Davis Real Estate Fund
Update from
Andrew A. Davis and Chandler Spears
Portfolio Managers
Semi-Annual Review 2019

Investment Results
Davis Real Estate Fund’s Class A shares provided a total return on net asset value for the year-to-date period ended June 30, 2019 of 18.6%.1 Over the same time period the Wilshire U.S. Real Estate Securities Index returned 17.9%. Over the most recent one, five and ten year periods, a $10,000 investment in Davis Real Estate Fund grew to $11,058, $15,118 and $37,210, respectively.1

The average annual total returns for Davis Real Estate Fund’s Class A shares for periods ending June 30, 2019, including a maximum 4.75% sales charge, are: 1 year, 5.32%; 5 years, 7.57%; and 10 years, 13.48%.The performance presented represents past performance and is not a guarantee of future results. Total return assumes reinvestment of dividends and capital gain distributions. Investment return and principal value will vary so that, when redeemed, an investor’s shares may be worth more or less than their original cost. The total annual operating expense ratio for Class A shares as of the most recent prospectus was 0.97%. The total annual operating expense ratio may vary in future years. Returns and expenses for other classes of shares will vary. Current performance may be higher or lower than the performance quoted. For most recent month-end performance, click here or call 800-279-0279.

This report includes candid statements and observations regarding investment strategies, individual securities, and economic and market conditions; however, there is no guarantee that these statements, opinions or forecasts will prove to be correct. Equity markets are volatile and an investor may lose money. Past performance is not a guarantee of future results. 1 As of 6/30/19. Class A shares without a sales charge.

Investment Overview

The Davis Real Estate Fund performed well over the first half of 2019. This has come not as a result of considerable Fund action, but from continued performance by those investments that have buoyed the Fund for the past few years. In fact, year-to-date turnover is one of the lowest first-half figures in the Fund’s history. However, even though we have actively chosen to allow the Fund to carry on without significant changes, there are some refinements we have made in the first six months of the year.

The industrial sector is one that we have long believed to be in the midst of secular change that has driven, and will continue to drive, very strong space demand. E-commerce is often pointed to as the primary reason, and we think that is the case. Problematically, high valuations have followed for almost all publicly-traded industrial real estate companies. At the moment anticipated growth supports these rich valuations, but we believe the market will become more discerning over the next couple of years.

Any dearly priced stock needs to have something to keep investors interested. For us that is expected owner earnings growth. The industrial property companies we watch should deliver impressive owner earnings growth over the next few years. Not only is demand strong for newly delivered developments, but core growth stands to benefit from strong mark-to- market rental growth. Where our research yields differently, however, is our focus on the specific location of the properties. Big industrial sheds matter and are necessary components of any logistics chain. Logistics demand is still strong, which is good for companies like Prologis (PLD), but higher demand is found in smaller industrial properties located in densely populated areas. These areas are the ones most sought by e-commerce companies looking for last-touch delivery fulfillment. As a result, the Fund has concentrated its industrial investments in Rexford Industrial Realty (REXR) and Terreno Realty Corporation (TRNO), both of which are well-positioned to deal with last-touch demand. They have contributed significantly to Fund performance over the past couple of years, and even though valuations have risen, we believe future growth should more than offset the higher returns that these valuations demand, and that this growth will actually bring down multiples for both firms to less than industry averages over the next few years.

Industrial is not the only sector where we have refined our investment focus. Retail is commonly considered the loser in an expanding e-commerce world. However, not all of it is destined for the waste container of commercial real estate. Sure, far-flung enclosed malls in secondary or tertiary locations are likely to become much less profitable or potentially worthless, but that will far less likely be the case for retail property in dense urban and suburban areas where such properties serve as gathering places. Unless we are willing to underwrite a world where people do not engage in social activity, there is no reason to avoid all retail space. That is the basis upon which we have refined our approach to the retail sector.

The Fund has taken select positions in retail real estate companies with exceptionally well-located properties that cater to experiential tenants and internet resistant retailers, and locations that can be expanded into multiple uses. Acadia Realty Trust (AKR) is a great example. Most of its assets are located in dense, highly affluent urban areas. To throw Acadia out with all other shopping center REITs is to underestimate the desire of people to live, work and play in the same area. Shopping center tenants do not really need the hinterlands nearly as much in an e-commerce world, but they want to be in Acadia’s properties for the simple reason that they are located in prime locations like The Magnificent Mile in Chicago and Soho in Manhattan. The point is that not all retail real estate is dying; it is evolving and, unfortunately for most property owners, the evolution is all about location. The Fund has benefited from its ownership in Acadia year-to-date, and we believe the market is only just beginning to appreciate how strongly positioned Acadia’s assets are in the new retail real estate landscape.

