Andrew A. Davis
38 Years Industry Experience
30 Years at Davis Funds
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E Chandler Spears
28 Years Industry Experience
23 Years at Davis Funds
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Key Takeaways

  • In the first half of 2023 Davis Real Estate Fund returned 2.39% compared to 6.78% for the Wilshire U.S. Real Estate Securities Index.
  • The mainstream media has been generating headlines and attention by writing off the entire office sector, but the situation is more complex than this. There are office assets we expect to thrive long-term, and we own some of them.
  • The portfolio is well-positioned in line with our asymmetric barbell strategy, which combines positions favored for long-term fundamental strength and return on capital with time-sensitive opportunities for above- average risk-adjusted returns.

Davis Real Estate Fund’s Class A shares provided a total return on net asset value for the six months ended June 30, 2023 of 2.39%. Over the same time period, the Wilshire U.S. Real Estate Securities Index returned 6.78%. During the most recent one-, five- and ten-year periods, a $10,000 investment in Davis Real Estate Fund would have returned $9,477, $11,532, and $17,590, respectively.

The average annual total returns for Davis Real Estate Fund’s Class A shares for periods ending June 30, 2023, including a maximum 4.75% sales charge, are: 1 year, -9.73%; 5 years, 1.90%; and 10 years, 5.30%. 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. For most recent month-end performance, visit or call 800-279-0279. Current performance may be lower or higher than the performance quoted. The total annual operating expense ratio for Class A shares as of the most recent prospectus was 0.95%. The total annual operating expense ratio may vary in future years. Returns and expenses for other classes of shares will vary.

This material 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. All fund performance discussed within this material refers to Class A shares without a sales charge and are as of 6/30/23 unless otherwise noted. This is not a recommendation to buy, sell or hold any specific security. Past performance is not a guarantee of future results. There is no guarantee that the Fund performance will be positive as equity markets are volatile and an investor may lose money.

Fund Activity:
Finding the Non-Average in the Office Sector

Never let it be said that fording a river is a risk-free proposition when signs along the banks suggest the average depth is only three feet. You might find to your dismay that part of the river is considerably deeper. Therein lies the problem with believing that averages alone tell you much, if anything. Much of the mainstream media seems blind to this notion, often freely using averages as the only basis for grand and often hyperbolic claims. Further, if the story is good enough, the same "data" will be used repeatedly to draft more "news" that actually offers no additional information. The end result is a narrative that obfuscates the true story. This is the world in which office real estate lives today.

It would be no exaggeration to say that virtually every day there is an article discussing how bad things have gotten in the office sector. In almost all instances we see the author attempt to apply aggregate data to the whole of the office sector, as if all office buildings were the same. For example, a recent article in Forbes magazine suggested that office values might drop by 40%. That might indeed be what happens, but just because the average decline in values turns out to be 40%, that does not mean all office properties will drop by the same amount. Such an outcome is extremely unlikely. In fact there is a reasonable argument to be made that some office buildings will increase in value over the long haul. Said a bit differently, we are confident that the unweighted dispersion in office building values is going to grow significantly. Our job is to determine how to best invest in the correct side of that distribution.

Davis Real Estate Fund has always tried to find signal amid the noise created by blind reliance on average values. Early in the fund's history we championed hotels when the 9/11 attacks threw into question the prospect of future airline travel. And later, when it seemed that Amazon would dominate the retail landscape to the detriment of bricks-and-mortar real estate, we stepped into certain retail REITs. We see the same dynamic today with office REITs where many are loudly proclaiming that the end of office is near. Even most of our peers in the investment management world eschew the office sector in favor of sectors where growth is more obviously tangible, while often paying a significant premium for the privilege.

"We added to positions in the office sector where we believe valuation is too pessimistic and where balance sheets are sufficient to navigate a recovery."

As value investors we can't justify putting new money to work in fully priced stocks. Through the first half of 2023 we added to positions in the office sector where we believe valuation is too pessimistic and, perhaps more importantly, where balance sheets provide sufficient wherewithal to navigate what is likely to be a protracted recovery. Chief among those positions are Sunbelt-focused Cousins Properties (CUZ) and blue-chip Boston Properties, Inc (BXP). Both own just the sort of office assets we expect to thrive long-term, and are guided by excellent management teams that "get it", as we see things, and also understand how to cultivate value. They are anything but average companies and trade at considerable discounts to our estimates of fair value.

