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<TABLE>
<S> <C>
DIRECTORS OFFICERS
Barton M. Biggs James W. Grisham
CHAIRMAN OF THE BOARD VICE PRESIDENT
Chairman and Director, Morgan Stanley Michael F. Klein
Asset Management Inc. and Morgan Stanley VICE PRESIDENT
Asset Management Limited; Managing Harold J. Schaaff,
Director, Morgan Stanley & Co. Jr.
Incorporated; Director, Morgan Stanley VICE PRESIDENT
Group Inc. Joseph P. Stadler
Warren J. Olsen VICE PRESIDENT
DIRECTOR AND PRESIDENT Valerie Y. Lewis
Principal, Morgan Stanley Asset SECRETARY
Management Inc. and Morgan Stanley & Co. Karl O. Hartmann
Incorporated ASSISTANT SECRETARY
John D. Barrett II James R. Rooney
Chairman and Director, TREASURER
Barrett Associates, Inc. Joanna M. Haigney
Gerard E. Jones ASSISTANT TREASURER
Partner, Richards & O'Neil LLP
Andrew McNally IV
Chairman and Chief Executive Officer, Rand
McNally
Samuel T. Reeves
Chairman of the Board and CEO, Pinacle
L.L.C.
Fergus Reid
Chairman and Chief Executive Officer,
LumeLite Corporation
Frederick O. Robertshaw
Of Counsel, Bryan, Cave LLP
</TABLE>
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INVESTMENT ADVISER AND ADMINISTRATOR
Morgan Stanley Asset Management Inc.
1221 Avenue of the Americas
New York, New York 10020
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DISTRIBUTOR
Morgan Stanley & Co. Incorporated
1251 Avenue of the Americas
New York, New York 10020
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CUSTODIANS
The Chase Manhattan Bank
770 Broadway
New York, New York 10003
Morgan Stanley Trust Company
One Pierrepont Plaza
Brooklyn, New York 11210
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LEGAL COUNSEL
Morgan, Lewis & Bockius LLP
2000 One Logan Square
Philadelphia, Pennsylvania 19103
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INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
1177 Avenue of the Americas
New York, New York 10036
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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, 1997
<PAGE>
LETTER TO SHAREHOLDERS
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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 months ended March 31, 1997, the Portfolio had a total return of
4.37% for the Class A shares and 4.24% for the Class B shares, as compared to a
total return of 0.71% for the National Association of Real Estate Investment
Trusts (NAREIT) Equity Index. The average annual total return for the year ended
March 31, 1997 and the period from inception on February 24, 1995 through March
31, 1997 was 38.50% and 31.04%, respectively, for the Class A shares as compared
to 33.17% and 23.83%, respectively, for the Index.
PERFORMANCE COMPARED TO THE NATIONAL ASSOCIATION OF REAL ESTATE INVESTMENT
TRUSTS (NAREIT) EQUITY INDEX(1)
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<TABLE>
<CAPTION>
TOTAL RETURNS(2)
---------------------------------------
ONE AVERAGE ANNUAL
YTD YEAR SINCE INCEPTION
--------- --------- -----------------
<S> <C> <C> <C>
PORTFOLIO--CLASS A................ 4.37% 38.50% 31.04%
PORTFOLIO--CLASS B(3)............. 4.24 38.08 34.13
INDEX............................. 0.71 33.17 23.83
</TABLE>
1. The NAREIT Equity Index is an unmanaged market weighted index of tax
qualified 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.
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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.
The publicly-quoted U.S. property sector continued to move into record territory
during the first quarter of 1997, defying the prediction of many analysts who
believed that a correction was in order following the sector's strong showing
during the final quarter of 1996. Shares hit their highs for the quarter by
early March, however, and the sector did begin a modest correction along with
the broader equity markets by the end of the month. Looking back over the
preceding period, we can identify two distinct phases. The first, beginning with
the New Year and continuing through February, was marked by a continuation of
market leadership by the office and hotel sectors. These two sectors, which were
up 51.8% and 49.2% on a total return basis in 1996, showed a further 10% to 15%
rise in the price of selected securities during the first two months of the
year. This price performance is even more noteworthy given the heavy volume of
secondary equity issuance activity, which topped $1.7 billion for the quarter
for offices and $0.5 billion for hotel companies (vs. $4.4 billion for the real
estate sector overall). The apartment and retail sectors, by contrast, continued
their practice, begun in 1995, of lagging the broader market.
The second phase began with the onset of the real estate correction in
mid-March. Amidst a deteriorating environment for equities generally, REIT
investor attention became fixated suddenly on the specter of substantial IPO and
secondary equity issuance by REITs generally and office REITs specifically.
