<PAGE>
- --------------------------------------------------
OFFICERS AND DIRECTORS
Barton M. Biggs James W. Grisham
CHAIRMAN OF THE BOARD VICE PRESIDENT
Frederick B. Whittemore Michael F. Klein
VICE-CHAIRMAN OF THE VICE PRESIDENT
BOARD Harold J. Schaaff, Jr.
Warren J. Olsen VICE PRESIDENT
PRESIDENT AND DIRECTOR Joseph P. Stadler
John D. Barrett II VICE PRESIDENT
DIRECTOR Valerie Y. Lewis
Gerard E. Jones SECRETARY
DIRECTOR Karl O. Hartmann
Andrew McNally, IV ASSISTANT SECRETARY
DIRECTOR James R. Rooney
Samuel T. Reeves TREASURER
DIRECTOR Joanna M. Haigney
Fergus Reid ASSISTANT TREASURER
DIRECTOR
Frederick O. Robertshaw
DIRECTOR
- --------------------------------------------------
INVESTMENT ADVISER AND ADMINISTRATOR
Morgan Stanley Asset Management Inc.
1221 Avenue of the Americas
New York, New York 10020
- --------------------------------------------------
DISTRIBUTOR
Morgan Stanley & Co. Incorporated
1251 Avenue of the Americas
New York, New York 10020
- --------------------------------------------------
CUSTODIANS
The Chase Manhattan Bank, N.A.
770 Broadway
New York, New York 10003
Morgan Stanley Trust Company
One Pierrepont Plaza
Brooklyn, New York 11210
- --------------------------------------------------
LEGAL COUNSEL
Morgan, Lewis & Bockius LLP
2000 One Logan Square
Philadelphia, Pennsylvania 19103
- --------------------------------------------------
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
1177 Avenue of the Americas
New York, New York 10036
- --------------------------------------------------
For current performance, current net asset value, or for assistance with your
account, please contact the Fund at (800) 548-7786. This report is authorized
for distribution only when preceded or accompanied by prospectuses of the Morgan
Stanley Institutional Fund, Inc.
[LOGO] MORGAN STANLEY
INSTITUTIONAL FUND, INC.
P.O. Box 2798
Boston, MA 02208-2798
[LOGO] MORGAN STANLEY
INSTITUTIONAL FUND, INC.
U.S. REAL ESTATE PORTFOLIO
FIRST QUARTER REPORT
MARCH 31, 1996
<PAGE>
LETTER TO SHAREHOLDERS
- -------
The U.S. Real Estate Portfolio seeks to provide above average current income and
long-term capital appreciation by investing primarily in equity securities of
companies in the U.S. real estate industry, including real estate investment
trusts.
For the three month period ended March 31, 1996, the Portfolio had a total
return of 5.17% for the Class A shares and 4.35% for the Class B shares, as
compared to a total return of 2.30% for the National Association of Real Estate
Investment Trusts (NAREIT) Index. The average annual total return for the twelve
months ended March 31, 1996 and for the period from inception on February 24,
1995 through March 31, 1996 was 26.43% and 24.58%, respectively for the Class A
shares, as compared to 17.60% and 15.44%, respectively for the Index.
PERFORMANCE COMPARED TO THE NATIONAL ASSOCIATION OF REAL ESTATE INVESTMENT
TRUSTS (NAREIT) INDEX(1)
- ----------------------------------------------------
<TABLE>
<CAPTION>
TOTAL RETURNS(2)
---------------------------------------
ONE AVERAGE ANNUAL
YTD YEAR SINCE INCEPTION
--------- --------- -----------------
<S> <C> <C> <C>
PORTFOLIO--CLASS A................ 5.17% 26.43% 24.58%
PORTFOLIO--CLASS B(3)............. 4.35 N/A N/A
INDEX............................. 2.30 17.60 15.44
</TABLE>
1. The NAREIT Index is an unmanaged market weighted index of tax qualified
REITs (excluding healthcare REITs) listed on the New York Stock Exchange,
American Stock Exchange and the NASDAQ National Market System, including
dividends.
