MERRILL LYNCH
REAL ESTATE
FUND, INC.
FUND LOGO
Quarterly Report
August 31, 1998
This report is not authorized for use as an offer of sale or a
solicitation of an offer to buy shares of the Fund unless
accompanied or preceded by the Fund's current prospectus. Past
performance results shown in this report should not be considered a
representation of future performance. Investment return and
principal value of shares will fluctuate so that shares, when
redeemed, may be worth more or less than their original cost.
Statements and other information herein are as dated and are subject
to change.
Merrill Lynch
Real Estate Fund, Inc.
Box 9011
Princeton, NJ
08543-9011
Printed on post-consumer recycled paper
MERRILL LYNCH REAL ESTATE FUND, INC.
DEAR SHAREHOLDER
During the quarter ended August 31, 1998, the relative performance
of the real estate securities market has been both disappointing and
surprising in that the real estate securities market dramatically
underperformed both the broader stock and bond markets. Total
returns for Merrill Lynch Real Estate Fund, Inc.'s Class A, Class B,
Class C and Class D Shares for the quarter ended August 31, 1998
were -17.35%, -17.59%, -17.59% and -17.41%, respectively. Total
return for the unmanaged Morgan Stanley Real Estate Investment Trust
Index for the quarter ended August 31, 1998 was -15.81%. These
returns compare to total returns of -11.93% for the unmanaged
Standard & Poor's 500 Index (S&P 500) and +5.31% for the ten-year
Treasury note for the same period.
Throughout the August quarter, perhaps the most surprising
development was the benign backdrop that surrounded real estate
securities. At the beginning of the fiscal year, our relatively
positive outlook on real estate stocks was based on a number of
opinions, including our belief that construction activity would
increase at a moderate rate to allow vacancies to continue to fall
while rents would continue to rise. We also believed that real
estate investment trust (REIT) earnings would rise at low double-
digit rates, and moderating inflation would increase the appeal of
higher-yielding securities. During the quarter ended August 31,
1998, these expectations essentially were realized. Construction
remained moderate, REIT funds from operations (FFO) growth exceeded
expectations (growing 15% in the first half of 1998), and ten-year
Treasury yields declined by 76 basis points (0.76%). Additionally,
S&P earnings growth was revised lower on fears of slowing foreign
economies, and the dollar continued to appreciate, making US-based
assets more valuable than foreign-based assets. In our opinion, all
of these developments should have been neutral to positive for the
relative performance of real estate securities. However, REIT prices
declined during the August quarter.
It appears to us that the stock market is discounting an economic
slowdown. Specifically, the sectors that seem to be under the most
pressure are those perceived to be the most economically sensitive,
including REITs. Although we believe that the economic sensitivity
of many of the sub-sectors of the REIT market is quite low,
investors seem to believe that real estate is cyclical and should be
sold. During the quarter ended August 31, 1998, the poorest-
performing sectors were hotels and office, while manufactured homes
and regional malls outperformed their peers.
We believe several factors militate against the markets' current
view. First, we believe that the advent of the public market pricing
discipline will function to smooth out the historically volatile
return pattern of real estate, resulting in longer cycles with more
muted returns. We also expect that capital will be more prudently
deployed throughout the cycle, creating lower construction peaks and
higher troughs. Third, even after the significant reduction of
equity, today's REITs still have modest leverage (about 40% of total
capitalization) and modest payout ratios (averaging about 70% of
cash flow). Fourth, the average REIT (excluding hotel and apartment
REITS) has contractual leases that typically average 4 years--15
years. We view this revenue stream as inherently more stable than
that of a typical industrial company. Last, because of the
combination of a multi-year lease structure and the recovery in the
property markets, most REITs continue to see lease rates move higher
as existing leases are renewed. We expect this phenomenon to
continue for the next several years.
Merrill Lynch Real Estate Fund, Inc.
