MERRILL LYNCH
REAL ESTATE
FUND, INC.
FUND LOGO
Quarterly Report
August 31, 1999
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
Real estate-related securities experienced difficulties during the
three months ended August 31, 1999, and Merrill Lynch Real Estate
Fund, Inc. was no different. The Fund's Class A, Class B, Class C
and Class D Shares had total returns of -7.14%, -7.40%, -7.40% and
- -7.09%, respectively, for the August quarter. (Investment results do
not reflect sales charges, and would be lower if sales charges were
included. Complete performance information can be found on pages 3
and 4 of this report to shareholders.) These total returns trailed
the +1.75% total return generated for the unmanaged Standard &
Poor's 500 (S&P 500) Index, the -1.65% total return of the US ten-
year Treasury note and the -5.86% total return for real estate
stocks as measured by the unmanaged Morgan Stanley Real Estate
Investment Trust (REIT) Index for the same three-month period.
We are disappointed that real estate stocks could not maintain the
momentum that had begun in the second quarter of 1999, but we remain
optimistic based upon low relative valuations and high current
dividend yields obtainable within the sector. While our value-
oriented stock selection has not benefited performance, we believe
it will help our relative performance improve moving forward.
Market Review
After such a strong second quarter, we were optimistic that investor
interest in the sector would be rekindled and would support positive
cash flows into the stocks. This did not happen. Instead, negative
cash flows forced many REIT fund managers to sell real estate
stocks, contributing to more difficult quarterly results. However,
from a fundamental real estate standpoint, we remain bullish. On the
supply side, overall new construction has remained at moderate
levels, roughly meeting new demand. We believe capital markets will
act as an effective governor of capital and restrain new
construction before serious new supply problems develop. This thesis
will be tested from time to time and from market to market, but we
believe it should provide the discipline necessary to enable REITs
to continue to grow their funds from operation (FFO) at high single
digit rates for an extended period.
On the demand side, the economy continues to surprise most observers
with its resilience. After the financial crisis last fall, most
economists expected a marked slowdown. This really never developed,
and most signs point to continued growth. This should be good news
for real estate, since it is likely to provide for continued space
demand in virtually all property types. Interestingly, Merrill Lynch
Global Securities Research and Economics Group believes that the
rate of inflation, which bottomed in 1998, will begin to grow as
global disinflationary pressures abate. Many in the real estate
industry believe that while this may be bad for most financial
assets, it would be helpful to real estate assets. While it may make
new development more expensive, raising the rent-pricing umbrella,
it could also cause the economy and ultimately space demand to slow
down, and should therefore be viewed as a double-edged sword.
From a valuation standpoint, REITs are almost as inexpensive as they
have ever been. From a multiple of earnings perspective, REITs
appear very reasonably priced compared to the broad market.
Similarly, REIT dividend yields dwarf those of the S&P 500 and
utility stocks, especially on a historic basis. However, strong
economic growth has enabled many non-REIT stocks to post much
stronger earnings growth than previously expected. This may have
bolstered investors' confidence in valuations of non-REIT stocks,
encouraging them to invest further in these stocks. For their part,
REITs continued to make good progress on the earnings front, posting
same store gains (percentage change in net operating income per
square foot at a store open for more than one year) in the 4%--6%
range. This, along with leverage, resulted in FFO growth averaging
10%. Nevertheless, the rotation into REIT stocks witnessed last
quarter clearly did not continue this quarter.
Merrill Lynch Real Estate Fund, Inc.
August 31, 1999
According to the National Association of Real Estate Investment
Trusts, property acquisitions by REITs have fallen 80% from a year
ago in the second quarter to $2.7 billion. Going forward, the idea
for REITs will be to sell "expensive" property and buy "cheap"
stock. We expect to see significant share repurchase announcements
and/or going private transactions in the near future. While we have
seen Irvine Apartments return to the private sector, and Berkshire
Realty and Sunstone Hotel Investors have both announced management-
led buyout bids, we expect more transactions of this type. More
recently, Burnham Pacific Properties has created more negative press
for the REIT sector by spurning a private market bid nearly 20%
above the then-current stock price and subsequently granting large
golden parachutes to the top executives.
On a more positive note, it looks like any action on a REIT
modernization bill would likely enable REITs to provide more
services to their tenants. Ultimately, this could help bolster
earnings growth rates. Also, Senate Bill 1500 could prove to be a
positive catalyst for the battered healthcare sector. Early drafts
indicate that about one-half of the funding cut brought about by the
Medicare prospective payment system (PPS) could be restored. This
could enable the nursing home operators to survive and continue
making payments to the healthcare REITs that own properties. We have
recently added to our Meditrust Companies position, which has
performed very poorly this year. Though we underestimated the
potential stock price impact of PPS concerns (combined with a
cyclical downturn in the hotel business), we believe current
valuations more than discount future prospects. Despite our historic
bias against healthcare real estate companies, we view the current
dislocation in the stock market as an opportunity to increase our
stake in this area.