2. Total returns for the Portfolio reflect expenses waived and reimbursed, if
applicable, by the Adviser. Without such waiver and reimbursement, total
returns would be lower.
3. The Portfolio began offering Class B shares on January 2, 1996.
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
- ------------------------------
THE PERFORMANCE RESULTS PROVIDED ARE FOR INFORMATIONAL PURPOSES ONLY AND SHOULD
NOT BE CONSTRUED AS A GUARANTEE OF THE PORTFOLIO'S FUTURE PERFORMANCE. PAST
PERFORMANCE SHOWN IS NOT PREDICTIVE OF FUTURE PERFORMANCE. INVESTMENT RETURN AND
PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY
BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST.
Total returns for the Portfolio and for the Index are generally consistent with
our view of gradual, steady improvement in the underlying conditions of the U.S.
real estate industry. Rents and occupancy for most types of commercial real
estate were even to modestly higher for the first quarter of 1996. Improving
liquidity in the real estate capital markets has also lead to a gradual firming
in capital values, although prices of most commercial property remain below
replacement costs. This improvement in liquidity was mirrored in the public real
estate markets, where $1.6 billion was raised in 13 public and 2 private
offerings of equity securities by 14 REITs. In addition, real estate mutual
funds registered net inflows of $238.8 million and average daily trading volume
for the companies in Morgan Stanley's real estate investment universe reached 7
million shares for the first quarter.
The various sectors that together comprise the U.S. real estate industry
provided somewhat divergent returns during the first quarter. The apartment
sector generally continued a recovery which began during the fourth quarter of
1995, registering a total return of 3.7%. As we have noted in past reports,
analyst concerns regarding new apartment construction appear to have been in
part unwarranted as new building has stabilized at approximately 275,000 units
annually, or roughly the rate necessary to meet new demand. We remain slightly
underweight in this sector (at 24% for the Portfolio vs. 26% for the Index),
with our focus continuing to be on high-end units in markets with little new
construction (e.g., Avalon in the Northeast and Irvine in Southern California)
and middle-income apartments in those areas with the most new development (e.g.,
South West Property Trust in Texas).
During the first quarter we stepped up our commitment to the manufactured home
sector, raising our total exposure to 7% of the Portfolio compared to 3% for the
Index. Following the recent run-up in apartment values we have concluded that
this sector carries little pricing premium in return for relatively low
volatility, inflation-protected rental growth. Our favorite name in the sector
continues to be ROC Communities.
2
<PAGE>
The retail sector includes strip shopping centers, regional malls and factory
outlet and has the largest weighting in the Index (36%). This sector continues
to face the most challenging operating environment in real estate due to
relatively sluggish consumer demand (particularly for apparel) and surprisingly
robust new construction (due to the expansion plans of discount retailers and
so-called "category killers"). We continue to believe that this combination of
negative secular and cyclical trends bodes ill for the industry and remain
significantly underweight at 15% for the Portfolio. The sector, nonetheless,
continues to provide surprises and occasional opportunities for profit. One such
event was the recently announced stock merger of Simon Property Group and
DeBartolo Realty to form the nation's largest shopping center company. While we
remain somewhat skeptical of the synergistic benefits of such deals, they have
served to unlock the significant asset value in underpriced shares of companies
such as DeBartolo (a 2.5% position in the Portfolio). As a result, while we
continue to add to positions in the retail sector only opportunistically, we are
encouraged to maintain our discipline of focusing on those shares that provide
the best underlying real estate value consistent with our top-down asset
allocation plan.
