MERRILL LYNCH
REAL ESTATE
FUND, INC.
FUND LOGO
Quarterly Report
February 28, 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 origi-nal 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
The quarter ended February 28, 1999 was difficult both in absolute and
relative terms for Merrill Lynch Real Estate Fund, Inc. During the
three months ended February 28, 1999, total returns for the Fund's
Class A, Class B, Class C and Class D Shares were -7.56%, -7.82%,
- -7.71% and -7.63%, respectively. This was disappointing on an absolute
basis and as compared to the performance of the unmanaged Morgan
Stanley Real Estate Investment Trust Index and the Lipper Real Estate
Funds average, which declined -5.99% and -4.44%, respectively, for the
same period. Additionally, real estate sector returns continue to lag
those of both the Standard & Poor's (S&P) 500 Index and the ten-year
US Treasury note, which were +6.76% and -2.93%, respectively, over the
three-month period ended February 28, 1999. We view the real estate
securities market as very attractive on a valuation basis and expect
that as the year progresses, better absolute performance will return.
Though disappointed at our poor start this year, we continue to
believe that our bottom up, value-oriented stock selection approach
will add value.
During the quarter ended February 28, 1999, investor interest in real
estate investment trust (REIT) shares remained subdued. This trend was
reflected in the Fund's considerable outflows during the period. In
total, these outflows amounted to approximately $7.5 million (more
than 10% of net assets). On a more optimistic note, the outflows
appear to have peaked and in fact slowed dramatically in the second
half of February to a rate of less than $1 million per month.
Nevertheless, the sector's cash flows were negative for the past 13
consecutive months. In our view, this is the primary reason for the
dramatic underperformance of the real estate sector.
Over the last year, many reasons were cited for the constant
redemptions experienced by dedicated real estate funds. In 1998,
Congress changed the "paired share" rules affecting four REITs. Two of
those have subsequently opted to become "C" corporations, one is
splitting into two companies (both focused REITs) and the last
continues to muddle along, though under new management. All four were
poor-performing stocks over the last year, and helped to sour
investors on the real estate sector. However, this year President
Clinton proposed broadening the scope of services that REITs could
provide their tenants by allowing REITs to set up taxable subsidiaries
to handle service business that previously did not qualify under REIT
rules. While the dramatic change in direction from last year's
proposal to this year's proposal has encouraged REIT professionals, it
has not inspired investors.
The debate about supply and demand continues. We continue to believe
that increased information available today (because of the public
market influence) will prevent the dramatic overbuilding that marked
the end of previous real estate cycles. We would argue that the
pockets of overbuilding that will periodically occur in certain
property types in selected cities will reinforce the discipline being
created by the public markets and encourage potential capital sources
to hold private players to the same higher standards. The good news is
that any overbuilding is likely to be in higher-growth markets where
it can be absorbed more quickly. Over time, we believe this should
encourage investors to trust the markets to help rein in new supply
before it becomes excessive, thereby leading to lower required risk
premiums and ultimately higher multiples.
During the past 12 months, the REIT sector has seen vacancy rates
generally decline, rents generally rise, and funds from operation
(FFO) grow by approximately 13% as compared to the prior 12-month
period. Most analysts expect REITs to grow their FFO by a further 10%
or more in 1999 and 6%-8% in the year 2000.
Merrill Lynch Real Estate Fund, Inc.
February 28, 1999
Investment Strategy
During the February quarter, our poor relative performance was
primarily the result of specific stock selection. In particular, four
stocks hurt the Fund in the first quarter. Prime Retail, Inc.,
Meditrust Companies, Prison Realty Corporation and JP Realty, Inc. all
declined by 15% or more for the three months ended February 28, 1999.
