Repositioning for Recovery: Davis Real Estate Fund and the Path to Outperformance in a Shifting Real Estate Landscape

The Davis Real Estate Fund (DREF) has faced a turbulent first half of 2025, with a -1.79% total return on net asset value, trailing the Wilshire U.S. Real Estate Securities Index's +1.74% gain. Yet, beneath this underperformance lies a strategic repositioning that could position the fund for a meaningful rebound. As supply-driven shifts reshape industrial, office, and apartment REITs, DREF's disciplined focus on undervalued sectors and high-quality assets offers a compelling case for long-term investors.

Supply-Driven Rebalancing: The Industrial Sector's Crossroads

The industrial real estate market, a cornerstone of DREF's portfolio, is at a pivotal juncture. National vacancy rates rose to 7.1% in Q2 2025, with speculative construction hitting a five-year low of 62.3%. While this signals a slowdown in oversupply, challenges persist. The West region, for instance, recorded negative net absorption (-2.3 million square feet), driven by oversaturated markets like the Inland Empire and Los Angeles.

DREF's overweight position in Rexford Industrial Realty (REXR), a leader in “last-touch” logistics properties, reflects its conviction in the sector's long-term durability. Despite a 5% projected rent decline in 2025, Rexford's 4.4% dividend yield and focus on high-barrier locations (e.g., Southern California, Florida) position it to outperform as demand normalizes.

The fund's exposure to American Tower (AMT) further underscores its strategic pivot. With 30.4% of industrial deliveries in H1 2025 being build-to-suit projects, the demand for infrastructure tied to e-commerce and 5G expansion remains robust. American Tower's stable cash flows and 2.6% annual rent growth in Q2 2025 highlight its resilience, even as broader industrial REITs face near-term headwinds.

Office REITs: A Tale of Two Markets

The office sector's bifurcation between prime and non-prime assets has created asymmetric opportunities. Prime vacancy rates stand at 14.5%, while non-prime rates hover at 9.3%, reflecting a “flight to quality” by tenants. DREF's holdings in BXP and Prologis (industrial) align with this trend, as companies prioritize high-quality, energy-efficient spaces.

Notably, DREF's underweight in seniors housing—a sector plagued by high valuations—has shielded it from weaker performance in that segment. Meanwhile, its cautious optimism about office REITs is grounded in improving supply fundamentals. With 2025 office deliveries projected at a 13-year low (13 million square feet), the path to stabilization is clearer.

Apartment REITs: A Spring-Loaded Recovery

The multifamily sector, though still grappling with a 4% vacancy rate (as of Q2 2025), is showing early signs of normalization. Strong absorption in H1 2025 has offset supply pressures, particularly in urban markets with robust employment. DREF's focus on “spring-loaded” recovery scenarios—where slowing construction and job growth drive demand—positions it to capitalize on a delayed rent rebound.

However, the fund's cautious stance on Alexandria Real Estate Equities (ARE), a life sciences REIT, highlights its risk-adjusted approach. With Trump-era funding cuts dampening demand for lab space, Alexandria's fundamentals are expected to stabilize only by 2027. DREF's patience here underscores its long-term orientation.

Strategic Positioning and Cost Efficiency

DREF's low expense ratios (1.00% net for Class A shares) and strong balance sheet provide a buffer against volatility. Its adherence to the Davis Investment Discipline—prioritizing best-of-breed management and durable cash flows—has preserved capital during the downturn. For example, its underweight in seniors housing and overweight in industrial REITs have mitigated losses while maintaining exposure to high-conviction sectors.

Investment Implications

For investors, DREF's repositioning offers a blueprint for navigating a fragmented real estate market:
1. Industrial REITs: Overweight positions in Rexford and American Tower are well-suited for a post-supply rebalancing environment.
2. Office REITs: Undervalued prime assets (e.g., BXP) offer upside as demand normalizes.
3. Apartment REITs: A patient approach to multifamily recovery, with a focus on infill urban properties.

While DREF's short-term returns have lagged, its strategic alignment with supply-driven trends and sector-specific undervaluation positions it for outperformance as market conditions evolve. For long-term investors, the fund's disciplined approach and cost efficiency make it a compelling case study in real estate repositioning.