The combined office and industrial sector registered somewhat mixed performance
for the first quarter, with a total return of -2.9%. This sector was one of the
leaders of the 1995 REIT market, with total performance of 25.8% vs. 14.2% for
the Index as a whole. By early 1996, however, share prices of office and
industrial companies exceeded in many cases their underlying property values by
as much as 20% to 30%. While we remain quite positive on the fundamentals for
these two property types and overweight in the sector overall (19% for the
Portfolio vs. an 18% weighting for the Index), we have become concerned that
these prices are unsustainable and will lead inevitably to increased new
issuance volume. As a result, we began in February a process of rotating out of
those positions which we felt were most vulnerable to a correction and into
newer names that appeared to offer superior pricing. At the same time, we
stepped up discussions with selected companies that seek to raise capital
directly from large investors such as the Portfolio. These discussions led to an
investment by the Portfolio in common stock and warrants of Meridian Industrial
Trust, which now is one of the largest holdings in the sector. As the first
quarter drew to a close, prices of many office and industrial stocks had fallen
10% from their intra-quarter highs, and new issue volume of office/industrial
shares reached $802 million (including 3 deals filed with the SEC for offering
during April). Going forward, we will continue to attempt to remain overweight
in this sector, but will maintain a rigorous view towards identifying attractive
underlying asset value for the Portfolio.
The self storage sector registered the poorest relative performance of any REIT
sector in the first quarter (-4.8%) despite the announcement of an investment by
Security Capital Group into Storage USA which briefly lifted share prices in the
group. The Portfolio's 5% weighting in the sector vs. 7% for the Index reflects
our view that industry fundamentals remain generally sound although upward
momentum is clearly slowing and operating risk shows signs of increasing. Our
largest position in the sector is Shurgard (3%), which we believe offers the
best relative asset value and the potential for upside from the development of
new storage centers during 1996 and 1997.
Lastly, we remain overweight in the lodging sector at 17% vs. 6% for the Index.
While occupancy growth for U.S. hotels continued to slow during the course of
1995, growth in room rates more that compensated, resulting in 5-9% growth in
REVPAR, the industry's primary measure of revenue. Given the fixed nature of
hotel expenses, this has lead to a continuation in relatively sharp increases in
hotel and company operating income. The Portfolio continues to focus on
companies with an exposure in the full service segment of the market. While the
limited service segment has witnessed a worrying increase in new construction
and the slowest growth in occupancy, remarkably few new full service hotels are
under construction today. Full service hotel values remain in most cases well
below replacement cost and underlying property yields remain above 10%. Our
favorite names in the sector remain Servico (3.6%), Red Lion (3.6%) and Host
Marriott (3.2%).
Russell C. Platt
PORTFOLIO MANAGER
Theodore R. Bigman
PORTFOLIO MANAGER
April 1996
3
<PAGE>
INVESTMENTS (UNAUDITED)
- ----------
MARCH 31, 1996
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- --------------- ---------
<C> <S> <C>
COMMON STOCKS (89.0%)
APARTMENT (23.8%)
72,000 Amli Residential Properties Trust
REIT $ 1,449
186,000 Avalon Properties, Inc. REIT 3,999
226,600 Essex Property Trust, Inc. REIT 4,702
185,100 Irvine Apartment Communities, Inc.
REIT 3,540
111,500 Paragon Group, Inc. REIT 1,965
200,300 South West Property Trust REIT 2,679
236,700 Wellsford Residential Property
Trust REIT 5,178
---------
23,512
---------
LAND (1.7%)
203,700 Atlantic Gulf Communities Corp. 1,222
56,500 Catellus Development Corp. 438
---------
1,660
---------
LODGING/LEISURE (16.7%)
80,600 Felcor Suite Hotels, Inc. REIT 2,499
232,200 Host Marriot Corp. 3,135
263,100 John Q Hammons Hotels, Inc. 2,861
183,000 Red Lion Hotels, Inc. 3,546
300,700 Servico, Inc. 3,571
77,800 ShoLodge, Inc. 875
---------
16,487
---------
MANUFACTURED HOME (7.4%)
13,400 Chateau Properties, Inc. REIT 305
295,850 ROC Communities, Inc. REIT 6,952
---------
7,257
---------
OFFICE AND INDUSTRIAL (19.3%)
INDUSTRIAL (7.0%)
86,700 East Group Properties REIT 1,907
233,884 Meridian Industrial Trust, Inc.