While disheartening in the short term, we remain optimistic about each
of these companies. All four companies are out-of-favor names in out-
of-favor areas within the REIT sector. Specifically, Prime Retail is
the largest factory outlet REIT in America, priced at five times 1999
estimated FFO, growing FFO at a mid-single digit rate and providing a
14% or better dividend yield. Meditrust is about to split into a
focused healthcare REIT and a focused hotel REIT. Currently, Meditrust
is paying nearly 15% in dividends, growing FFO at a mid-single digit
rate and priced at five times 1999 estimated FFO. Prison Realty is the
dominant private prison provider in the United States. Its stock,
which pays a 10% dividend, is growing FFO at about 15% and is trading
at 7.5 times 1999 estimated FFO. Finally, JP Realty is a retail REIT
(malls and shopping centers) in the mountain states that pays a 10%
dividend, is growing FFO at a mid-single digit rate, and is priced at
about eight times 1999 estimated FFO. Each of these companies is
viewed as capital constrained by investors in general, yet pays out
only 80% or so of its FFO in dividends. We believe these stocks will
provide the portfolio with income stability and modest growth going
forward, and in the case of Prison Realty, we see potentially high
growth. While we might pare the relative weighting of any of these
names on strength, we have no intention of selling them at current
levels and believe they will all prove to be solid performers over the
balance of 1999. In the aggregate, these issues represent
approximately 20% of the portfolio and account for substantially all
of the underperformance of the Fund compared to the benchmark, the
unmanaged Morgan Stanley Real Estate Investment Trust Index.
We plan to maintain our overweighting in the office sector, where
internal growth should be sustained by expiring rents increasing to
today's higher market rates. We view this as our offensive position
and believe that when investors return to the REIT market, they are
likely to first move into these larger-capitalization, higher-growth
names. The other significant overweighting in the portfolio is in the
triple net lease sector, which we consider our more defensive
position. These companies are typically making investments that earn
10%--12% on initial cost with 1%--4% growth. Their leases require
the tenant to pay all expenses (for example, taxes and maintenance),
and have an initial term of 7 years--15 years, with extensions beyond
that. We believe these stocks should perform well if inflation and
interest rates continue to decline. In deference to investor
enthusiasm for the Internet, we continued to maintain an
underweighting in the retail sector in general. Finally, we are
concerned about the effect of continued strength in single-family home
building in the apartment sector, along with the generally fuller
valuations. While this barbell approach, which emphasizes the office
and triple net lease sectors, did not fare well in the February
quarter, we believe this plan has merit, and we intend to adhere to
this strategy.
In Conclusion
Looking ahead, real estate fundamentals remain healthy. Certain cities
will see some excess supply in specific property types in the coming
12 months, in our opinion. While we are mindful of this, we do not
anticipate a repeat of the late 1980s. We believe that any excess
supply generally will be a local phenomenon and will only help to
restrain the non-public capital sources in the future, putting the
real estate industry on even stronger ground. In 1999, we will look
for REIT cash flows to continue to grow by an average of approximately
10%. We also believe that REIT dividends will continue to show mid-
single digit growth. With these stocks at record low relative
valuations compared to stocks, bonds and utilities, and trading at
meaningful discounts to net asset value, we believe the valuations are
compelling. However, none of these factors are catalysts that will
necessarily bring investors back into the real estate sector. Until
the negative cash flows abate, it is difficult to see the sector
making much upward progress, despite its otherwise attractive
investment merits.
We thank you for your interest and continued support of Merrill Lynch
Real Estate Fund, Inc., and we look forward to reviewing our outlook
and strategy with you in our next report to shareholders.
Merrill Lynch Real Estate Fund, Inc.
February 28, 1999
Sincerely,
(Terry K. Glenn)
Terry K. Glenn
President and Director
(Jay Willoughby)
Jay Willoughby
Senior Vice President and Portfolio Manager
April 6, 1999
After more than 20 years of service, Arthur Zeikel recently retired as
Chairman of Merrill Lynch Asset Management, L.P. (MLAM). Mr. Zeikel
served as President of MLAM from 1977 to 1997 and as Chairman since
December 1997. Mr. Zeikel is one of the country's most respected
leaders in asset management and presided over the growth of Merrill
Lynch's asset management business. During his tenure, client assets
under management grew from $300 million to over $500 billion. Mr.