1996, of course, bore witness to record new issuance activity, and market
participants seemed to greet each new offering with enthusiasm. With new funds
flows beginning to slow by the middle of the first quarter, however, the portent
of as many as a dozen new office IPO's began to lead some industry observers to
draw comparisons, somewhat belatedly, to the 1994 downturn in apartment REITs
which was accentuated by that year's apartment IPO craze. Further disturbing
investors were reports of seemingly high prices being paid by some office REITs
in their dash to implement nationwide growth strategies. The
2
<PAGE>
mere rumor of ill discipline in the ranks of office entrepreneurs arrived like a
flashback to the bad old days of the 1980's when the office sector was tarred
with the brush of excessive growth, over-leverage and over-paying. The
subsequent correction, which carried through into mid-April dragged down the
valuations of the once-darlings of the office and hotel sector by as much as 15%
to 20%.
Against the backdrop of this volatile first quarter, we have executed on a
two-pronged strategy to re-position our Portfolio. In the first instance, we
have engineered a modest realignment of the sector weightings in the Portfolio,
bringing our apartment weightings up to a more modestly underweight 13.1% (vs.
22.3% for the benchmark). We would not be surprised to see our apartment
holdings move to a market weighting by the second half of 1997. We also have
begun to take a closer look at the retail sector. While we remain underweight in
all three sub-components of retail, it is not impossible that we would move
closer to a market weight position by late 1997. At the same time, we have
continued a policy of reducing our overweight position in hotels, a move begun
during 1996. And, we have, for the first time, begun to take some profits in our
significant office and industrial portfolio. While we remain overweight in the
sector, and believe that the bull market in office properties has further room
to go, we are becoming increasingly cautious in the face of deteriorating
TECHNICALS in the sector.
The second element of our repositioning strategy is a modest increase in the
average market capitalization of our Portfolio. You may recall that we undertook
a policy of replacing high multiple large cap REITs (particularly in the office
and industrial sector) with smaller capitalization companies during the second
and third quarters of 1996. Our theory, which was ultimately borne out, was that
the rising tide of capital would permit small companies, which were then trading
at 20% to 40% discounts to their peers, to raise cheap capital to grow into
large cap status and obtain at the same time large cap valuation multiples. As
we examine the investment landscape at the end of the first quarter, we believe
that this theme has largely played out. In fact, the recent decline in the price
of large cap office REITs has resulted in relatively attractive pricing for many
of these companies for the first time since early 1996. As a result, we have
begun to opportunistically replace small cap names with larger cap companies
that enjoy in many cases the benefits of significant management infrastructure
together with high quality property portfolios and superior customer/tenant
franchises. If the pricing of REITs in the market permits us to continue to play
out this theme, it is not unreasonable to expect that our Portfolio may see a
substantial makeover as we enter into the second half of the year.
Russell C. Platt
PORTFOLIO MANAGER
Theodore R. Bigman
PORTFOLIO MANAGER
April 1997
3
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INVESTMENTS (UNAUDITED)
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MARCH 31, 1997
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- --------------- -------
<C> <S> <C>
COMMON STOCKS (94.2%)
APARTMENT (12.9%)
236,200 Associated Estates Realty Corp. $ 5,285
228,500 Avalon Properties, Inc. REIT 6,284
85,400 Bay Apartment Communities, Inc. 3,064
207,600 Essex Property Trust, Inc. REIT 6,202
133,200 Evans Withycombe Residential, Inc.
REIT 2,747
53,100 Gables Residental Trust REIT 1,354
118,400 Irvine Apartment Communities, Inc.
REIT 3,360
10,400 Merry Land & Investment Company,
Inc. REIT 213
90,700 Oasis Residential, Inc. REIT 2,041
52,200 Paragon Group, Inc. REIT 887
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31,437
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HEALTHCARE (8.5%)
60,900 Assisted Living Concepts, Inc. 594
54,700 Health Care Property Investors,
Inc. 1,812
12,700 Healthcare Realty Trust, Inc. 348
71,700 LTC Properties, Inc. REIT 1,192
401,300 Nationwide Health Properties, Inc.
REIT 8,578
262,300 Omega Healthcare Investors, Inc.
REIT 8,197
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20,721
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LAND (2.7%)
449,400 Atlantic Gulf Communities Corp. 2,472
271,500 Catellus Development Corp. 4,140
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6,612
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LODGING/LEISURE (14.6%)
379,400 American General Hospitality Corp.
REIT 10,339
60,400 Capstar Hotel Co. 1,691
514,100 Host Marriott Corp. 8,740
473,000 John Q Hammons Hotels, Inc. 4,257
346,100 Servico, Inc. 6,100
247,200 Suburban Lodges of America, Inc. 4,450
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35,577
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MANUFACTURED HOME (6.9%)
646,653 Chateau Properties, Inc. REIT 16,732
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OFFICE AND INDUSTRIAL (29.9%)
INDUSTRIAL (7.1%)
72,100 East Group Properties REIT 2,001
350,072 Meridian Industrial Trust, Inc.
