N-CSRS 1 y98140nvcsrs.txt N-CSRS UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM N-CSR CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES Investment Company Act file number: 811-09117 Morgan Stanley Real Estate Fund (Exact name of registrant as specified in charter) 1221 Avenue of the Americas, New York, New York 10020 (Address of principal executive offices) (Zip code) Ronald E. Robison 1221 Avenue of the Americas, New York, New York 10020 (Name and address of agent for service) Registrant's telephone number, including area code: 212-762-4000 Date of fiscal year end: November 30, 2004 Date of reporting period: May 31, 2004 Item 1 - Report to Shareholders Welcome, Shareholder: In this report, you'll learn about how your investment in Morgan Stanley Real Estate Fund performed during the semiannual period. We will provide an overview of the market conditions, and discuss some of the factors that affected performance during the reporting period. In addition, this report includes the Fund's financial statements and a list of Fund investments. This material must be preceded or accompanied by a prospectus for the fund being offered. Market forecasts provided in this report may not necessarily come to pass. There is no assurance that the Fund will achieve its investment objective. The Fund is subject to market risk, which is the possibility that market values of securities owned by the Fund will decline and, therefore, the value of the Fund shares may be less than what you paid for them. Accordingly, you can lose money investing in this Fund. FUND REPORT For the six month period ended May 31, 2004 TOTAL RETURN FOR THE SIX MONTHS ENDED MAY 31, 2004
LIPPER REAL NAREIT ESTATE EQUITY FUNDS CLASS A CLASS B CLASS C CLASS D INDEX(1) INDEX(2) 7.38% 6.93% 6.94% 7.50% 6.09% 5.73%
The performance of the Fund's four share classes varies because each has different expenses. The Fund's total return figures assume the reinvestment of all distributions, but do not reflect the deduction of any applicable sales charges. Such costs would lower performance. Past performance is no guarantee of future results. See Performance Summary for standardized performance information. MARKET CONDITIONS Domestic equity markets performed well during the six months ended May 31, 2004 due to continued evidence that the economic recovery that began in 2003 would continue. Low inflation rates, consumer spending, manufacturing activity and gross domestic product growth all suggested that U.S. economic conditions were improving. Interest rates remained at low levels as well, though Federal Reserve Chairman Alan Greenspan hinted numerous times that rates would have to rise at some point. As investors gauged the threat of interest rate increases and the slower-than-expected new job creation data they sought defensive sectors that had lagged the market through most of 2003. In this environment, the real estate sector struggled early in the period due to the "jobless" economic recovery. Apartment and office buildings were affected most negatively by continued weakness in jobs growth; these properties were at peak vacancy levels. In April and May of 2004, however, encouraging employment data spurred an increase in demand for these segments of the market. Retail properties performed well as consumer spending remained consistently high during the period. From a capital markets perspective, real estate properties ended the period near historical peaks due to an ongoing influx of capital. Institutional investors were the largest source of capital flows into the asset class, though other investors have increased their exposure to real estate as well. Investors have shown increased interest in REITs, especially in an environment when many foresee unappealing returns from bonds and equities. The sector was also helped by a relatively low level of equity issuance amid this high demand. PERFORMANCE ANALYSIS Morgan Stanley Real Estate Fund outperformed the NAREIT Equity Index and the Lipper Real Estate Funds Index for the six-month period ended May 31, 2004. The Fund received strong relative performance from its stock picking in hotel, office and mall sectors. Hotels were favorable due to the Fund's focus on companies with such exposure in major urban centers. These companies were attractively valued and saw cash flow increases as business travel picked up. The Fund's office holdings also contributed strong relative performance by focusing on companies with office exposure in New York, District of Columbia and Southern California areas while avoiding suburban areas and the Sun Belt. The Fund's focus on urban office properties was due to expectations that they would recover faster than less-developed areas. While the Fund performed strongly, not all of its stock picks did as well as expected. The Fund had an overweighting in apartments due to