<PAGE>
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DIRECTORS OFFICERS
Barton M. Biggs Stefanie V. Chang
CHAIRMAN OF THE BOARD VICE PRESIDENT
Chairman and Director, Morgan Stanley Asset Management Harold J. Schaaff, Jr.
Inc. and Morgan Stanley VICE PRESIDENT
Asset Management Limited; Managing Joseph P. Stadler
Director, Morgan Stanley & Co. Incorporated VICE PRESIDENT
Michael F. Klein Valerie Y. Lewis
DIRECTOR AND PRESIDENT SECRETARY
Principal, Morgan Stanley Asset Management Inc. and Karl O. Hartmann
Morgan Stanley & Co. Incorporated ASSISTANT SECRETARY
John D. Barrett II Joanna M. Haigney
Chairman and Director, TREASURER
Barrett Associates, Inc. Belinda A. Brady
Gerard E. Jones ASSISTANT TREASURER
Partner, Richards & O'Neil LLP
Andrew McNally IV
River Road Partners
Samuel T. Reeves
Chairman of the Board and Chief
Executive Officer,
Pinacle L.L.C.
Fergus Reid
Chairman and Chief Executive Officer, LumeLite
Plastics Corporation
Frederick O. Robertshaw
Of Counsel, Copple, Chamberlin &
Boehm, P.C.
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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
1221 Avenue of the Americas
New York, New York 10020
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CUSTODIANS
The Chase Manhattan Bank
3 Chase MetroTech Center
Brooklyn, New York 11245
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
PricewaterhouseCoopers 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.
EUROPEAN REAL ESTATE PORTFOLIO
THIRD QUARTER REPORT
SEPTEMBER 30, 1998
<PAGE>
LETTER TO SHAREHOLDERS
- -------
PERFORMANCE COMPARED TO THE GPR LIFE EUROPEAN REAL ESTATE T.R. INDEX(1)
- ----------------------------------------------------
<TABLE>
<CAPTION>
TOTAL RETURNS(2)
--------------------------------
YTD SINCE INCEPTION
----- -------------------
<S> <C> <C>
PORTFOLIO--CLASS A(3)..................... 5.21% 0.24%
PORTFOLIO--CLASS B(3)..................... 5.07 0.07
INDEX..................................... 3.06 3.09
</TABLE>
1. The GPR Life European Real Estate T.R. Index is a European market
capitalization weighted index of listed property/real estate securities
measuring total return.
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 commenced operations on October 1, 1997.
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
- ------------------------------
THE INFORMATION CONTAINED IN THIS OVERVIEW REGARDING SPECIFIC SECURITIES IS FOR
INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE CONSTRUED AS A RECOMMENDATION TO
PURCHASE OR SELL THE SECURITIES MENTIONED. THE COUNTRY SPECIFIC PERFORMANCE
RESULTS PROVIDED IN THIS OVERVIEW 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. PLEASE SEE THE PROSPECTUS FOR A
DESCRIPTION OF CERTAIN RISK CONSIDERATIONS ASSOCIATED WITH INTERNATIONAL
INVESTING.
The investment objective of the European Real Estate Portfolio is to provide
current income and long-term capital appreciation by investing primarily in
equity securities of companies in the European real estate industry.
For the nine months ended September 30, 1998, the Portfolio had a total return
of 5.21% for the Class A shares and 5.07% for the Class B shares compared to
3.06% for the GPR Life European Real Estate T.R. Index (the "Index"). From
inception on October 1, 1997 through September 30, 1998, the Portfolio had a
total return of 0.24% for Class A shares and 0.07% for Class B shares compared
to 3.09% for the Index.
Global fears and light trading volumes contributed to a fall in the European
real estate securities market of 13.2% during the third quarter of 1998. A
continued collapse of the global broader markets has cast concern into the
hearts of European property investors. The larger European investors have
dug-in, planning to wait-out the declines, while smaller foreign investors have
driven down the pricing with miniscule volumes and a sell at any cost strategy.
The result was increased volatility in all the markets, most notably Sweden and
Spain, but with a lack of sufficient share liquidity to enable an investor to
significantly capitalize on the price declines. We remain positive on the
underlying property fundamentals in most of these countries, and have chosen to
buy on the dips in anticipation of a refocus by investors on European real
estate over the coming months.
The U.K. continued through the third quarter as one of Europe's worst performing
real estate securities markets. The U.K. component of the Index, in ECU terms,
fell 15.7% during the quarter, or 2.5% relative to the European Index, both in
ECU terms. Concerns over an economic slowdown have hurt the retail sector, while
the potential impact of the global securities markets decline on employment in
the financial industry has cautioned office investors. However, we believe the
worst underperformance for the U.K. is behind it. The potential for a Bank of
England rate cut, and the lack of central office space development bode well for
the sector. Furthermore, the industry has moved from a 20-30% premium on net
asset value in the first quarter to the current 10-20% discount, providing a
degree of downside protection. Notwithstanding, we remain underweight the U.K.
property market, expecting the shares to trade sideways in the near future. In
response, we are also focusing our exposure on the larger, higher quality names.