We have also made other attempts to take advantage of the rout in retail stocks, in particular initiating a small position in STORE Capital Corporation (STOR), a net-lease REIT. Until this year, the Fund had not invested in net-lease real estate in any meaningful way since 2007, when Spirit Finance Corporation was taken private. We are not intrigued with a sector whose primary means of growing earnings is simply getting bigger. Times are good and stock value is high when capital is plentiful, but stock becomes little more than a bond when capital is hard to source. What makes STORE different is the composition of its tenancy. You will not find in its rent roll any of the sorts of retailers closing stores today. Rather, you will find necessity-based and entertainment-based tenants that we believe to be internet resistant. Further, STORE has over 2,300 properties in its portfolio and over 400 tenants responsible for rent payment on those locations. Said differently, the portfolio is massively diversified with over 80% of tenants paying less than 1% in rent and the top tenant paying less than 3%. The failure of one or even several locations simply would not matter much, which translates into a net-lease REIT with core growth that is more durable than most. When married to a conservatively managed balance sheet, a sector-leading payout ratio and a top-flight management team, you have the potential for the makings of a great long-term investment.

Fund Positioning

We have always approached investing with a value mindset. In the world of real estate this means an inexorable focus on dividend growth. For almost all public real estate companies, that has been a default condition, at least for those that survived the great credit crisis of 2007–2008. After all, the past decade has been blessed with strong property fundamentals, very low interest rates and, thankfully, disciplined lending. As we contemplate the next several years, there are some factors we think deserve special attention because dividend growth might become a bit more elusive.

Underwriting any investment requires thoughtful attention to what sustains growth over long periods, which in turn helps drive consistent dividend growth. For decades our assumptions have been based on the assessment of durable same-store growth. It is usually a straightforward exercise, but there are times when the calculus fails. We are particularly concerned that populist movements in certain areas of the country could structurally change our assumption of long-term growth in the apartment sector.

The Fund is currently tracking over a dozen rent control bills that seek to regulate rent growth or alter how vacancy can be managed at for-rent properties in California, New York, Oregon and Washington. It should not be missed that certain cities in those states have been responsible for stellar earnings growth at some of our favorite apartment investments, including AvalonBay Communities (AVB) and Essex Property Trust (ESS) among others. The likelihood that rent control passes is guesswork at best, but it’s fair to say the probability is not zero. Likewise, should any or all of these bills be approved, we do not know the form they will take. We simply cannot ignore that rent control could meaningfully slow same-store growth. Our response is to evaluate all possible outcomes, which means calculating a range of fair value in a world with no rent control as well as one in which rent control exists. On the latter, we have factored measures from mild to onerous into our analysis. Ultimately, we end up with adjustments to our estimates of terminal growth, which is the single most influential variable in the Fund’s financial models. For now, we feel our investment in the apartment sector is justified and underpinned by reasonable valuation even if rent control measures pass. And if these measures fail, we believe AvalonBay and Essex will end up trading at a considerable discount to fair value.

As mentioned earlier, the Fund has taken a somewhat contrarian view toward retail real estate. But ours is not a cavalier approach that assumes anything trading at a discount is worth considering. Just because something is cheap does not make it a good value. Rather, we think commercial real estate value is driven by the old adage, “location, location, location.” Retail properties that survive and thrive should be those located in areas with growing populations, proximity to transportation nodes, and those that lend themselves to multiple uses. Federal Realty Investment Trust (FRT), like Acadia, exemplifies a business with just such an opportunity set. This shopping center REIT is blessed with great locations and has proven masterful at transforming its properties to meet a changing retailer landscape and recognizing the need to pursue new uses to maximize value. For example, one of Federal Realty’s properties, Santana Row, located in the heart of San Jose, California, was originally contemplated as a predominately retail property back in 2001. Today it comprises 50 shops, 30 restaurants, 10 spas and salons, 615 rental homes, over 690,000 square feet of office space, a boutique hotel and a movie theater. Santana Row is the quintessential live-work-play development, and there is more to come as final build-out is slated for 2022. While not every asset in Federal Realty’s portfolio is so endowed, most offer very attractive use expansion opportunities. As investors you should understand that our investment in retail is driven by a focus on these sorts of assets. Even though we are value investors, growth is necessary to make a value investment great. We trust the market will eventually recognize that some retail is well-suited to a world driven by e-commerce.

More broadly, as fellow shareholders in the Fund, we continue to execute the Davis Investment Discipline by investing in real estate businesses best able to generate free cash flow growth, whatever the sector. We research companies on an individual basis and invest in great businesses purchased at value prices that consistently grow earnings, and dividends, year after year. Looking forward to the second half of 2019 and beyond, we thank you for your continued confidence and trust.

This report is authorized for use by existing shareholders. A current Davis Real Estate Fund prospectus must accompany or precede this material if it is distributed to prospective shareholders. You should carefully consider the Fund’s investment objective, risks, charges, and expenses before investing. Read the prospectus carefully before you invest or send money.