Zeikel will remain on Merrill Lynch Real Estate Fund, Inc.'s Board of
Directors. We are pleased to announce that Terry K. Glenn has been
elected President and Director of the Fund. Mr. Glenn has held the
position of Executive Vice President of MLAM since 1983.
Mr. Zeikel's colleagues at MLAM join the Fund's Board of Directors in
wishing him well in his retirement from Merrill Lynch and are pleased
that he will continue as a member of the Fund's Board of Directors.
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.
Merrill Lynch Real Estate Fund, Inc.
February 28, 1999
PERFORMANCE DATA (concluded)
<TABLE>
Recent Performance Results*
<CAPTION>
12 Month 3 Month Since Inception
Total Return Total Return Total Return
<S> <C> <C> <C>
ML Real Estate Fund, Inc. Class A Shares -18.56% -7.56% -17.33%
ML Real Estate Fund, Inc. Class B Shares -19.34 -7.82 -18.29
ML Real Estate Fund, Inc. Class C Shares -19.30 -7.71 -18.25
MLReal Estate Fund, Inc. Class D Shares -18.69 -7.63 -17.55
<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
commenced operations on 12/26/97.
</TABLE>
Average Annual Total Return
% Return Without % Return With
Sales Charge Sales Charge**
Class A Shares*
Year Ended 12/31/98 -11.72% -16.36%
Inception (12/26/97)
through 12/31/98 -11.31 -15.91
[FN]
*Maximum sales charge is 5.25%.
**Assuming maximum sales charge.
% Return % Return
Without CDSC With CDSC**
Class B Shares*
Year Ended 12/31/98 -12.55% -15.91%
Inception (12/26/97)
through 12/31/98 -12.21 -14.71
[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 12/31/98 -12.61% -13.45%
Inception (12/26/97)
through 12/31/98 -12.27 -12.27
[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 12/31/98 -11.95% -16.58%
Inception (12/26/97)
through 12/31/98 -11.54 -16.12
[FN]
*Maximum sales charge is 5.25%.
**Assuming maximum sales charge.
Merrill Lynch Real Estate Fund, Inc.
February 28, 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 25,000 Avalonbay Communities, Inc. $ 809,725 $ 789,063 1.6%
60,000 Camden Property Trust 1,707,277 1,470,000 2.9
75,000 Summit Properties Inc. 1,414,536 1,242,187 2.5
------------ ------------ ------
3,931,538 3,501,250 7.0
Diversified/Mixed 345,000 Capital Automotive 4,851,325 4,010,625 7.9
Use 27,700 Cousins Properties, Inc. 798,087 801,569 1.6
200,000 Entertainment Properties Trust 3,633,619 3,425,000 6.8
73,100 Pacific Gulf Properties, Inc. 1,542,817 1,471,137 2.9
140,000 Prison Realty Corporation 3,385,569 2,791,250 5.5
------------ ------------ ------
14,211,417 12,499,581 24.7
Factory Outlets 243,400 Prime Retail, Inc. 2,651,712 1,947,200 3.8
Health Care 180,000 Meditrust Companies 4,053,332 2,205,000 4.4
Office Property 75,000 CarrAmerica Realty Corporation 2,186,528 1,612,500 3.2
95,000 Crescent Real Estate Equities Company 3,201,107 1,983,125 3.9
80,000 Equity Office Properties Trust 2,360,962 2,060,000 4.1
35,000 Highwoods Properties, Inc. 1,186,679 837,812 1.7
30,000 Kilroy Realty Corporation 631,650 646,875 1.3
15,000 Mack-Cali Realty Corporation 436,050 434,062 0.8
124,000 Prentiss Properties Trust 2,834,063 2,480,000 4.9
40,000 Tower Realty Trust, Inc. 762,325 780,000 1.5
------------ ------------ ------
13,599,364 10,834,374 21.4
Regional Malls 120,000 Glimcher Realty Trust 2,370,761 1,777,500 3.5
140,000 JP Realty, Inc. 3,142,100 2,590,000 5.1
100,000 Simon Property Group, Inc. 2,501,000 2,543,750 5.0
------------ ------------ ------
8,013,861 6,911,250 13.6
Shopping Centers 40,000 Philips International Realty Corp. 692,750 552,500 1.1
85,000 Regency Realty Corporation 2,092,838 1,721,250 3.4
------------ ------------ ------
2,785,588 2,273,750 4.5
Storage 50,000 Public Storage, Inc. 1,344,550 1,275,000 2.5
30,000 Storage USA, Inc. 1,159,925 849,375 1.7
------------ ------------ ------
2,504,475 2,124,375 4.2
Warehouse/Industrial 150,000 Cabot Industrial Trust 3,015,103 2,850,000 5.6
Total Real Estate Investment Trusts 54,766,390 45,146,780 89.2
</TABLE>
Merrill Lynch Real Estate Fund, Inc.