2
<PAGE>
France remains one of the strongest performing European markets suffering a 6.9%
ECU loss in the third quarter. We believe this decline in France was a reaction
by smaller investors to the global confusion, rather than a fundamental property
reallocation by institutions. Our belief is strengthened by the large price
fluctuations brought about by limited trading volume these past few months. In
addition, we continue to see evidence of a rebounding property market. Strong
demand in the Paris office market, where vacancy rates have fallen by 150 basis
points, is beginning to translate into higher rental levels. At the same time,
the increasing possibility of a European Bank rate cut at the introduction of
the Euro and the economy's continued growth, albeit at a slower rate than
previously anticipated, is maintaining the pressure on yields. As a result, we
remain overweight in the office and commercial sector.
During the third quarter, the levered Swedish real estate companies demonstrated
the risk of a highly geared portfolio. The Swedish property sector returned
- -16.3% for the quarter, qualifying as one of the worst performing European
markets in ECU terms. The decline was felt across the board, with only one
company reporting a positive total return for the three months, while four
companies were down more than 20%. A large portion of the selling came from
foreign investors trying to realize profits as the world markets fell apart. The
one bright side to the market is that the fall was a result of global fears,
rather than market fundamentals. Stockholm posted an 11% rise in rents over the
past 12 months, while Gothenburg and Malmo saw 7% jumps. With limited new
construction activity, decreasing vacancies, and a growing domestic economy,
rents are primed for a further rise in the months ahead. We remain positive on
Sweden, increasing a few of our overweight positions by buying at bargain
prices.
The remainder of Scandinavia was mixed, with Norway declining 28.3%, and Denmark
and Finland both falling, but outperforming the European Index by 1.7% and 1.5%
respectively, each in ECU terms. The Norwegian collapse was a combination of
factors: currency devaluation, a 250 basis point rise in short-term interest
rates, and a flight to safety into the Euro countries as Russia's economic
concerns increased. The Danish property stocks outperformed the broader equity
market due to further expectations from the infrastructure investment in and
around Copenhagen. Finland was sheltered from the meltdown by their Euro
involvement and strong domestic growth. Notwithstanding the third quarter
performance, we remain strongly overweight throughout Scandinavia. Our
aggressive stance is based on the belief that continuing fundamental advances
will overcome investor broader market fears. In Norway, property stocks are
selling at a 50% discount to the company's underlying net asset value. Denmark's
valuation and infrastructure growth will continue to present a favorable
environment in the near to medium-term. Meanwhile, Finland's growth rate remains
one of the strongest in Europe.
<TABLE>
<CAPTION>
GDP GROWTH (%) CPI INFLATION (%) 10-YEAR
BOND YIELDS
(%)
------------ ------------ ----------------------------
1997 1998E 1997 1998E 02-SEP98 DEC 98E
--- ----------- --- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
DENMARK................... 3.4 2.7 2.2 2.1 4.8 4.5
FINLAND................... 5.9 4.0 1.2 1.4 4.6 4.3
NORWAY.................... 3.6 3.5 2.5 2.8 5.7 4.7
SWEDEN.................... 1.9 2.7 0.9 0.7 4.8 4.6
</TABLE>
For the second quarter in a row, the conservatively geared Dutch property
companies fell during the third quarter, but at a much slower rate than the rest
of Europe. Overall, the Dutch real estate companies outperformed Europe during
the quarter by 2.5% in ECU terms. The key to the outperformance in Holland is
the above average gross domestic product growth and strong employment which is
increasing the demand for office space in an already 96% occupied market. The
only shortcoming to the market is that while stock prices are falling, the real
estate shares remain pricey. As a result, we are maintaining our overall
underweight stance, but keeping a close eye on the domestic office companies.
The offering activity in Belgium has dried up, but the markets outperformance
remains strong. During the third quarter, Belgium's 5.7% return outperformed
Europe by 18.9% in ECU terms. However, going forward we are less bullish on this
market. The Brussels office market is dominated by one tenant, the European
Community. Our concern with this structure is the EC's bargaining strength to
dictate rents. Until we are able to
3
<PAGE>
find evidence that landlords and not the tenant will be driving the market, we
plan to sit tight with our slightly overweight Asticus exposure (listed in
Sweden).
Spain has taken a strong hit based on concerns regarding the emerging markets,
in particular Brazil and the rest of Latin America. During the third quarter,
the property market fell 17.5%, giving back nearly 40% of their 39.2% first half
performance, in ECU terms. However, even though the market is underperforming
European property shares, it is serving as a safety net for Spanish investors,
with the Ibex 35 Index falling 24.3% during the third quarter. We believe the
relative performance against the broader market is strong evidence that the drop
is technical in nature, rather than predicated by real estate concerns. After
all, office rental rates in Madrid have risen by over 20% so far this year. Our
view is that this decline in pricing is an opportunity to buy into a strong
underlying property market. As such, we have increased our position.