This report includes candid statements and observations regarding investment strategies, individual securities, and economic and market conditions; however, there is no guarantee that these statements, opinions or forecasts will prove to be correct. These comments may also include the expression of opinions that are speculative in nature and should not be relied on as statements of fact.

Objective and Risks. Davis Real Estate Fund’s investment objective is total return through a combination of growth and income. There can be no assurance that the Fund will achieve its objective. Under normal circumstances the Fund invests at least 80% of its net assets, plus any borrowing for investment purposes, in companies principally engaged in the real estate industry. Some important risks of an investment in the Fund are: common stock risk: an adverse event may have a negative impact on a company and could result in a decline in the price of its common stock; fees and expenses risk: the Fund may not earn enough through income and capital appreciation to offset the operating expenses of the Fund; headline risk: the Fund may invest in a company when the company becomes the center of controversy. The company’s stock may never recover or may become worthless; large-capitalization companies risk: companies with $10 billion or more in market capitalization generally experience slower rates of growth in earnings per share than do mid- and small-capitalization companies; manager risk: poor security selection may cause the Fund to underperform relevant benchmarks; mid- and small-capitalization companies risk: companies with less than $10 billion in market capitalization typically have more limited product lines, markets and financial resources than larger companies, and may trade less frequently and in more limited volume; real estate risk: real estate securities are susceptible to the many risks associated with the direct ownership of real estate, such as declines in property values and increases in property taxes; stock market risk: stock markets have periods of rising prices and periods of falling prices, including sharp declines; and variable current income risk: the income which the Fund pays to investors is not stable. See the prospectus for a complete description of the principal risks.

Davis Funds is committed to communicating with our investment partners as candidly as possible because we believe our investors benefit from understanding our investment philosophy and approach. Our views and opinions include “forward-looking statements” which may or may not be accurate over the long term. Forward-looking statements may be identified by words like “believe,” “expect,” “anticipate,” or similar expressions. You should not place undue reliance on forward-looking statements, which are current as of the date of this report. We disclaim any obligation to update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise. While we believe we have a reasonable basis for our appraisals and we have confidence in our opinions, actual results may differ materially from those we anticipate.

Owner Earnings are the excess cash a business generates after reinvesting enough to maintain current capacity and competitive advantages but before investing for growth.

The information provided in this material should not be considered a recommendation to buy, sell or hold any particular security. As of 6/30/19, the top ten holdings of Davis Real Estate Fund were: Simon Property Group, Inc., 5.65%; Avalonbay Communities, Inc., 5.49%; Equinix, Inc., 4.92%; Prologis, Inc., 4.72%; Boston Properties, Inc., 3.39%; Ventas, Inc., 3.13%; Essex Property Trust, Inc., 3.08%; Camden Property Trust, 3.03%; Alexandria Real Estate Equities, Inc., 2.98%; Hudson Pacific Properties Inc., 2.94%.

Davis Funds has adopted a Portfolio Holdings Disclosure policy that governs the release of non-public portfolio holding information. This policy is described in the Statement of Additional Information. Holding percentages are subject to change. Click here or call 800-279-0279 for the most current public portfolio holdings information.

Turnover Rate is a measure of the trading activity in a mutual fund’s investment portfolio that reflects how often securities are bought and sold.

We gather our index data from a combination of reputable sources, including, but not limited to, Thomson Financial, Lipper and index websites.

The Wilshire U.S. Real Estate Securities Index is a broad measure of the performance of publicly traded real estate securities, such as Real Estate Investment Trusts (REITs) and Real Estate Operating Companies (REOCs). The index is capitalization-weighted. The beginning date was 1/1/78, and the index is rebalanced monthly and returns are calculated on a buy and hold basis. Investments cannot be made directly in an index.

Broker-dealers and other financial intermediaries may charge Davis Advisors and/or Davis Distributors, LLC substantial fees for selling its funds and providing continuing support to clients and shareholders. For example, broker-dealers and other financial intermediaries may charge: sales commissions; distribution and service fees; and record-keeping fees. In addition, payments or reimbursements may be requested for: marketing support; placement on a list of offered products; access to sales meetings, sales representatives and management representatives; and participation in conferences or seminars, sales or training programs for invited registered representatives and other employees, client and investor events, and other dealer-sponsored events. Financial advisors should not consider Davis Advisors’ and/or Davis Distributors, LLC’s payment(s) to a financial intermediary as a basis for recommending the Fund.

After 10/31/19, this material must be accompanied by a supplement containing performance data for the most recent quarter end.

Shares of the Davis Funds are not deposits or obligations of any bank, are not guaranteed by any bank, are not insured by the FDIC or any other agency, and involve investment risks, including possible loss of the principal amount invested.

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