relative valuation and our expectation that they would recover in tandem with the economy. Unfortunately, these properties lagged and hindered performance. Additionally, the Fund was underweighted relative to the NAREIT Equity Index in health care REITs due to unattractive real estate values; these companies went on to perform well for the period and hurt relative performance. The Fund was also hurt by its lack of exposure to Plum Creek Lumber, a net-lease REIT which we chose not to hold in the portfolio. The security gained sharply on rising commodity prices, supporting our view that its stock price would be driven more by that factor than by the underlying real estate fundamentals that are at the core of our long-term approach. 2
TOP 10 HOLDINGS Simon Property Group, Inc. 8.2% Brookfield Properties Corp. 6.2 Archstone-Smith Trust 5.6 AvalonBay Communities, Inc. 5.5 Starwood Hotels and Resorts World Wide Inc. 5.3 Boston Properties, Inc. 4.4 Equity Office Properties Trust 4.2 Rouse Company 4.2 Public Storage, Inc. 4.0 Prologis 3.7
PORTFOLIO COMPOSITION Common Stocks 98.6% Short-Term Investment 1.4
Subject to change daily. All percentages for Top 10 Holdings are as a percentage of net assets and Portfolio Composition is a percentage of total investments. Provided for informational purposes only and should not be deemed as a recommendation to buy or sell the securities mentioned. Morgan Stanley is a full-service securities firm engaged in securities trading and brokerage activities, investment banking, research and analysis, financing and financial advisory services. INVESTMENT STRATEGY THE FUND WILL NORMALLY INVEST AT LEAST 80% OF ITS ASSETS IN INCOME PRODUCING COMMON STOCKS AND OTHER EQUITY SECURITIES (WHICH MAY INCLUDE CONVERTIBLE SECURITIES) OF COMPANIES THAT ARE PRINCIPALLY ENGAGED IN THE U.S. REAL ESTATE INDUSTRY. A COMPANY IS CONSIDERED TO BE "PRINCIPALLY ENGAGED" IN THE U.S. REAL ESTATE INDUSTRY IF (I) IT DERIVES AT LEAST 50% OF ITS REVENUES OR PROFITS FROM THE OWNERSHIP, LEASING, CONSTRUCTION, MANAGEMENT, DEVELOPMENT, FINANCING OR SALE OF RESIDENTIAL, COMMERCIAL OR INDUSTRIAL REAL ESTATE; OR (II) IT HAS AT LEAST 50% OF THE VALUE OF ITS ASSETS INVESTED IN U.S. RESIDENTIAL, COMMERCIAL OR INDUSTRIAL REAL ESTATE. COMPANIES PRIMARILY ENGAGED IN THE REAL ESTATE INDUSTRY MAY INCLUDE REAL ESTATE INVESTMENT TRUSTS KNOWN AS "REITS," WHICH POOL INVESTOR FUNDS MOSTLY FOR INVESTMENT IN COMMERCIAL REAL ESTATE PROPERTIES. THEY ALSO MAY INCLUDE, AMONG OTHER BUSINESSES, REAL ESTATE DEVELOPERS, BROKERS AND OPERATING COMPANIES, AS WELL AS COMPANIES WHOSE PRODUCTS AND SERVICES ARE SIGNIFICANTLY RELATED TO THE REAL ESTATE INDUSTRY, SUCH AS BUILDING SUPPLIERS AND MORTGAGE LENDERS. IN DECIDING WHICH SECURITIES TO BUY, HOLD OR SELL, THE FUND'S "INVESTMENT MANAGER," MORGAN STANLEY INVESTMENT ADVISORS INC., CONSIDERS MARKET, ECONOMIC AND POLITICAL FACTORS. PROXY VOTING POLICIES AND PROCEDURES A DESCRIPTION OF THE FUND'S POLICIES AND PROCEDURES WITH RESPECT TO THE VOTING OF PROXIES RELATING TO THE FUND'S PORTFOLIO SECURITIES IS AVAILABLE WITHOUT CHARGE, UPON REQUEST, BY CALLING (800) 869-NEWS (6397). THIS INFORMATION IS ALSO AVAILABLE ON THE SECURITIES AND EXCHANGE COMMISSION'S WEBSITE AT HTTP://WWW.SEC.GOV. 3 PERFORMANCE SUMMARY AVERAGE ANNUAL TOTAL RETURNS -- PERIOD ENDED MAY 31, 2004
CLASS A SHARES* CLASS B SHARES** CLASS C SHARES(+) CLASS D SHARES(++) (since 04/28/99) (since 04/28/99) (since 04/28/99) (since 04/28/99) SYMBOL REFAX REFBX REFCX REFDX 1 YEAR 27.19%(3) 26.26%(3) 26.18%(3) 27.46%(3) 20.51(4) 21.26(4) 25.18(4) -- 5 YEARS 12.55(3) 11.65(3) 11.65(3) 12.85(3) 11.34(4) 11.40(4) 11.65(4) -- SINCE INCEPTION 12.73(3) 11.84(3) 11.84(3) 13.02(3) 11.54(4) 11.72(4) 11.84(4) --
Past performance is no guarantee of future results and current performance may be lower or higher than the figures shown. For more up-to-date information, including month-end performance figures, please visit morganstanley.com or speak with your financial advisor. Investment returns and principal value will fluctuate and fund shares, when redeemed, may be worth more or less than their original cost. The table does not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares. Performance for Class A, Class B, Class C, and Class D shares will vary due to differences in sales charges and expenses. * The maximum front-end sales charge for Class A is 5.25%. ** The maximum contingent deferred sales charge (CDSC) for Class B is 5.0%. The CDSC declines to 0% after six years. + The maximum contingent deferred sales charge for Class C is 1% for shares redeemed within one year of purchase. ++ Class D has no sales charge. (1) The NAREIT Equity Index measures the performance of real estate securities, which will fluctuate with changes in the values of their underlying properties. The Index is an unmanaged benchmark of real estate investment trusts