Portfolio Strategy
We continued to pursue our barbell approach, emphasizing the office
and triple net lease stocks as our aggressive and defensive
holdings, respectively, while we remained underweight in the
apartment and retail sectors. During the coming months, we expect to
sell additional retail holdings to make room for healthcare and
other new issues. This is based on our belief that as news of
tremendous Internet sales growth is disseminated, the retail names
will have a tough time making much progress.
Overall, our portfolio continues to exhibit what we view as
attractive characteristics. At August 31, 1999, the average stock in
the portfolio paid a dividend of 8.7% and traded at 8.7 times
expected FFO, with 14% growth anticipated next year. In spite of
what has been a long year, we remain very optimistic about the
future. We believe this may be an excellent time for investors to
buy REITs at prices generally below net asset value. In our opinion,
the stable income streams generated by these sound companies will
lead to growing dividends for many years to come.
In Conclusion
We thank you for your continued investment in Merrill Lynch Real
Estate Fund, Inc., and we look forward to reviewing our outlook and
strategy with you again in our next report to shareholders.
Sincerely,
(Terry K. Glenn)
Terry K. Glenn
President and Director
(Jay Willoughby)
Jay Willoughby
Senior Vice President and Portfolio Manager
October 8, 1999
Merrill Lynch Real Estate Fund, Inc.
August 31, 1999
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 "Average Annual 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.
Average Annual Total Return
% Return Without % Return With
Sales Charge Sales Charge**
Class A Shares*
Year Ended 6/30/99 -10.78% -15.47%
Inception (12/26/97)
through 6/30/99 - 7.33 -10.58
[FN]
*Maximum sales charge is 5.25%.
**Assuming maximum sales charge.
% Return % Return
Without CDSC With CDSC**
Class B Shares*
Year Ended 6/30/99 -11.59% -14.99%
Inception (12/26/97)
through 6/30/99 - 8.20 - 9.95
[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*
Year Ended 6/30/99 -11.68% -12.53%
Inception (12/26/97)
through 6/30/99 - 8.25 - 8.25
[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*
Year Ended 6/30/99 -10.93% -15.61%
Inception (12/26/97)
through 6/30/99 - 7.52 -10.77
[FN]
*Maximum sales charge is 5.25%.
**Assuming maximum sales charge.
Merrill Lynch Real Estate Fund, Inc.
August 31, 1999
PERFORMANCE DATA (concluded)
<TABLE>
Recent Performance Results*
<CAPTION>
3 Month 12 Month Since Inception
As of August 31, 1999 Total Return Total Return Total Return
<S> <C> <C> <C>
ML Real Estate Fund, Inc. Class A Shares -7.14% +2.86% -15.05%
ML Real Estate Fund, Inc. Class B Shares -7.40 +1.85 -16.49
ML Real Estate Fund, Inc. Class C Shares -7.40 +1.74 -16.55
ML Real Estate Fund, Inc. Class D Shares -7.09 +2.59 -15.37
<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 12/26/97.
</TABLE>
PORTFOLIO INFORMATION
As of August 31, 1999
Percent of
Ten Largest Holdings Net Assets
Capital Automotive 8.9%
Prison Realty Corporation 7.4
TrizecHahn Corporation 6.8
Entertainment Properties Trust 5.9
Mission West Properties Inc. 5.7
Prentiss Properties Trust 5.0
Prime Retail, Inc. 5.0
JP Realty, Inc. 4.2
Equity Office Properties Trust 3.7
Meditrust Companies 3.7
Portfolio Changes for the Quarter
Ended August 31, 1999
Additions
Mission West Properties Inc.
Reckson Associates Realty Corporation
Deletions
Kilroy Realty Corporation
Parkway Properties, Inc.
Security Capital Group Incorporated (Class B)
Tower Realty Trust, Inc.
Merrill Lynch Real Estate Fund, Inc.
