Baron Real Estate Income Fund: Latest Insights and Commentary

U.S. equities were broadly higher in the third quarter, building on gains from the prior quarter. The S&P 500 Index and NASDAQ Composite set new record highs, most recently on September 22, and the Dow Jones Industrial Average ended the quarter at an all-time high. Small caps led the market recovery, with the Russell 2000 Index finally surpassing its previous record high achieved almost four years ago on November 8, 2021. Market volatility remained muted during the quarter as the CBOE Volatility Index (VIX) continued to trade in the mid-teens, well below its long-term average of around 20. 

The preeminent driver of market strength was the increased likelihood of Federal Reserve (Fed) rate cuts, prompted by signs of weakness in the labor market and the subsequent emergence of more dovish Fed commentary. Rate cut expectations rose in early August following a much weaker-than-expected July nonfarm payrolls report and significant downward revisions to prior numbers. Dovish Fedspeak intensified as the month wore on, with Chair Powell hinting a possible interest rate cut while delivering remarks at the Fed’s annual Jackson Hole conference. Similarly, Governor Waller continued to advocate for cuts while speaking at the Economic Club of Miami. The Fed eventually resumed its rate-cutting cycle at the September meeting, lowering its policy rate by 25 basis points to a range of 4% to 4.25%, after being on hold since its previous cut last December. Robust corporate earnings, narrowing trade uncertainties, a resilient consumer, increased M&A and IPO activity, and sustained AI optimism also contributed to market gains during the quarter. 

The Magnificent Seven complex dominated market returns for a second consecutive quarter, accounting for nearly two-thirds of the S&P 500 Index’s third-quarter gains. The group appreciated 15.5% in the period, outperforming all other securities in the Index, which were up 4.6%, by a double-digit margin. Tesla (+40.0%), Alphabet (+38.1%), Apple (+24.2%), and NVIDIA (+18.1%) posted the largest gains. Meta and Amazon were essentially flat in the period, trailing the broader Index. 

Most sectors closed higher in the period, with Information Technology, Communication Services, and Consumer Discretionary being the only sectors to outperform the broader market thanks to the heavy influence of the Magnificent Seven. Consumer Staples was the only sector to decline in the period, driven by broad-based weakness across a range of sub-industries, including distillers & vintners, personal care products, food retail, tobacco, and household products. Other laggards were Real Estate, Financials, Health Care, Industrials, Energy, and Materials. From a style perspective, small caps outperformed in the third quarter, rising more than 12% and narrowing the gap with mid- and large-cap stocks this year. Performance was mixed between growth and value, with growth stocks dominating in July, losing out to value in August, and rebounding in September. Despite recent volatility, growth generally remains ahead of value year to date, with the largest differential in the mid- and large-cap segments thanks to the heavy influence of Palantir and the broader Magnificent Seven. 

Beyond the U.S., emerging market (EM) equities meaningfully outperformed in September to finish ahead of their developed market counterparts for the quarter. The rally in Chinese equities was largely responsible for EM outperformance, with gains being driven by investor optimism about AI innovation, which bolstered Chinese technology and internet companies. Targeted government initiatives, easing trade tensions with the U.S., and significant domestic capital inflows also contributed to strength in China. Taiwanese and Korean equities also performed well in the period, overshadowing weakness in India, where equity markets were pressured by underwhelming corporate earnings and concerns about recently enacted U.S. tariffs. Foreign investor flows in Indian markets turned negative in the third quarter after being meaningfully positive in May and June. Performance in developed markets was held back by weakness in continental Europe (Denmark, Germany, Norway, Switzerland, France, and Sweden). European equities were hurt by weak corporate earnings, Trump tariff headwinds, and political instability, particularly in France, where the country’s prime minister resigned after losing a crushing confidence vote in parliament.

CONTRIBUTORS

• Welltower Inc. operates senior housing, life science, and medical office real estate properties. Shares rose during the quarter after the company reported above-industry rent and occupancy growth. We continue to that believe Welltower offers both offensive and defensive investment attributes in the current uncertain macroeconomic environment. Both senior housing cash flow and per share earnings growth exceeded 20% and surpassed expectations. We view management as highly disciplined capital allocators who continue to execute on a robust and expanding acquisition pipeline, while also realizing value through selective asset sales. Over the past decade, Welltower has completed $16 billion in dispositions, and should the company choose to divest its lower-growth medical office portfolio and further emphasize higher-growth senior housing, we believe it would create an even more valuable and faster-growing platform.
• Wynn Resorts, Limited is a global luxury resort operator with properties in Las Vegas and Macau and a new integrated resort under development in the UAE. Shares rose during the quarter following a strong earnings release that showed better-than-expected performance in Las Vegas and signs of accelerating growth in Macau. After years of stagnation, Macau is experiencing renewed visitation from higher-end VIP players, positioning Wynn as a key beneficiary given its premium offering and potential for EBITDA expansion in the region. The company is demonstrating strong momentum across all markets and operates the most differentiated property on the Las Vegas Strip, where we believe the outlook is set to improve in 2026. We also expect the Wynn Al Marjan development to be a major success and to gain increasing attention from the investment community as it progresses toward completion in 2026.
• Prologis, Inc. is the largest owner and operator of industrial warehouse real estate in the world. Shares rose after the company reported strong second-quarter financial results and provided an optimistic outlook for business conditions over the next 18 months. Management expects the broader industrial warehouse market to improve over the next several quarters and for Prologis' earnings growth to accelerate to a high-single-digit rate annually. We believe Prologis’ multi-year growth outlook remains compelling given its scale, strategic locations, and best-in-class operations.

