You may qualify for sales-charge discounts if you and your family invest, or agree to invest in the future, at least $50,000 in Delaware Investments® Funds. More information about these and other discounts is available from your financial advisor, in the Fund's prospectus under the section entitled "About your account," and in the Fund's statement of additional information under the section entitled "Purchasing shares."
The following table describes the fees and expenses that you may pay if you buy and hold shares of the Fund.
|Maximum sales charge (load) imposed on purchases as a percentage of offering price
|Maximum contingent deferred sales charge (load) as a percentage of original purchase price or redemption price, whichever is lower
|Annual fund operating expenses
|Distribution and service (12b-1) fees
|Total annual fund operating expenses1
|Fee waivers and expense reimbursements
|Total annual fund operating expenses after fee waivers and expense reimbursements
1The Fund's investment manager, Delaware Management Company (Manager), has contractually agreed to waive all or a portion of its investment advisory fees and/or pay/reimburse expenses (excluding any 12b-1 plan, taxes, interest, inverse floater program expenses, short sale and dividend interest expenses, brokerage fees, certain insurance costs, acquired fund fees and expenses, and nonroutine expenses or costs, including, but not limited to, those relating to reorganizations, litigation, conducting shareholder meetings, and liquidations) in order to prevent total annual fund operating expenses from exceeding 1.25% of the Fund's average daily net assets from Feb. 28, 2013 through Feb. 28, 2014. These waivers and reimbursements may only be terminated by agreement of the Manager and the Distributor, as applicable, and the Fund.
Within the Fund
For the third quarter of 2013, Delaware REIT Fund (Class A shares at net asset value) posted a negative return and underperformed its benchmark, the FTSE NAREIT Equity REITs Index. Notes on relative performance at the sector level follow:
The Fund’s underweight and poor stock selection in the lodging sector hurt performance this quarter. Several hotel REITs, namely LaSalle Hotel Properties and DiamondRock Hospitality (neither a Fund holding), had very good results after underperforming over the past several quarters. We continue to believe the hotel cycle is improving and, along with a potentially stronger economy, investors in REITs may gravitate toward those sectors with shorter duration. The lodging cycle has been supported by transient demand (consumers and business travelers), but group business (that is, conferences) is becoming an increasing portion of hotel revenues. The group business has been slow to materialize, as the recession made companies that much more cautious about spending on large conferences.
Underperformance in the specialty sector was due more to what the Fund did not own. Corrections Corp of America, a prison REIT, was up 4.9%, as certain outsourcing contracts helped the company post strong results in the quarter. We sold the Fund’s American Tower position as we believed the weakness in REITs was providing good opportunities in cheaper stocks, as American Tower held up relatively better during the downturn in the third quarter.
In regional malls, the Fund’s overweight position and larger-cap style hurt relative performance. Malls underperformed as retail sales slowed and investors seemed to be spooked by potential rent declines. At times, investors seem to forget why malls are such a great business. The supply of malls has been less than 1% annually for the past 10 years. Public REITs own more than 20% of all the malls in the United States, and a much higher percentage of the better-performing malls. In our opinion, the business is essentially an oligopoly (a market situation in which each of a few producers affects but does not control the market), and many retailers, despite slowing sales, have continued to desire space in the malls held within the Fund. Notably, Simon Property Group and General Growth Properties own some of the highest-quality real estate in the U.S., and, as mall stocks are cheap, we have added to the Fund’s positions.
The Fund outperformed in the mixed sector owing to strong stock selection led by DuPont Fabros Technology, a data center REIT, and Duke Realty, an owner of industrial, office, and medical office buildings. DuPont Fabros had strong leasing in its development pipeline and improvement in its balance sheet. In addition, its corporate governance steps were a move in the right direction. In our view, the current CEO was stronger as an entrepreneur than as a public CEO. The company is currently interviewing for a new CEO, which should help in its dealings with investors. Duke Realty continues to execute in a strong industrial market. The company has benefited from several years of repositioning its portfolio from suburban office to more industrial and medical office properties. Our avoidance of Digital Realty, down 13% for the quarter, helped relative performance, as the company is facing a slowing of top-line rents.
In the industrial sector, our overweight allocation and strong stock selection aided performance during the quarter. First Industrial Realty Trust has been on a three-year turnaround that is now beginning to bear results as net operating income (rents minus expenses) is on the rise and this stock remains cheap relative to its peers. The company has refinanced and extended debt maturities and is now on a growth path buying in secondary but recovering markets. DCT Industrial Trust, another smaller-cap Fund holding, has grown organically and is developing additions to its growth profile over the next year.
Our underweight to the healthcare sector significantly helped Fund returns, as long-duration leases underperformed. Healthcare REITs generally have long leases with very little internal growth, as they rely on acquisitions. When rates rise, accessing equity becomes more expensive as the stock price falls. As a result, many large-cap healthcare REITs have seen a rise in their costs of capital. In addition, with several of these companies (including Fund holding Health Care REIT) having made multiple acquisitions over the years, the companies are now seeing the need to do larger, less-accretive purchases.
The third quarter was a difficult environment for real estate investment trust (REIT) investors, and for equity income investors in general, as REITs underperformed the S&P 500® Index by more than eight percentage points. We believe this underperformance can be explained by investors’ belief that higher rates would cause cap rates to rise and real estate values to fall. While cap rates could rise, if the economic backdrop were improving then REIT rents and net operating income (NOI) would tend to increase as well.
Most REITs either have very-short-duration leases (one year or less for hotels, self storage, and multifamily) or longer-duration leases (industrials and malls). Short-duration leases can adjust daily or monthly and can keep pace with inflation as a result. Longer-duration leases have annual rent increases that are indexed to inflation, which allows them to keep pace with rising rates or inflation. Good REIT landlords will combine these periodic rent increases with fixed long-term debt, thereby providing cash flow growth that is greater than inflation.
Given the selloff in the REIT sector, we have seen opportunities to buy attractive companies that are selling at discounts to net asset value (NAV), most notably in the mall sector, where the average discount to NAV is -14%. Contrast this with the self-storage sector, whose average premium to NAV is +38%. (Data: Citigroup Global Markets.) Historically, investors have tended to overpay for growth, and we believe this anomaly may be corrected in the coming year or so.
The S&P 500 Index measures the performance of 500 mostly large-cap stocks weighted by market value, and is often used to represent performance of the U.S. stock market.
The views expressed represent the Manager's assessment of the Fund and market environment as of the date indicated, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Information is as of the date indicated and subject to change.
Document must be used in its entirety.