REIT 3,888
11,100 Meridian Point Realty Trust '83
REIT 12
62,600 Pacific Gulf Properties, Inc. REIT 1,158
---------
6,965
---------
OFFICE (2.1%)
10,300 Carr Realty Corp. REIT 247
31,700 Cousins Properties, Inc. REIT 618
106,100 Crocker Realty Trust, Inc. REIT 1,008
<CAPTION>
VALUE
SHARES (000)
- --------------- ---------
<C> <S> <C>
17,000 Koger Equity, Inc. REIT $ 185
---------
2,058
---------
OFFICE AND INDUSTRIAL (10.2%)
257,400 Bedford Property Investors, Inc.
REIT 1,963
172,000 Duke Realty Investments, Inc. REIT 5,182
142,300 Liberty Property Trust REIT 2,935
---------
10,080
---------
TOTAL OFFICE AND INDUSTRIAL 19,103
---------
RETAIL (14.8%)
FACTORY OUTLET CENTER (1.3%)
127,400 Factory Stores of America, Inc.
REIT 1,258
---------
REGIONAL MALL (9.1%)
409,300 Crown American Realty Trust REIT 3,121
160,100 DeBartolo Realty Corp. REIT 2,401
146,800 Glimcher Realty Trust REIT 2,496
50,700 Taubman Centers, Inc. REIT 501
21,600 Urban Shopping Centers, Inc. REIT 481
---------
9,000
---------
SHOPPING CENTER (4.4%)
242,600 Alexander Haagen Properties, Inc.
REIT 2,790
124,700 Burnham Pacific Property Trust
REIT 1,372
5,600 Price REIT, Inc., Common 162
---------
4,324
---------
TOTAL RETAIL 14,582
---------
SELF STORAGE (5.3%)
99,500 Public Storage, Inc. REIT 2,027
122,500 Shurgard Storage Centers, Inc.,
Series A REIT 3,216
---------
5,243
---------
TOTAL COMMON STOCKS (Cost $85,209) 87,844
---------
CONVERTIBLE PREFERRED STOCKS (0.9%)
LAND (0.9%)
17,500 Catellus Development Corp. $3.75,
Series A (Cost $928) 923
---------
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
NO. OF VALUE
WARRANTS (000)
- --------------- ---------
<C> <S> <C>
WARRANTS (0.0%)
INDUSTRIAL (0.0%)
29,470 Meridian Industrial Trust, Inc.,
expiring 2/23/99 (Cost $0) $ --
---------
<CAPTION>
FACE
AMOUNT
(000)
- ---------------
<C> <S> <C>
SHORT-TERM INVESTMENT (9.9%)
REPURCHASE AGREEMENT (9.9%)
$ 9,795 The Chase Manhattan Bank, N.A.,
5.15%, dated 3/29/96 due 4/01/96,
to be repurchased at $9,799,
collateralized by $9,930 United
States Treasury Notes, 6.00%, due
8/31/97, valued at $9,856 (Cost
$9,795) 9,795
---------
TOTAL INVESTMENTS (99.8%) (Cost $95,932) 98,562
---------
OTHER ASSETS AND LIABILITIES (0.2%)
Other Assets 1,577
Liabilities (1,418)
---------
159
---------
NET ASSETS (100%) $ 98,721
---------
---------
CLASS A SHARES:
Net Assets $96,135
Shares Issued and Outstanding ($0.001 par value)
(Authorized 500,000,000 shares) 8,003
Net Asset Value, Offering and Redemption Price
Per Share $12.01
---------
---------
CLASS B SHARES:
Net Assets $2,586
Shares Issued and Outstanding ($0.001 par value)
(Authorized 500,000,000 shares) 215
Net Asset Value, Offering and Redemption Price
Per Share $12.00
---------
---------
</TABLE>
- ----------------------------------
REIT -- Real Estate Investment Trust
5
