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Delaware REIT Fund Quarterly commentary September 30, 2016

Within the Fund

For the third quarter of 2016, Delaware REIT Fund (Institutional Class shares and Class A shares at net asset value) underperformed its benchmark, the FTSE NAREIT Equity REITs Index. Notes on relative performance at the sector level follow:

In the healthcare sector, the Fund underperformed due to both stock selection and the Fund’s underweight relative to the benchmark index. With its higher-than-average yield, this sector was highly sought after by investors looking for higher income. Notably, the smaller-cap healthcare companies have higher yields, and generalist investors have been large buyers. We have been more cautious, however. We are wary that changes in government payments for skilled nursing facilities could erode margins and occupancy. Cyclically higher supply of senior housing should also affect these operators. Nonetheless, in the third quarter, yield prevailed over fundamentals.

The shopping centers sector had outperformed in the first and second quarters of this year. We believe there was some rotation out of this stable group into sectors generating more yield. The Fund underperformed in this sector due to stock selection, as many of the higher-quality companies in the portfolio underperformed higher yielding, overleveraged, and poorer-quality companies. The low yield environment has forced investors to hunt for the highest yield, regardless of fundamentals. This group has low supply and steady net operating income growth. There is little speculative development, which plagued the sector in the last cycle. We plan to maintain the Fund’s overweight, as we believe other sectors should see more significant slowdowns in cash flow.

Although the Fund’s two holdings in the diversified sector, Vornado Realty Trust and Washington Real Estate Investment Trust, outperformed the benchmark index, several small-cap names not held in the portfolio outperformed even more strongly in the quarter. NorthStar Realty Finance and NorthStar Realty Europe, for example, were up almost 20% as investors chased higher yields. Vornado is a New York and Washington, D.C.-centric office company that has been selling noncore assets in a streamlining effort. The potential for spinning off the D.C. assets should be a positive. However, given the company’s many parts, its stock has traded at a discount over the years. Washington Real Estate Investment Trust is another D.C.-based company that is selling noncore assets to focus more on multifamily units and less on office space within the region. We believe this should give the company a higher multiple over time.

Strong stock selection drove performance in the office sector as Hudson Pacific Properties and Empire State Realty Trust were both up more than 10%. Hudson is a California-focused company. Its below-market leases are rolling up as they expire, providing strong rent growth. Empire State is a New York City–focused company that has redevelopment projects on the side streets (smaller than those on the main avenues). The projects are adding significant value and translating into strong rent growth. We have reduced the Fund’s position in two large New York real estate investment trusts (REITs), Boston Properties and SL Green Realty. These companies are sensitive to the slowdown afflicting investment banking and performance issues that have shuttered many hedge funds.

The apartment sector has struggled all year as growth of net operating income slowed and rents softened, setting up unfavorable comparisons with prior years. During the quarter, however, one of the Fund’s holdings, Post Properties, received a takeover bid from Mid-America Apartment Communities. We were not surprised, given that Post had been culling its portfolio and paying down debt. Given the all-stock transaction, we have reduced the Fund’s position. The purchase price, which we thought was on the high end, was not favorably received by the investment community at first. We sold most of the position to reduce risk. In turn, we added to Equity Residential as it had underperformed and was selling at close to a 20% discount to net asset value (NAV). Overall, supply is coming down as banks reduce their lending to multifamily properties, which, in our view, should be good for the market over the next 12–18 months. There could be more volatility in the sector as it works through a modest slowdown in rents and some pockets of oversupply in cities like New York and San Francisco.

On Aug. 18 — the day that the U.S. Justice Department announced it would like to end the use of private prisons currently contracted by the Bureau of Prisons — GEO Group and Corrections Corporation of America (not a holding), both in the specialty sector, declined 35–40%. With the Fund having had only a small, nonmaterial position in GEO Group, which has less than 15% overall exposure to private prisons, we believe the Fund was well positioned. Prison populations have declined during the Obama administration. We think this would probably continue under a Clinton administration, though the opposite might occur if Trump were to become president. GEO Group rebounded more than 25% during September, allowing us to reduce the Fund’s position. As there will likely be a great deal of discussion and political posturing over this issue, and given the recent REIT selloff, we thought it prudent to look for companies that, in our view, may offer more potential at a lower price. At the same time, given GEO’s small prison exposure and the strength of its balance sheet, we plan to retain a small position for the time being.


As of this writing, REITs are in a selloff phase given the rise in interest rates. From Aug. 1 through Oct. 4, they declined 8.76%. We had anticipated such a move, given REITs’ prior outperformance and valuations. Our belief is that the 10-year Treasury yield, which climbed from 1.35% to 1.71% during the quarter, could begin to decline if economic data slows. There has been some recent improvement in the data, but we believe it is transitory. This raises the question: Are REITs too correlated with interest rates?

In the short term, we believe the answer is “yes.” Given that this is not the first time interest rates have risen and REITs have sold off, we see potential for attractive opportunities in the near future.

August saw the creation of a new Global Industry Classification Standard (GICS®) REIT sector in the S&P 500® Index. As a result, more generalist investors are attending conferences and inquiring about REITs. While many observers think this will likely result in added flow of investments into REITs, we believe that flows can go both ways. More importantly, however, we hope that REITs increasingly trade on their fundamentals and real estate characteristics rather than on yield alone, which has been the case for the past three years.

REITs tend to have stable cash flows and provide modest growth, and they’ve outperformed even private real estate over the past 20 years. They provide transparency, permanent capital, and the alignment of interest and higher-quality properties. Many have argued, correctly, that REITs can be highly volatile. Nonetheless, we believe that, like private real estate, REITs should be a long-term holding. Taking that view, the volatility of REITs represents not just risk but opportunity.

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.


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)1.32%
Class A (Net)1.32%
Institutional Class shares (Gross)1.07%
Institutional Class shares (Net)1.07%
Share class ticker symbols
Institutional ClassDPRSX
Top 10 holdings as of 12/31/2016
Holdings are as of the date indicated and subject to change.
List excludes cash and cash equivalents.
Holding% of portfolio
Simon Property Group Inc.7.5%
Equinix Inc.4.7%
Equity Residential4.3%
Vornado Realty Trust4.3%
Prologis Inc.3.9%
Public Storage3.9%
AvalonBay Communities Inc.3.8%
Host Hotels & Resorts Inc.3.4%
General Growth Properties Inc.3.1%
Welltower Inc.2.8%
Total % Portfolio in Top 10 holdings41.7%

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