A Real Estate Mutual Fund that Succeeds With Limited REIT Holdings

Mutual funds that focus on real estate investment trusts—owners of apartments, offices and other types of property—have, on average, lost money over the past year. But a few real estate funds have notched double-digit gains. How? Mostly by avoiding REITs.

Baron Real Estate (BREFX), for example, had just 30% of its assets in REITs at last report, compared with 94% for the typical real estate fund. Manager Jeffrey Kolitch has the bulk of his fund’s assets in other kinds of firms tied to real estate, such as homebuilders, lodging companies, suppliers of construction materials and even cruise lines (“hotels on the water,” he calls them). Many of these stocks have left REITs in the dust as real estate has recovered in recent years, and Kolitch expects the trend to continue as housing and other types of real estate continue to prosper.

Kolitch finds some REITs appealing, though. Firms that own data centers and cell phone towers are benefiting from “megatrends,” he says, such as the boom in cloud computing and the explosion in mobile-phone data usage. Warehouse owners are thriving as the growth in online shopping fuels demand for storage facilities and shipment centers. Kolitch also likes REITs that own portfolios of single-family rental houses, as well as those that hold office buildings.

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Overall, however, the fund is built more for growth than income. Many of its stocks pay slim, if any, dividends. As a result, Baron yields just 1.5%, about one-third less than the average real estate fund. A low yield isn’t a big drawback when the market is rising, but it becomes more noticeable when stocks are flat or dip moderately.

Investors shouldn’t expect steady gains in the fund, either. The shares posted modest losses in 2015 and 2016—years in which the average real estate fund produced total returns of 2.4% and 6.9%, respectively. Baron’s rebound this year—the fund returned 19%, including dividends, in the first eight months of 2017—has more than made up for that bout of weakness, though, and helped drive the fund’s strong five-year return.

One other caveat: The fund doesn’t come cheap. Its 1.33% annual expense ratio slightly exceeds the category average of 1.22% for real estate mutual funds.