February 28, 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/Mixed 5,000 IRSA Inversiones y Representaciones
Use SA (GDR)** $ 114,050 $ 115,938 0.2%
25,000 Security Capital Group Incorporated
(Class B) 322,750 306,250 0.6
165,000 TrizecHahn Corporation 3,725,770 3,207,187 6.4
1,380,000 Wihlborgs Fastigheter AB (Class B) 1,549,528 1,563,978 3.1
Total Common Stocks 5,712,098 5,193,353 10.3
Face
Amount Short-Term Securities
Commercial Paper* $ 153,000 General Motors Acceptance Corp., 4.88%
due 3/01/1999 152,959 152,959 0.3
Total Short-Term Securities 152,959 152,959 0.3
Total Investments $ 60,631,447 50,493,092 99.8
============
Other Assets Less Liabilities 111,867 0.2
------------ ------
Net Assets $ 50,604,959 100.0%
============ ======
Net Asset Value: Class A--Based on net assets of $2,892,483 and 366,911
shares outstanding $ 7.88
============
Class B--Based on net assets of $35,327,321 and 4,488,348
shares outstanding $ 7.87
============
Class C--Based on net assets of $7,086,733 and 900,850
shares outstanding $ 7.87
============
Class D--Based on net assets of $5,298,422 and 672,307
shares outstanding $ 7.88
============
<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.
**Global Depositary Receipts (GDR).
</TABLE>
Merrill Lynch Real Estate Fund, Inc.
February 28, 1999
PORTFOLIO INFORMATION
As of February 28, 1999
Portfolio Changes for the Quarter
Ended February 28, 1999
Additions
*Colonial Properties Trust
IRSAInversiones y Representaciones SA(GDR)
Prison Realty Corporation
Security Capital Group Incorporated (Class B)
Simon Property Group, Inc.
Deletions
Castellum AB
*Colonial Properties Trust
Corrections Corporation of America
Homestead Village Incorporated
Starwood Hotels & Resorts
Urban Shopping Centers, Inc.
[FN]
*Added and deleted in the same quarter.
Percent of
Ten Largest Holdings Net Assets
Capital Automotive 7.9%
Entertainment Properties Trust 6.8
TrizecHahn Corporation 6.4
Cabot Industrial Trust 5.6
Prison Realty Corporation 5.5
JP Realty, Inc. 5.1
Simon Property Group, Inc. 5.0
Prentiss Properties Trust 4.9
Meditrust Companies 4.4
Equity Office Properties Trust 4.1
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
Jay L. Willoughby, Senior Vice President
and Portfolio Manager
Donald C. Burke, Vice President and 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
Gerald M. Richard, Treasurer and Norman R. Harvey, Senior Vice
President of Merrill Lynch Real Estate Fund, Inc. have recently
retired. Their colleagues at Merrill Lynch Asset Management, L.P.
join the Fund's Board of Directors in wishing Mr. Richard and
Mr. Harvey well in their retirements.