August 31, 1998
Currently, it appears that liquidity, or lack thereof, has been the
overriding driver of return in the real estate securities market. In
the broader stock market, stocks that have outperformed generally
are the most highly regarded, largest-capitalization issues. In
contrast, in the real estate securities markets, these types of
stocks have been the poorest performers. Seven of the eight largest-
capitalization stocks in the Morgan Stanley REIT Index
underperformed the Index during the quarter ended August 31, 1998 by
an average of more than 300 basis points. As many of the better-
managed, higher-quality, larger-capitalization REITs performed
relatively poorly in the first seven months of the year, we took
this opportunity to trade up by selling our less dynamic, less
liquid, smaller-capitalization holdings. While over the long term we
expect these higher-quality holdings to outperform the broader
market, in the short term they have underperformed significantly.
During the month of August, when the Morgan Stanley REIT Index
declined by 9.3%, the Fund declined by 11.8%. This was the second
time in 1998 that the Fund trailed the Index, and by far our widest
margin of underperformance.
The most probable explanation for the underperformance of large-
capitalization REITs is negative cash flows into the sector.
Although cash flow into the broad equity market remained positive
throughout the year, at over $20 billion per month, funds dedicated
to real estate decreased in February 1998 and have not yet turned
around. In the second and third quarters of 1998, more than $600
million had actually been redeemed from these funds. In addition, it
is also likely that some of the more value-oriented general stock
mutual funds have been sellers, as investor redemptions forced the
selling of underperforming stocks as well.
According to the Merrill Lynch Comparative Valuation REIT Weekly
(August 28, 1998), REITs are currently trading at a multiple that is
less than one-half that of the broader market. This is the lowest
that REITs have traded in many years. Similarly, REITs are less
expensive compared to the bond market than they have been in recent
years. While ten-year Treasury note rates have declined by 71 basis
points to their lowest level in decades, REIT-adjusted FFO yields
have backed up by 242 basis points to their highest level since at
least 1993. Such disparate movements are a first for this
relationship. Also, the Merrill Lynch Comparative Valuation REIT
Weekly (August 28, 1998) indicated that most REITs can be purchased
for less than the underlying value of their real estate holdings for
the first time in several years. Consequently, investors can buy
real estate cheaper on the floor of the New York Stock Exchange than
they can on "Main Street." In particular, the office/industrial
sector at a 16% discount to net asset value and the hotel sector at
a 24% discount to net asset value look attractive on this basis. In
our opinion, all of these value relationships that point in the same
direction serve only to underscore the relative value currently
present in REIT securities.
Though the lack of liquidity in the real estate securities market
continues to be a problem for the sector, other factors point toward
better prospects for real estate securities. Fundamentals remain
solid in the underlying real estate markets. The contractual nature
of revenue streams helps to assure double-digit growth in FFO for
both this year and the next. The valuations of real estate stocks
are very low compared to stocks and bonds, and in most property sub-
sectors are below the net asset values of the underlying real estate
portfolios. Dividend yields are high and secure compared to
alternatives. From our perspective, the bottom line is that
investors can now purchase the best-managed, highest-quality real
estate companies in the United States at historically low prices.
However, we do not believe this is a condition that will persist.
Looking ahead, we expect better relative performance from the sector
and will remain essentially fully invested. At August 31, 1998, our
portfolio of stocks traded at about 8.5 times consensus 1999 FFO
estimates with expected growth of over 16% and paying dividends to
the Fund of about 7.25%.
In Conclusion
We thank you for your investment in Merrill Lynch Real Estate Fund,
Inc. We look forward to discussing our investment strategy and
outlook with you in our upcoming annual report to shareholders.
Sincerely,
(Arthur Zeikel)
Arthur Zeikel
President
(Jay Willoughby)
Jay Willoughby
Senior Vice President and Portfolio Manager
October 7, 1998
Merrill Lynch Real Estate Fund, Inc.