Italy is another early year high-flyer reclaiming extraordinary returns. The
market fell 15.3% in the third quarter, a far cry from the 74.0% return in the
first quarter, both in ECU terms. However, similar to Spain, the property
market's sharp drop over the past three months is outperforming the broader
equity market's 17.8% decline. Furthermore, the underlying property fundamentals
in Italy remain positive heading into the Euro. In particular, we believe the
upcoming floatation of the INA property portfolio will serve as a trigger to
reemphasize the strong growth available in Italian real estate. We remain
slightly overweight.
The closed-end property companies in Germany, Switzerland and Austria each
outperformed Europe as a whole, returning -6.0%, 4.7%, and 3.9%, respectively
for the quarter, in ECU terms. However, the underlying property markets continue
to be dominated by the inefficient open-end fund structure. For this reason we
have steered clear of these markets. Yet, we believe the time is ripening to
invest in this bloc, and intend to keep a close eye on the few names available
in these three countries.
Jan Willem de Geus
PORTFOLIO MANAGER
October 1998
4
<PAGE>
INVESTMENTS (UNAUDITED)
- ----------
SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- ----------- -------
<C> <S> <C>
COMMON STOCKS (98.1%)
DENMARK (2.4%)
26,300 EjendomsSelskabet Norden A/S $ 1,434
-------
FINLAND (2.7%)
232,700 Sponda Oyj 1,557
-------
FRANCE (17.2%)
7,479 Groupe Financement Construction 830
11,877 Klepierre 2,089
3,381 Locindus 468
8,000 Silic 1,643
6,800 Societe Fonciere Lyonnaise 1,044
27,586 Sophia 1,059
20,722 Unibail 2,905
6 Union Immobiliere de France 1
-------
10,039
-------
IRELAND (2.8%)
4,135,500 Dunloe Ewart plc 1,653
-------
ITALY (2.7%)
885,000 Ciga S.p.A. 535
1,004,200 Immobiliare Metanopoli S.p.A. 1,034
-------
1,569
-------
NETHERLANDS (3.0%)
78,300 Rodamco N.V. 1,779
-------
NORWAY (5.1%)
193,100 Avantor ASA 1,044
518,000 Choice Hotels Scandinavia ASA 700
209,081 Linstow ASA 1,216
-------
2,960
-------
SPAIN (4.7%)
248,000 Vallehermoso 2,769
-------
SWEDEN (14.3%)
16,700 Asticus AB 166
306,200 Castellum AB 3,027
182,400 Diligentia AB 1,547
85,300 Fastighets AB Tornet 1,252
200,950 Piren AB 1,538
752,500 Platzer Bygg AB, Class B 835
-------
8,365
-------
TURKEY (1.4%)
137,280,000 Yapi Kredi Koray Gayrimen Kul, Class B 791
-------
<CAPTION>
VALUE
SHARES (000)
- ----------- -------
<C> <S> <C>
UNITED KINGDOM (40.6%)
492,400 British Land Co. plc $ 4,889
1,333,100 Buford Holdings plc 2,142
349,400 Capital Shopping Centers plc 2,131
84,400 Chelsfield plc 367
414,900 Freeport Leisure plc 2,349
1,087,700 Grantchester Holdings plc 2,339
169,600 Great Portland Estates plc 577
241,900 Hammerson plc 1,624
164,900 Jarvis Hotels plc 297
171,476 MEPC plc 1,367
1,207,294 NHP plc 3,202
28,314 Stylo plc 18
388,176 Town Centre Securities plc 495
1,514,200 Wates City Of London Properties plc 1,880
-------
23,677
-------
UNITED STATES (1.2%)
131,250 Omega Worldwide, Inc. 673
-------
TOTAL COMMON STOCKS (Cost $62,783) 57,266
-------
<CAPTION>
NO. OF
WARRANTS
- -----------
<C> <S> <C>
WARRANTS (0.0%)
FRANCE (0.0%)
6,800 Societe Fonciere Lyonnaise (Cost $0) 9
-------
<CAPTION>
FACE
AMOUNT
(000)
- -----------
<C> <S> <C>
FOREIGN CURRENCY (1.3%)
IEP 495 Irish Punt (Cost $714) 739
-------
SHORT-TERM INVESTMENT (1.2%)
REPURCHASE AGREEMENT (1.2%)
$ 711 Chase Securities, Inc. 5.25%, dated 9/30/98, due
10/01/98, to be repurchased at $711,
collateralized by U.S. Treasury Notes, 5.00%,
due 2/15/99, valued at $731 (Cost $711) 711
-------
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
Value
(000)
----------
<S> <C>
TOTAL INVESTMENTS (100.6%) (Cost $64,208) $ 58,725
----------
OTHER ASSETS AND LIABILITIES (-0.6%)
Other Assets 1,306
Liabilities (1,684)
----------
(378)
----------
NET ASSETS (100%) $ 58,347
----------
----------
CLASS A:
- --------
NET ASSETS $ 54,779
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 5,492,749 outstanding $0.001 par value shares
(authorized 500,000,000 shares) $ 9.97
-----
-----
CLASS B:
- --------
NET ASSETS $ 3,568
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 357,760 outstanding $0.001 par value shares
(authorized 500,000,000 shares) $ 9.97
-----
-----
</TABLE>
6