REIT 8,095
<CAPTION>
VALUE
SHARES (000)
- --------------- -------
<C> <S> <C>
INDUSTRIAL (CONTINUED)
184,843 Meridian Industrial Trust, Inc.,
REIT (Warrants) $ 1,317
11,100 Meridian Point Realty Trust '83
REIT 34
257,200 Pacific Gulf Properties, Inc. REIT 5,594
10,000 Security Capital Industrial Trust
REIT 244
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17,285
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OFFICE (19.9%)
304,300 Arden Realty Group, Inc. 8,292
580,454 Brandywine Realty Trust REIT 11,754
30,000 Brookfield Properties Corp. 340
319,800 Brookfield Properties Corp.
(Instalment Receipts -- second
instalment: c$6.50/Shr due on
2/13/98) 2,116
610,000 Great Lakes, Inc. REIT 7,930
203,300 Koger Equity, Inc. REIT 3,507
138,200 Parkway Properties, Inc. 3,317
8,900 Reckson Associates Realty Corp. 410
15,100 TriNet Corporate Realty Trust,
Inc. REIT 477
457,418 Trizec Hahn Corp. REIT 10,235
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48,378
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OFFICE AND INDUSTRIAL (2.9%)
26,000 Bedford Property Investors, Inc.
REIT 513
241,200 Prentiss Properties Trust REIT 6,120
13,400 Spieker Properties, Inc. 523
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7,156
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TOTAL OFFICE AND INDUSTRIAL 72,819
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RETAIL (15.6%)
REGIONAL MALL (8.9%)
75,300 CBL & Associates Properties, Inc. 1,845
413,000 First Union Real Estate REIT 5,472
98,400 Simon DeBartolo Group, Inc., REIT 2,977
199,300 Taubman Centers, Inc. REIT 2,591
293,700 Urban Shopping Centers, Inc. REIT 8,811
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21,696
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SHOPPING CENTER (1.4%)
1,700 First Washington Realty Trust,
Inc. 38
304,900 IRT Property Co. REIT 3,354
2,200 Ramco-Gershenson Properties Trust
REIT 39
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3,431
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</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- --------------- -------
<C> <S> <C>
RETAIL (CONTINUED)
STRIP CENTER (5.3%)
418,100 Alexander Haagen Properties, Inc.
REIT $ 5,801
551,700 Burnham Pacific Property Trust
REIT 7,034
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12,835
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TOTAL RETAIL 37,962
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SELF STORAGE (3.1%)
272,300 Shurgard Storage Centers, Inc.,
Series A, REIT 7,522
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TOTAL COMMON STOCKS (Cost $203,723) 229,382
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PREFERRED STOCKS (1.0%)
SHOPPING CENTER (1.0%)
81,800 First Washington Realty Trust,
Series A 2,413
33,150 Great Lakes, Inc. REIT --
-------
TOTAL PREFERRED STOCKS (Cost $2,290) 2,413
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<CAPTION>
FACE
AMOUNT
(000)
- ---------------
<C> <S> <C>
CORPORATE BOND (0.6%)
OFFICE (0.6%)
$ 2,934 Brookfield Properties Corp.
(Instalment Receipts -- second
instalment: c$50.00 per debenture
due on 2/13/98) 6.00%, 2/14/07
(Cost $1,098) $ 1,421
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SHORT-TERM INVESTMENT (0.7%)
REPURCHASE AGREEMENT (0.7%)
1,716 Chase Securities, Inc. 6.00%,
dated 3/31/97, due 4/1/97, to be
repurchased at $1,716,
collateralized by U.S. Treasury
Notes, 5.5%, due 12/31/00, valued
at $1,755 (Cost $1,716) 1,716
-------
TOTAL INVESTMENTS (96.5%) (Cost $208,827) $234,932
-------
OTHER ASSETS AND LIABILITIES (3.5%)
Other Assets $ 9,294
Liabilities (650)
-------
8,644
-------
NET ASSETS (100%) 243,576
-------
-------
<CAPTION>
VALUE
(000)
-------
<C> <S> <C>
CLASS A:
NET ASSETS $236,921
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 15,755,874 outstanding $0.001 par
value shares (authorized 500,000,000 shares) $15.04
-------
-------
CLASS B:
NET ASSETS $6,655
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 443,605 outstanding $0.001 par value
shares (authorized 500,000,000 shares) $15.00
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-------
-----------------------------------
REIT -- Real Estate Investment Trust
</TABLE>
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