August 31, 1998
PERFORMANCE DATA
About Fund Performance
Investors are able to purchase shares of the Fund through the
Merrill Lynch Select Pricing SM System, which offers four pricing
alternatives:
* Class A Shares incur a maximum initial sales charge (front-end
load) of 5.25% and bear no ongoing distribution or account
maintenance fees. Class A Shares are available only to eligible
investors, as detailed in the Fund's prospectus.
* Class B Shares are subject to a maximum contingent deferred sales
charge of 4% if redeemed during the first year, decreasing 1% each
year thereafter to 0% after the fourth year. In addition, Class B
Shares are subject to a distribution fee of 0.75% and an account
maintenance fee of 0.25%. These shares automatically convert to
Class D Shares after 8 years. (There is no initial sales charge for
automatic share conversions.)
* Class C Shares are subject to a distribution fee of 0.75% and an
account maintenance fee of 0.25%. In addition, Class C Shares are
subject to a 1% contingent deferred sales charge if redeemed within
one year of purchase.
* Class D Shares incur a maximum initial sales charge of 5.25% and
an account maintenance fee of 0.25% (but no distribution fee).
None of the past results shown should be considered a representation
of future performance. Figures shown in the "Recent Performance
Results" and "Aggregate Total Return" tables assume reinvestment of
all dividends and capital gains distributions at net asset value on
the ex-dividend date. Investment return and principal value of
shares will fluctuate so that shares, when redeemed, may be worth
more or less than their original cost. Dividends paid to each class
of shares will vary because of the different levels of account
maintenance, distribution and transfer agency fees applicable to
each class, which are deducted from the income available to be paid
to shareholders.
Aggregate Total Return
% Return Without % Return With
Sales Charge Sales Charge**
Class A Shares*
Inception (12/26/97)
through 6/30/98 -0.07% -5.32%
[FN]
*Maximum sales charge is 5.25%.
**Assuming maximum sales charge.
% Return % Return
Without CDSC With CDSC**
Class B Shares*
Inception (12/26/97)
through 6/30/98 -0.59% -4.55%
[FN]
*Maximum contingent deferred sales charge is 4% and is reduced to 0%
after 4 years.
**Assuming payment of applicable contingent deferred sales charge.
% Return % Return
Without CDSC With CDSC**
Class C Shares*
Inception (12/26/97)
through 6/30/98 -0.57% -1.56%
[FN]
*Maximum contingent deferred sales charge is 1% and is reduced to 0%
after 1 year.
**Assuming payment of applicable contingent deferred sales charge.
% Return Without % Return With
Sales Charge Sales Charge**
Class D Shares*
Inception (12/26/97)
through 6/30/98 -0.23% -5.47%
[FN]
*Maximum sales charge is 5.25%.
**Assuming maximum sales charge.
Merrill Lynch Real Estate Fund, Inc.
August 31, 1998
PERFORMANCE DATA (concluded)
<TABLE>
Recent Performance Results*
<CAPTION>
3 Month Since Inception
Total Return Total Return
<S> <C> <C>
ML Real Estate Fund, Inc. Class A Shares -17.35% -17.42%
ML Real Estate Fund, Inc. Class B Shares -17.59 -18.00
ML Real Estate Fund, Inc. Class C Shares -17.59 -17.98
ML Real Estate Fund, Inc. Class D Shares -17.41 -17.51
<FN>
*Investment results shown do not reflect sales charges; results
shown would be lower if a sales charge was included. Total
investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital
gains distributions at net asset value on the ex-dividend date. The
Fund's inception date is December 26, 1997.
