Cap ($ billions) | Contribution to Return (%) | |
|---|---|---|
| GDS Holdings Limited | 4.6 | 0.67 |
| Blackstone Inc. | 210.6 | 0.55 |
| Equinix, Inc. (EQIX) | 91.0 | 0.43 |
| Digital Realty Trust, Inc. (DLR) | 60.0 | 0.34 |
| Expedia Group, Inc. (EXPE) | 23.9 | 0.33 |
Shares of GDS Holdings Limited 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 Blackstone Inc., the world’s largest alternative asset manager, continued to perform well due to strong quarterly business results and expectations for enduring and compelling long-term growth prospects. In the year ahead, we believe growth prospects for Blackstone should be strong as management sees meaningful opportunities in private wealth, AI, and data centers, a cyclical recovery in real estate, and additional opportunities which should help to grow fees. In addition, there are emerging green shoots that transaction activity is poised to come back strongly after several years of depressed levels. Increased transaction activity provides the ability to realize carried interest/provide clarity on valuation marks and return capital to limited partners, which feeds the “flywheel” of capital formation for additional fund vehicles.
Blackstone is the largest real estate manager in the world with an impressive investment track record. We believe Blackstone is a true “best-in-class” company. It has a premier brand, a global franchise, loyal customers, and substantial insider ownership. Blackstone is fast growing, manages its business in an asset-light manner with limited needs for capital, produces high cash-flow margins, is anchored by a recurring revenue base, and is able to return nearly 100% of its cash generated through dividends and share repurchases. Led by its exceptional CEO Stephen Schwarzman and President Jon Gray, the company attracts and retains excellent talent. We believe Blackstone is remarkably positioned to continue to increase market share in a secular growth opportunity for alternative assets.
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.
Table VIII.
Top detractors from performance for the quarter ended December 31, 2024
| Quarter End Market Cap ($ billions) | Contribution to Return (%) | |
|---|---|---|
| D.R. Horton, Inc. | 44.9 | -1.22 |
| Lennar Corporation | 36.9 | -1.17 |
| Toll Brothers, Inc. | 12.6 | -0.70 |
| Installed Building Products, Inc. (IBP) | 4.9 | -0.35 |
| SiteOne Landscape Supply, Inc. (SITE) | 5.9 | -0.34 |
As noted earlier in this letter, we chose to decrease the Fund’s homebuilder exposure in D.R. Horton, Inc., Lennar Corporation, and Toll Brothers, Inc. in the most recent quarter following exceptional share price performance over the prior two years. From September 30, 2022, through September 30, 2024, shares of Toll Brothers, Lennar, and D.R. Horton increased 269%, 155%, and 184%, respectively. Homebuilder valuations for our investments had approached near peak valuations from prior cycles (at or above 2 times tangible book value). We also have concerns that the recent 100 basis point increase in interest rates will further crimp housing affordability. This could lead to flattening home prices and elevated homebuilder incentives to entice buyers to purchase a home. Further, the new administration policy decisions around tariffs, immigration, and deportation may increase the cost for labor and materials. The issues cited above may lead to pressure on homebuilder gross margins in 2025.
Though we have become near-term cautious, the shares of several homebuilders and residential-related building product/services companies foreshadowed some of these concerns in the fourth quarter and valuations are becoming more compelling. We are monitoring developments closely and may look to acquire additional shares in 2025.
Importantly, we maintain our long-term optimism for residential real estate due to the following considerations:
- A multi-decade structural underinvestment in the construction of residential real estate relative to the demographic needs of our country bodes well for long-term housing construction activity, sales, rentals, pricing, and repair and remodel activity.
- Cyclical tailwinds (pent-up demand, low inventory levels, and a still healthy consumer).
- Secular tailwinds (flexible work arrangements that favor suburban living, a desire to own newly built homes rather than existing homes which, on average, are more than 40 years old, and the lock-in effect for existing homeowners to remain in their homes due to the move higher in mortgage rates).
- The strategic pivot by several homebuilders to a more land-light business model, the utilization of lower leverage, improved capital allocation, and the prioritization of scale advantages may lead to higher valuations for homebuilders over time.
Recent Activity
Table IX.
Top net purchases for the quarter ended December 31, 2024
| Quarter End Market Cap ($ billions) | Net Amount Purchased ($ millions) | |
|---|---|---|
| Expedia Group, Inc. | 23.9 | 71.7 |
| Kilroy Realty Corporation (KRC) | 4.8 | 49.1 |
| Equinix, Inc. | 91.0 | 41.5 |
| The Macerich Company (MAC) | 4.5 | 30.8 |
| Jones Lang LaSalle Incorporated | 12.0 | 28.1 |
We continued to acquire shares in our newly initiated investment in Expedia Group, Inc. in the fourth quarter after building further confidence following positive data confirming several of our investment thesis points and spending more time with its new CEO Ariane Gorin. Expedia is a travel company providing online reservations and other services to consumers and businesses. The company is investing behind three core brands today including Expedia, Hotels.com and VRBO with 3.5 million properties including 2.5 million alternative accommodations (VRBO). We believe Expedia is a “fallen angel” (cheap/discounted valuation with catalysts), through peak pain on its technology platform migration (three-to four-year journey) and is finally seeing green shoots of growth in its highly valuable VRBO business (“hidden asset” home rental platform that is getting misvalued within the broader company). Lastly, Expedia is led by a strong executive team with new CEO Ariane Gorin, who has made organizational changes to streamline reporting structures, better align interests, and drive the business forward. We believe these changes will allow the company to be well positioned to capitalize on the compelling secular growth in travel going forward.