Speaking more broadly, volatile trading in the REIT sector tends to create significant dislocations among smaller capitalization companies. This volatility sometimes creates a stock liquidity issue and the resulting price anomalies are fleeting. Just such an opportunity presented itself early in the year when we initiated a position in Community Healthcare Trust (CHCT). This company represents a unique opportunity in medical office buildings located in smaller markets throughout the country. It is a business we've been watching for a long time. We are attracted to the company's ability to invest shareholder capital at handsome investment spreads and, because it is not a very large company, just a few acquisitions would make a difference. With considerable balance sheet capacity, Community Healthcare Trust should be able to grow even if a recession comes to pass.

Making a return to the fund is Regency Centers (REG) which has the distinction of being a stock that almost always trades at a premium, and rightly so. Thanks to Regency's enviable portfolio of grocery-anchored assets located in robust markets, and a top-notch management team, it is difficult to find good entry points to purchase Regency shares. This year, however, Regency, along with most shopping center REITs, traded off, which is surprising. Given growing concern that a recession is inevitable it seems reasonable to believe investors would favor sectors more closely aligned with necessity consumption, such as groceries, but that hasn't been the case this year. Perhaps strong performance during 2022 created a situation where winners are sold to reinvest elsewhere, but we very much like the sector, and it's not often we find Regency trading at a discount.

Given the dearth of new fund subscriptions, we sometimes have to sell existing positions in order to purchase new investments. That has presented fund management with a quandary because we really do like our positioning at the moment. Even so, there are always stocks pushing the upper bounds of our estimated fair value. It should come as no surprise that in most instances those tend to be the stocks that have performed very well over the recent past. No sector exemplifies this more than industrial REITs. It's a sector we've long championed as our favorite, but it's fair to say that industrial REIT stocks are not bargains these days. As a result, we've trimmed positions to trade into better relative value while still maintaining considerable overweight positions in a few companies we believe are best-positioned among industrial REITs, primarily Terreno Realty (TRNO) and Rexford Industrial Realty (REXR).

"The issue we investors face is determining at what point lower market rents induce existing renters to skip renewal and move to a new unit."

Self-storage REITs have also realized significant multiple expansion over the past couple of years. This is a great business, to be sure, with a solid tenant base and minimal capital expenditure requirements for maintenance. What has changed over 2023 is the trajectory of new rent growth. It has been declining. The interesting dynamic that unfolds during periods of rent decline is the willingness of customers to renew at higher rents to avoid the inconvenience of moving to a new storage unit, even if that new unit offers a lower price. This is represented by a metric called existing customer rent increase (ECRI) and it can continue to grow even if market rents are declining. The issue we investors face is determining at what point lower market rents induce existing renters to skip renewal and move to a new unit.

Admittedly, the gap has widened more than we would have otherwise thought possible without a commensurate drop in renewal rates. Although we have not been able to estimate the exact timing of when ECRIs will stagnate or drop, it's fair to say that storage REITs are priced for continued robust operating fundamentals. Because we don't consider that a very likely outcome, we have trimmed our position in Public Storage (PSA) and liquidated Extra Space Storage (EXR).

Also making the sale list this year was Host Hotels & Resorts Inc. (HST). We always believed travel would return once the pandemic subsided, and it happened more quickly and more impressively than we originally expected. Valuations recovered significantly as a result and, while some investors believe that hotels are still a relative bargain, we find the sector's operating leverage to be an outsized risk. As of today the fund has only a small position in a single hotel REIT, Sunstone Hotel Investors (SHO). Sunstone has two unique characteristics that offset our general dislike for high operating leverage: 1) it has higher than average exposure to business travel, which is still growing, unlike leisure demand, which we believe has peaked; 2) it is still small enough to be considered a privatization candidate, especially since it trades at a discount to replacement cost and carries low leverage.