</TABLE>
PORTFOLIO INFORMATION
As of August 31, 1998
Percent of
Ten Largest Holdings Net Assets
Cabot Industrial Trust 6.7%
Capital Automotive 6.0
Crescent Real Estate Equities Company 4.8
JP Realty, Inc. 4.7
Equity Office Properties Trust 4.6
TrizecHahn Corporation 4.5
Entertainment Properties Trust 4.2
Kilroy Realty Corporation 4.1
Starwood Hotels & Resorts 3.8
CarrAmerica Realty Corporation 3.6
Portfolio Changes
For the Quarter Ended August 31, 1998
Additions
Brandywine Realty Trust
Burnham Pacific Properties, Inc.
*CDL Hotels International, Ltd.
Castellum AB
*CenterPoint Properties Trust
*Factory Realty Trust, Inc.
Homestead Village, Inc.
*Horizon Group Properties, Inc.
MeriStar Hospitality Corporation
*Merry Land & Investment Company, Inc.
Pacific Gulf Properties, Inc.
Patriot American Hospitality, Inc.
Prentiss Properties Trust
Prime Retail, Inc.
Public Storage, Inc.
Wihlborg Fastigheter AB
Deletions
Accor S.A.
Arden Realty, Inc.
Bay Apartment Communities, Inc.
Boykin Lodging Company
CBL & Associates Properties, Inc.
*CDL Hotels International, Ltd.
*CenterPoint Properties Trust
Chelsea GCA Realty, Inc.
*Factory Realty Trust, Inc.
FelCor Suite Hotels, Inc.
*Horizon Group Properties, Inc.
Interstate Hotels Company
*Merry Land & Investment Company, Inc.
Post Properties, Inc.
SL Green Realty Corp.
Shurgard Storage Centers, Inc.
Sponda OYJ
Sun Communities, Inc.
Weeks Corporation
[FN]
*Added and deleted in the same quarter.
Merrill Lynch Real Estate Fund, Inc.
August 31, 1998
<TABLE>
SCHEDULE OF INVESTMENTS
<CAPTION>
Shares Percent of
Industries Held Real Estate Investment Trusts Cost Value Net Assets
<S> <C> <S> <C> <C> <C>
Apartments 57,000 Avalon Properties, Inc. $ 2,078,191 $ 1,881,000 3.0%
68,310 Camden Property Trust 1,994,738 1,712,019 2.8
80,000 Summit Properties Inc. 1,515,149 1,340,000 2.1
------------ ------------ ------
5,588,078 4,933,019 7.9
Diversified/Mixed Use 310,000 Capital Automotive 4,627,575 3,739,375 6.0
60,000 Cousins Properties, Inc. 1,736,725 1,668,750 2.7
177,200 Entertainment Properties Trust 3,278,035 2,635,850 4.2
63,100 Pacific Gulf Properties, Inc. 1,359,299 1,198,900 1.9
------------ ------------ ------
11,001,634 9,242,875 14.8
Factory Outlets 209,200 Prime Retail, Inc. 2,359,339 1,961,250 3.2
Health Care 145,000 Meditrust Companies 3,872,401 2,247,500 3.6
Hotel/Restaurant 40,000 MeriStar Hospitality Corporation 787,250 675,000 1.1
135,000 Patriot American Hospitality, Inc. 2,998,752 1,822,500 2.9
65,000 Starwood Hotels & Resorts 3,280,763 2,372,500 3.8
------------ ------------ ------
7,066,765 4,870,000 7.8
Office Property 20,000 Brandywine Realty Trust 412,638 360,000 0.6
100,000 CarrAmerica Realty Corporation 2,983,915 2,250,000 3.6
130,000 Crescent Real Estate Equities Company 4,534,489 2,990,000 4.8
125,000 Equity Office Properties Trust 3,781,163 2,835,938 4.6
65,000 Highwood Properties, Inc. 2,267,681 1,653,438 2.7
125,000 Kilroy Realty Corporation 2,946,875 2,570,313 4.1
100,000 Prentiss Properties Trust 2,357,351 2,237,500 3.6
15,000 Tower Realty Trust, Inc. 320,075 315,937 0.5
------------ ------------ ------