DETRACTORS

• American Tower Corporation is a leading global REIT owning more than 150,000 wireless communication tower sites, with a heavy emphasis on developed markets. The stock declined during the quarter following strong gains in the first half of the year. Shares lagged the broader REIT sector, driven by a slight delay in U.S. billings from 2025 into 2026 and investor concerns regarding contractual commitments from a small customer, DISH, after EchoStar’s divestiture of its U.S. spectrum. While we acknowledge these near-term headwinds and expect shares may remain range-bound for a period of time, we believe American Tower is attractively valued on both an absolute and relative basis. The company’s business is supported by continued secular growth in mobile data, improving bookings activity, and strong visibility into mid- to high-single-digit organic earnings growth per share. We also see additional upside potential from capital allocation opportunities, including share repurchases, alongside a growing 3.5% dividend yield.
• Invitation Homes, Inc. is a premier single-family home leasing company that owns approximately 80,000 rental homes in 13 markets across nine states in the U.S. Shares lagged during the quarter alongside broader residential real estate stocks. While operating fundamentals remained positive, investor concerns surfaced around softening employment data and increased shadow inventory in select markets, raising fears of potentially weakening pricing power. Additionally, expectations that lower mortgage rates could encourage more renters to purchase homes weighed on sentiment given possible impacts on occupancy and turnover. Despite these near-term concerns, we believe valuation remains compelling and continue to see strong long-term support from favorable demographic trends, a solid rent-versus-buy value proposition, and exposure to high-demand markets. We also see potential for external growth through development and partnerships with homebuilders.
• American Homes 4 Rent (AMH), an operator of more than 55,000 single-family rental homes, detracted from performance during the quarter. While the company’s operating fundamentals remained positive, concerns surfaced regarding weakening employment data and an increase in shadow inventory in select markets, which could weigh on pricing power. In addition, investors worried that lower mortgage rates could prompt more tenants to purchase homes, pressuring occupancy and increasing turnover. Nonetheless, we believe AMH’s valuation remains compelling, supported by favorable long-term demographic trends, an attractive rent-versus-buy value proposition, visible growth through the company’s self-funded development pipeline, and diversified market exposure.

When reviewing performance attribution on our portfolio, please be aware that we construct the portfolio from the bottom up, one stock at a time. Each stock is included in the portfolio if it meets our rigorous investment criteria. To help manage risk, we are aware of our sector and security weights, but we do not include a holding to achieve a target sector allocation or to approximate an index. Our exposure to any given sector is purely a result of our stock selection process.

Baron Real Estate Income Fund (the Fund) rose 5.43% (Institutional Shares) in the third quarter, modestly outperforming the MSCI US REIT Index by 94 basis points primarily due to differences in REIT category weights.

Unique exposure to non-REIT real estate companies contributed 227 basis points of relative gains, accounting for the entirety of the outperformance in the period. Strength in the category was broad based, led by sharp gains from luxury resort operator Wynn Resorts, Limited and building material supplier CRH public limited company. Wynn’s shares rose in response to a strong earnings release that showed better-than-expected performance in Las Vegas and signs of accelerating growth in Macau. After years of stagnation, Macau is experiencing renewed visitation from higher-end VIP players, positioning Wynn as a key beneficiary given its premium offering and potential for EBITDA expansion in the region. The company is demonstrating strong momentum across all markets and operates the most differentiated property on the Las Vegas Strip, where we believe the outlook is set to improve in 2026. We also expect the Wynn Al Marjan development to be a major success and to gain increasing attention from the investment community as it progresses toward completion in 2026.

CRH’s stock price appreciated following solid financial results that underscored the consistency of the company’s business model. In particular, CRH benefited from ongoing business improvement initiatives that drove further margin expansion—marking 11 consecutive years of improvement—and strong contributions from prior M&A activity. The company also highlighted positive underlying demand trends and healthy backlogs, supporting a favorable organic growth outlook. We retain conviction given management’s credible framework for double-digit annual earnings growth, CRH’s multiple growth avenues, and a valuation that we view as not fully reflecting the company’s quality, consistency, and long-term potential. Data center operator GDS Holdings Limited, luxury homebuilder Toll Brothers, Inc., and real estate-focused alternative asset managers Brookfield Corporation and Blackstone Inc. were other sources of strength in the category.

The Fund also benefitted from being underweight multi-family, self-storage, and data center REITs, which added nearly 100 basis points of relative gains.

Somewhat offsetting the above was unique exposure to wireless tower REITs, where American Tower Corporation was a material detractor. American Tower’s stock pulled back following strong gains in the first half of the year. Share price performance was hindered by a slight delay in U.S. billings from 2025 into 2026 and investor concerns regarding contractual commitments from a small customer, DISH, following EchoStar’s divestiture of its U.S. spectrum. While we acknowledge these near-term headwinds and expect shares may remain rangebound for a period, we believe American Tower is attractively valued on both an absolute and relative basis. The company’s business is supported by continued secular growth in mobile data, improving bookings activity, and strong visibility into mid- to high-single-digit organic earnings growth per share. We also see additional upside potential from capital allocation opportunities, including share repurchases, alongside a growing 3.5% dividend yield. 

Cash exposure in a rising market and underexposure to better performing health care REITs also weighed on performance.