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 in the greater San Francisco Bay Area. The Bay Area commands the highest proportion 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.
In the most recent quarter, we acquired additional shares of Equinix, Inc., the premier global operator of network-dense, carrier-neutral data centers.
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. The company 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.
Stepping back, we believe the multi-year prospects for real estate data centers are highly compelling – perhaps as strong as they have ever been.
Data center landlords such as Equinix and Digital Realty Trust, Inc. 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.
Table X.
Top net sales for the quarter ended December 31, 2024
| Quarter End Market Cap or Market Cap When Sold ($ billions) | Net Amount Sold ($ millions) | |
|---|---|---|
| Toll Brothers, Inc. | 12.6 | 56.4 |
| Caesars Entertainment, Inc. (CZR) | 7.0 | 53.6 |
| Lennar Corporation | 36.9 | 51.9 |
| D.R. Horton, Inc. | 44.9 | 43.0 |
| Prologis, Inc. (PLD) | 95.7 | 34.4 |
As noted earlier in this letter, we trimmed the Fund’s homebuilder investments in Toll Brothers, Inc., Lennar Corporation, and D.R. Horton, Inc. following exceptional share price performance in the last two years. We remain optimistic about the long-term prospects for our homebuilders and may look to reacquire shares over time.
We exited the Fund’s investment in Caesars Entertainment, Inc. following a disappointing third quarter earnings report and our expectation that growth may remain modest in 2025.
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.
15-Year Anniversary
There is something about a new year, never mind a 15-year anniversary that makes us more reflective.
The prior 15 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 #1 ranked real estate fund over this 15-year period.
As we look ahead, we are even more energized about the prospects for the Fund in the next 15 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 XI.
Top 10 holdings as of December 31, 2024
| Quarter End Market Cap ($ billions) | Quarter End Investment Value ($ millions) | Percent of Net Assets (%) | |
|---|---|---|---|
| Equinix, Inc. | 91.0 | 188.3 | 8.7 |
| Blackstone Inc. | 210.6 | 107.5 | 5.0 |
| CBRE Group, Inc. | 40.2 | 106.0 | 4.9 |
| GDS Holdings Limited | 4.6 | 105.6 | 4.9 |
| Brookfield Corporation | 94.6 | 105.2 | 4.9 |
| Jones Lang LaSalle Incorporated | 12.0 | 104.7 | 4.9 |
| Welltower Inc. (WELL) | 78.5 | 95.9 | 4.4 |
| Digital Realty Trust, Inc. | 60.0 | 89.5 | 4.2 |
| Vornado Realty Trust (VNO) | 8.0 | 85.0 | 3.9 |
| Expedia Group, Inc. | 23.9 | 78.9 | 3.7 |
On this, our 15th anniversary, 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 Fund.
Sincerely,
Jeffrey Kolitch, Portfolio Manager
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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. Investors should consider the investment objectives, risks, and charges and expenses of the investment carefully before investing. The prospectus and summary prospectus 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 Baron CapitalGroup.com. Please read them carefully before investing. Risks: In addition to general market conditions, the value of the Fund will be affected by the strength of the real estate markets as well as by interest rate fluctuations, credit risk, environmental issues and economic conditions. The Fund invests in companies of all sizes, including small and medium-sized companies whose securities may be thinly traded and more difficult to sell during market downturns. The Fund may not achieve its objectives. Portfolio holdings are subject to change. Current and future portfolio holdings are subject to risk. Discussions of the companies herein are not intended as advice to any person regarding the advisability of investing in any particular security. The views expressed in this report reflect those of the respective portfolio managers only through the end of the period stated in this report. The portfolio manager’s views are not intended as recommendations or investment advice to any person reading this report and are subject to change at any time based on market and other conditions and Baron has no obligation to update them. This report does not constitute an offer to sell or a solicitation of any offer to buy securities of Baron Real Estate Fund by anyone in any jurisdiction where it would be unlawful under the laws of that jurisdiction to make such an offer or solicitation. The portfolio manager defines “Best-in-class” as well-managed, competitively advantaged, faster growing companies with higher margins and returns on invested capital and lower leverage that are leaders in their respective markets. Note that this statement represents the manager’s opinion and is not based on a third-party ranking. EPS Growth Rate (3-5-year forecast) indicates the long term forecasted EPS growth of the companies in the portfolio, calculated using the weighted average of the available 3-to-5 year forecasted growth rates for each of the stocks in the portfolio provided by FactSet Estimates. The EPS Growth rate does not forecast the Fund’s performance. BAMCO, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission (SEC). Baron Capital, Inc. is a broker-dealer registered with the SEC and member of the Financial Industry Regulatory Authority, Inc. (FINRA). |
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