19,604,187 15,213,126 24.5
Regional Malls 97,000 Glimcher Realty Trust 2,133,762 1,576,250 2.6
144,200 JP Realty, Inc. 3,326,889 2,902,025 4.7
30,000 Taubman Centers, Inc. 373,194 393,750 0.6
30,000 Urban Shopping Centers, Inc. 997,445 952,500 1.5
------------ ------------ ------
6,831,290 5,824,525 9.4
Shopping Centers 50,000 Burnham Pacific Properties, Inc. 702,556 650,000 1.0
46,400 Federal Realty Investment Trust 1,163,134 933,800 1.5
45,000 Philips International Realty Corp. 780,250 666,562 1.1
75,000 Regency Realty Corporation 1,950,788 1,654,687 2.7
------------ ------------ ------
4,596,728 3,905,049 6.3
Storage 60,000 Public Storage, Inc. 1,615,715 1,402,500 2.3
35,000 Storage USA, Inc. 1,356,475 1,047,812 1.7
------------ ------------ ------
2,972,190 2,450,312 4.0
Warehouse/Industrial 225,000 Cabot Industrial Trust 4,665,637 4,190,625 6.7
Total Real Estate Investment Trusts 68,558,249 54,838,281 88.2
</TABLE>
Merrill Lynch Real Estate Fund, Inc.
August 31, 1998
<TABLE>
SCHEDULE OF INVESTMENTS (concluded)
<CAPTION>
Shares Percent of
Industries Held Common Stocks Cost Value Net Assets
<S> <C> <S> <C> <C> <C>
Diversified 50,000 Castellum AB $ 500,576 $ 473,186 0.8%
125,000 Corrections Corporation of America 2,873,526 1,914,063 3.1
165,000 TrizecHahn Corporation 3,803,883 2,815,313 4.5
900,000 Wihlborg Fastigheter AB 1,126,841 1,024,309 1.6
------------ ------------ ------
8,304,826 6,226,871 10.0
Hotels 30,000 Homestead Village Inc. 281,969 245,625 0.4
Total Common Stocks 8,586,795 6,472,496 10.4
Face
Amount Short-Term Securities
Commercial Paper* $644,000 General Motors Acceptance Corp., 5.81%
due 9/01/1998 644,000 644,000 1.0
Total Short-Term Securities 644,000 644,000 1.0
Total Investments $ 77,789,044 61,954,777 99.6
============
Other Assets Less Liabilities 258,532 0.4
------------ ------
Net Assets $ 62,213,309 100.0%
============ ======
Net Asset Value: Class A--Based on net assets of $2,188,893 and 269,541
shares outstanding $ 8.12
============
Class B--Based on net assets of $44,125,831 and 5,446,102
shares outstanding $ 8.10
============
Class C--Based on net assets of $9,139,537 and 1,128,326
shares outstanding $ 8.10
============
Class D--Based on net assets of $6,759,048 and 832,733
shares outstanding $ 8.12
============
<FN>
*Commercial Paper is traded on a discount basis; the interest rate
shown reflects the discount rate paid at the time of purchase by the
Fund.
</TABLE>
Merrill Lynch Real Estate Fund, Inc.
August 31, 1998
OFFICERS AND DIRECTORS
Arthur Zeikel, President and Director
Joe Grills, Director
Walter Mintz, Director
Robert S. Salomon Jr., Director
Melvin R. Seiden, Director
Steven B. Swensrud, Director
Terry K. Glenn, Executive Vice President
Norman R. Harvey, Senior Vice President
Jay L. Willoughby, Senior Vice President
and Portfolio Manager
Donald C. Burke, Vice President
Gerald M. Richard, Treasurer
Philip M. Mandel, Secretary
Custodian
The Bank of New York
90 Washington Street, 12th Floor
New York, NY 10286
Transfer Agent
Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, FL 32246-6484
(800) 637-3863