August 31, 1999
<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 20,000 Camden Property Trust $ 530,825 $ 555,000 1.1%
10,000 Summit Properties Inc. 174,966 198,750 0.4
------------ ------------ ------
705,791 753,750 1.5
Diversified/ 350,000 Capital Automotive 4,903,763 4,331,250 8.9
Mixed Use 189,800 Entertainment Properties Trust 3,424,132 2,906,313 5.9
35,000 Glenborough Realty Trust Incorporated 591,750 605,938 1.2
5,000 National Golf Properties, Inc. 122,175 111,875 0.2
275,000 Prison Realty Corporation 5,181,569 3,592,187 7.4
------------ ------------ ------
14,223,389 11,547,563 23.6
Factory Outlets 325,000 Prime Retail, Inc. 3,208,524 2,437,500 5.0
Health Care 200,000 Meditrust Companies 4,233,082 1,787,500 3.7
Hotels & Motels 10,000 Hospitality Properties Trust 268,125 268,750 0.6
50,000 Host Marriott Corporation 594,687 462,500 0.9
------------ ------------ ------
862,812 731,250 1.5
Office Property 20,000 CarrAmerica Realty Corporation 536,494 460,000 0.9
70,000 Crescent Real Estate Equities Company 2,168,895 1,452,500 3.0
70,000 Equity Office Properties Trust 2,044,169 1,789,375 3.7
25,000 Highwoods Properties, Inc. 829,199 620,313 1.3
30,000 Liberty Property Trust 722,112 735,000 1.4
15,000 Mack-Cali Realty Corporation 436,050 425,625 0.9
350,000 Mission West Properties Inc. 2,887,500 2,800,000 5.7
108,000 Prentiss Properties Trust 2,430,151 2,450,250 5.0
33,456 Reckson Associates Realty Corporation 903,312 727,668 1.5
------------ ------------ ------
12,957,882 11,460,731 23.4
Regional Malls 115,000 Glimcher Realty Trust 2,265,050 1,753,750 3.6
105,000 JP Realty, Inc. 2,230,116 2,034,375 4.2
70,000 Simon Property Group, Inc. 1,750,700 1,785,000 3.6
------------ ------------ ------
6,245,866 5,573,125 11.4
Shopping Centers 30,000 Developers Diversified Realty Corporation 475,875 448,125 0.9
30,000 New Plan Excel Realty Trust 560,250 568,125 1.2
30,000 Philips International Realty Corp. 517,750 465,000 0.9
75,000 Regency Realty Corporation 1,798,288 1,575,000 3.2
------------ ------------ ------
3,352,163 3,056,250 6.2
Storage 50,000 Public Storage, Inc. 1,344,550 1,300,000 2.6
35,000 Storage USA, Inc. 1,317,577 1,012,812 2.1
------------ ------------ ------
2,662,127 2,312,812 4.7
Warehouse/ 40,000 AMB Property Corporation 891,925 860,000 1.8
Industrial 18,000 Cabot Industrial Trust 331,650 363,375 0.7
63,100 Pacific Gulf Properties, Inc. 1,327,745 1,380,312 2.8
10,000 ProLogis Trust 200,700 196,250 0.4
------------ ------------ ------
2,752,020 2,799,937 5.7
Total Real Estate Investment Trusts 51,203,656 42,460,418 86.7
</TABLE>
Merrill Lynch Real Estate Fund, Inc.
August 31, 1999
<TABLE>
SCHEDULE OF INVESTMENTS (concluded)
<CAPTION>
Shares Percent of
Industries Held Common Stocks Cost Value Net Assets
<S> <C> <S> <C> <C> <C>
Diversified/ 170,000 TrizecHahn Corporation $ 3,797,483 $ 3,315,000 6.8%
Mixed Use 1,300,000 Wihlborgs Fastigheter AB (Class B) 1,435,434 1,395,391 2.8
------------ ------------ ------
5,232,917 4,710,391 9.6
Health Care 25,000 Assisted Living Concepts, Inc. 80,938 70,313 0.2
40,000 Sunrise Assisted Living, Inc. 1,334,501 997,500 2.0
------------ ------------ ------
1,415,439 1,067,813 2.2
Hotels & Motels 10,000 Promus Hotel Corporation 243,100 290,625 0.6
Total Common Stocks 6,891,456 6,068,829 12.4
Total Investments $ 58,095,112 48,529,247 99.1
============
Other Assets Less Liabilities 418,872 0.9
------------ ------
Net Assets $ 48,948,119 100.0%
============ ======
Net Asset Value: Class A--Based on net assets of $5,058,224 and
637,285 shares outstanding $ 7.94
============
Class B--Based on net assets of $30,828,902 and 3,889,052
shares outstanding $ 7.93
============
Class C--Based on net assets of $6,734,656 and 850,035
shares outstanding $ 7.92
============
Class D--Based on net assets of $6,326,337 and 797,268
shares outstanding $ 7.94
============
</TABLE>
Merrill Lynch Real Estate Fund, Inc.
August 31, 1999
OFFICERS AND DIRECTORS
Terry K. Glenn, President and Director
Joe Grills, Director
Walter Mintz, Director
Robert S. Salomon Jr., Director
Melvin R. Seiden, Director
Steven B. Swensrud, Director
Arthur Zeikel, Director
Robert C. Doll, Senior Vice President
Jay L. Willoughby, Senior Vice President
and Portfolio Manager
Donald C. Burke, Vice President and Treasurer
Barbara G. Fraser, 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
