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Delaware REIT Fund Quarterly commentary December 31, 2016

Within the Fund

For the fourth quarter of 2016, Delaware REIT Fund (Institutional Class shares and Class A shares at net asset value) outperformed its benchmark, the FTSE NAREIT Equity REITs Index.

Notes on relative performance at the sector level follow:

The Fund’s underperformance in the lodging sector was due to the Fund’s small allocation relative to the benchmark index. Stock selection was strong as both Sunstone Hotel Investors and Host Hotels & Resorts outperformed the index. After the U.S. election, investors pivoted toward sectors that can provide a hedge against inflation. Hotels typically are positively correlated to changes in rates and inflation. With our focus on fundamentals, however, and given that revenue per available room (RevPAR) was weak throughout 2016, we had maintained a small relative allocation. In addition, Airbnb has been a threat to traditional lodging in many coastal cities given that, as a practical matter, it adds supply. In addition, a stronger U.S. dollar limits in-bound tourism and can affect hotels in California and New York.

The Fund underperformed in the specialty sector due to lack of exposure to two prison operators. Following the election, these stocks did well as investors seemed to assume that fewer prisoners would receive reduced sentences and that prison populations would stabilize or grow. Under the Obama administration, prison populations had declined and occupancy rates had weakened. During the quarter, we added a name in this sector, EPR Properties, taking advantage of its near-term underperformance as interest rates rose. EPR owns properties such as megaplex theaters, charter schools, and golf entertainment complexes. It has a solid yield, good internal growth, and an advantage with external growth given limited competition from other real estate investment trusts (REITs).

The freestanding sector was the Fund’s weakest-performing sector on both an absolute and relative basis. Triple-net lease companies often suffer the most severe declines as interest rates rise. Although they have limited internal growth, they buy on an accretive basis, taking advantage of their favorable cost of capital relative to private capitalization rates. Although, they have some of the most stable cash flows, freestanding REITs lost some investors to short-duration sectors such as hotels. The freestanding sector declined more than 13%, underperforming the index by more than 10 percentage points for the quarter. Although stock selection was neutral, the Fund’s mild overweight hurt performance. We reduced positions pending further clarity on the economic outlook.

In the healthcare sector, the Fund’s underweight and strong stock selection resulted in outperformance throughout the quarter. This group is not only interest rate sensitive but is facing some structural and cyclical headwinds in 2017. Rising rates are a negative, given the lack of internal growth relative to other sectors. The need for external growth in a rising rate environment increases cost of capital. Both occupancy and reimbursement rates have come under pressure. Additionally, senior housing is facing short-term supply issues. For all these reasons, we have underweighted this sector in the Fund. One standout area is biotech office space, and Fund holding Alexandria Real Estate Equities was a positive over the past year. Underweighting HCP, a large-cap REIT that had issues with a skilled nursing operator, also helped performance.

Strong stock selection drove outperformance in the office sector. Two West Coast stocks, Kilroy Realty and Hudson Pacific Properties, have benefited from solid fundamentals in both the Bay Area and the Los Angeles basin. Kilroy Realty made timely acquisitions and development starts early in this cycle that are paying dividends today. Hudson Pacific Properties has a West Los Angeles portfolio that is realizing good rent growth. The company also acquired a property from Blackstone in the Bay Area that is experiencing strong occupancy growth. Mack-Cali Realty, now under new management, is a northern New Jersey office and apartment REIT selling noncore office space, paying down debt, and operating its apartment portfolio far more efficiently than it had under prior management. Brandywine Realty Trust, a Philadelphia-based office REIT, has sold noncore office space in Texas and other areas and has been reinvesting in Philadelphia-area developments that are experiencing strong increases in leases.

Mild outperformance in the shopping centers sector came mainly from Equity One as Regency Centers bid to buy the company. Equity One rose 2% for the quarter while the shopping center group declined more than 8%. The sector has been weak, with investors concerned about retail sales. Bankruptcies took their toll as well, notably that of Sports Authority, which had the negative effect of shaving about 0.5% off the net operating income of larger-cap REITs. Rising interest rates also had a negative effect on the group, given its lower but more stable growth rate.


Over the past few years, many investors have reacted to the perceived correlation between interest rates and REITs by selling when rates rise. When rates increase, many investors often immediately assume the worst. Historically, there is no doubt that over short periods of time (weeks to several quarters), REITs can be negatively affected by rising rates.