Both Sides of an Asymmetric Barbell

We don't expect the second half of 2023 will bring much relief to real estate valuations. Negative headlines are simply too easy to draft these days, and bank exposure to commercial real estate presents a very real threat to the proper functioning of credit markets. Nevertheless, most public real estate companies we monitor represent the best capitalized sort of real estate businesses, even those in the much maligned office sector. It is often said that an investor's most important talent is patience. We have argued many times in the past that real estate is by its very nature a longterm business. Frequent trading might appeal to some, but for us a patient long-term approach is the best way to optimize risk-adjusted returns. Even though the balance of the year is sure to be volatile, we have a very optimistic long-term view.

"The larger side of the barbell is invested in those sectors we favor most due to their long-term fundamental strength, high returns on invested capital, and balance sheet strength."

Still, we appreciate that questions remain regarding our investment approach. In response, we emphasize that the fund maintains its asymmetric barbell positioning. We have talked about this in recent shareholder letters, and provide a quick recap of the strategy here.

The larger side of the barbell is invested in those sectors we favor most due to their longterm fundamental strength, high returns on invested capital, and balance sheet strength. This larger side of the barbell includes sectors where we might be underweight relative to our benchmark, such as industrial and self-storage, but also those where we have a considerable overweight position. Apartments, grocery anchored shopping centers and cell tower REITs are the fund's largest overweight positions on the heavy side of the barbell. We believe that collectively these positions will produce the best relative performance across a very broad range of possible future economic scenarios. In essence, this is our anchor to windward.

Where we expect to produce better than average risk-adjusted returns is with the fund's investment on the smaller side of the barbell. That is where we have overweight positions in the office and life science sectors. We spoke earlier about our preference for those office buildings that we believe will thrive, but we should add that life science is often unfairly characterized as office. Our primary investment in this sector is Alexandria Real Estate (ARE) which has the distinction of being the longest tenured investment in Davis Real Estate Fund. It is an exceptional business that has thrived over the long haul. Its valuation has declined over the past year as investors question whether hybrid work poses a true threat to lab space. Life science employers will likely embrace hybrid work, but the best lab space will still thrive in that environment, just as the best office space will thrive. We also believe that plentiful supply in several of Alexandria's markets will be absorbed without significantly denting market rents. To state it simply, we believe that Alexandria continues to be a solid investment for the long term.

As always, we appreciate your confidence in fund management.

This material 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. Equity markets are volatile and an investor may lose money.

Davis Advisors 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 can 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.

Objective and Risks. The investment objective of Davis Real Estate Fund is total return through a combination of growth and income. There can be no assurance that the Fund will achieve its objective. Some important risks of an investment in the Fund are: stock market risk: stock markets have periods of rising prices and periods of falling prices, including sharp declines; 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; 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; 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; fees and expenses risk: the Fund may not earn enough through income and capital appreciation to offset the operating expenses of the Fund; 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; 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.

The information provided in this material should not be considered a recommendation to buy, sell or hold any particular security. As of 6/30/23, the top ten holdings of Davis Real Estate Fund were: Prologis, 7.09%; AvalonBay Communities, 5.10%; Public Storage, 4.91%; Essex Property Trust, 4.48%; Simon Property Group, 4.40%; Brixmor Property Group, 4.23%; Equinix, 4.23%; Cousins Properties, 4.20%; Welltower, 3.66%; Alexandria Real Estate Equities, 3.59%.

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. Visit or call 800-279-0279 for the most current public portfolio holdings information.

The Global Industry Classification Standard (GICS®) is the exclusive intellectual property of MSCI Inc. (MSCI) and S&P Global (“S&P”). Neither MSCI, S&P, their affiliates, nor any of their third party providers (“GICS Parties”) makes any representations or warranties, express or implied, with respect to GICS or the results to be obtained by the use thereof, and expressly disclaim all warranties, including warranties of accuracy, completeness, merchantability and fitness for a particular purpose. The GICS Parties shall not have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of such damages.

We gather our index data from a combination of reputable sources, including, but not limited to, Lipper, Wilshire 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.

After 10/31/23, this material must be accompanied by a supplement containing performance data for the most recent quarter end.