However, we have always contended that investors reacting this way lack a full understanding of REIT cash flow characteristics and real estate leases. To see why, let’s compare two periods of rate increases and REIT returns:

In 2013, as the Federal Reserve was tapering its quantitative easing program, the 10-year Treasury yield rose from 1.63% to 3.02% from May to December. The annual total return for REITs that year, as measured by the MSCI U.S. REIT Index, was 2.50% — not overly exciting in our view, but certainly not the disaster that generalists expected during the so-called taper tantrum. In 2016, when the 10-year Treasury yield rose from 1.36% to 2.59% from July through December, REITs delivered an 8.62% annual total return. Again, despite a few months of volatility, REITs still delivered solid returns. (Data: Bloomberg, FTSE.)

If inflation rises uncontrollably, REITs will suffer but will also have plenty of company as the overall stock market will likely decline as well. On the other hand, if growth accelerates, then real estate cash flows will rise given their sensitivity to the economic cycle.

It seems, at least to this analyst, that investors have been trained to think that an equity security with yield should be shunned if rates increase. It’s important to remember, however, that real estate companies have contractual rent increases embedded in their leases. That’s a natural inflation hedge that drops to the bottom line. In contrast, other industries that pass higher costs onto customers lack a real inflation hedge. We believe that increases in both interest rates and growth rates will be reflected in rising REIT cash flows and increases in dividends, which the market may then capitalize into higher equity pricing.

The MSCI U.S. REIT Index is a free float-adjusted market capitalization weighted index that comprises equity REITs included in the MSCI USA Investable Market Index, with the exception of certain specialized equity REITs that do not generate a majority of their revenue and income from real estate rental and leasing operations. The index represents approximately 99% of the U.S. REIT universe.


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.


The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance quoted.

Performance data current to the most recent month end may be obtained by calling 800 523-1918 or visiting

Total returns may reflect waivers and/or expense reimbursements by the manager and/or distributor for some or all of the periods shown. Performance would have been lower without such waivers and reimbursements.

Average annual total return as of quarter-end (12/31/2016)
YTD1 year3 year5 year10 yearLifetimeInception
Class A (NAV)-2.80%5.29%5.29%11.87%10.63%4.54%11.28%12/06/1995
Class A (at offer)-8.40%-0.78%-0.78%9.67%9.34%3.92%10.96%
Institutional Class shares-2.67%5.60%5.60%12.18%10.92%4.81%9.22%11/11/1997
FTSE NAREIT Equity REITs Index-2.89%8.52%8.52%13.38%12.01%5.08%n/a

Returns for less than one year are not annualized.

Class A shares have a maximum up-front sales charge of 5.75% and are subject to an annual distribution fee.

Index performance returns do not reflect any management fees, transaction costs, or expenses. Indices are unmanaged and one cannot invest directly in an index.

FTSE NAREIT Equity REITs Index (view definition)

Expense ratio
Class A (Gross)1.33%
Class A (Net)1.33%
Institutional Class shares (Gross)1.08%
Institutional Class shares (Net)1.08%
Share class ticker symbols
Institutional ClassDPRSX
Top 10 holdings as of 02/28/2017
Holdings are as of the date indicated and subject to change.
List excludes cash and cash equivalents.
Holding% of portfolio
Simon Property Group Inc.7.6%
Equinix Inc.5.3%
AvalonBay Communities Inc.5.1%
Vornado Realty Trust4.5%
Welltower Inc.4.5%
Prologis Inc.3.8%
HCP Inc.3.7%
GGP Inc.3.6%
Equity Residential3.0%
UDR Inc.2.9%
Total % Portfolio in Top 10 holdings44.0%

Institutional Class shares are only available to certain investors. See the prospectus for more information. 

All third-party marks cited are the property of their respective owners.

Carefully consider the Fund’s investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Fund’s prospectus and its summary prospectus, which may be obtained by clicking the prospectus link located in the right-hand sidebar or calling 800 523-1918. Investors should read the prospectus and the summary prospectus carefully before investing.

Investing involves risk, including the possible loss of principal.

Narrowly focused investments may exhibit higher volatility than investments in multiple industry sectors.

REIT investments are subject to many of the risks associated with direct real estate ownership, including changes in economic conditions, credit risk, and interest rate fluctuations.

A REIT fund's tax status as a regulated investment company could be jeopardized if it holds real estate directly, as a result of defaults, or receives rental income from real estate holdings.

All third-party marks cited are the property of their respective owners.

Not FDIC Insured | No Bank Guarantee | May Lose Value