compiled by the National Association of Real Estate Investment Trusts. Indexes are unmanaged and their returns do not include any sales charges or fees. Such costs would lower performance. It is not possible to invest directly in an index. (2) The Lipper Real Estate Funds Index is an equally weighted performance index of the largest qualifying funds (based on net assets) in the Lipper Real Estate Funds classification. The Index, which is adjusted for capital gains distributions and income dividends, is unmanaged and should not be considered an investment. There are currently 30 funds represented in this Index. (3) Figure shown assumes reinvestment of all distributions and does not reflect the deduction of any sales charges. (4) Figure shown assumes reinvestment of all distributions and the deduction of the maximum applicable sales charge. See the Fund's current prospectus for complete details on fees and sales charges. 4 Morgan Stanley Real Estate Fund PORTFOLIO OF INVESTMENTS - MAY 31, 2004 (UNAUDITED)
NUMBER OF SHARES VALUE ------------------------------------------------------ Common Stocks (98.5%) Hotels/Resorts/ Cruiselines (7.8%) 250,600 Hilton Hotels Corp. ..... $ 4,347,910 6,745 Interstate Hotels & Resorts Inc.*........... 36,086 225,093 Starwood Hotels & Resorts Worldwide, Inc. ........ 9,494,423 219,200 Wyndham International, Inc. (Class A)*......... 195,088 ------------ 14,073,507 ------------ Real Estate --Industrial/ Office (6.2%) 377,800 Brookfield Properties Corp. (Canada).......... 11,205,548 ------------ Real Estate -- Other (0.6%) 166,300 Frontline Capital Group*.................. 0 28,500 St. Joe Co. (The)........ 1,112,925 ------------ 1,112,925 ------------ Real Estate -- Retail (0.6%) 21,780 Forest City Enterprise, Inc. (Class A).......... 1,100,761 ------------ REIT -- Diversified (3.0%) 100,300 Vornado Realty Trust..... 5,481,395 ------------ REIT -- Healthcare (1.0%) 34,181 Nationwide Health Properties, Inc. ....... 660,719 84,000 OMEGA Healthcare Investors, Inc. ........ 804,720 4,300 Senior Housing Properties Trust................... 70,004 11,600 Ventas, Inc. ............ 270,512 ------------ 1,805,955 ------------
NUMBER OF SHARES VALUE ------------------------------------------------------ REIT -- Industrial/ Office (22.8%) 175,500 AMB Property Corp. ...... $ 5,800,275 214,800 Arden Realty, Inc. ...... 6,368,820 160,700 Boston Properties, Inc. ................... 7,932,152 22,200 Catellus Development Corp. .................. 542,346 281,885 Equity Office Properties Trust................... 7,596,801 47,400 Mack-Cali Realty Corp. .................. 1,894,104 207,610 ProLogis Trust........... 6,655,976 1,800 PS Business Parks, Inc. (Class A)............... 69,660 108,600 Reckson Associates Realty Corp. .................. 2,825,772 27,650 SL Green Realty Corp. ... 1,258,075 ------------ 40,943,981 ------------ REIT -- Lodging/ Resorts (3.4%) 478,100 Host Marriott Corp.*..... 5,861,506 25,400 MeriStar Hospitality Corp.*.................. 161,290 ------------ 6,022,796 ------------ REIT -- Residential (20.0%) 20,400 Affordable Residential Communities............. 326,400 160,300 Apartment Investment & Management Co. (Class A)...................... 4,629,464 344,807 Archstone-Smith Trust.... 10,016,643 183,000 Avalonbay Communities, Inc. ................... 9,964,350 132,390 Equity Residential....... 3,897,562 63,000 Essex Property Trust, Inc. ................... 4,129,650 39,500 Manufactured Home Communities, Inc. ...... 1,226,475 60,650 Post Properties, Inc. ... 1,764,915 1,000 Summit Properties Inc. ................... 23,170 ------------ 35,978,629 ------------
5 See Notes to Financial Statements Morgan Stanley Real Estate Fund PORTFOLIO OF INVESTMENTS - MAY 31, 2004 (UNAUDITED) continued
NUMBER OF SHARES VALUE ------------------------------------------------------ REIT -- Retail (26.3%) 6,200 Acadia Reality Trust..... $ 79,360 106,300 Burnham Pacific Properties, Inc.*....... 34,016 11,250 Chelsea Property Group, Inc. ................... 618,525 161,900 Federal Realty Investment Trust................... 6,459,810 215,800 General Growth Properties, Inc. ....... 6,340,204 6,700 Heritage Property Investment Trust........ 180,498 10,800 Kimco Realty Corp. ...... 496,260 25,800 Macerich Co. (The)....... 1,167,450 2,300 Pan Pacific Retail Properties, Inc. ....... 105,800 2,150 Price Legacy Corp. ...... 39,474 112,200 Regency Center Corp. .... 4,521,660 165,700 Rouse Co. (The).......... 7,564,205 285,600 Simon Property Group, Inc. ................... 14,728,392 221,700 Taubman Centers, Inc. ... 4,943,910 ------------ 47,279,564 ------------ REIT -- Specialty (0.4%) 23,400 Correctional Properties Trust................... 659,880 ------------ REIT -- Storage (6.4%) 158,200 Public Storage, Inc. .... 7,275,618 113,950 Shurgard Storage Centers, Inc. (Class A).......... 4,273,125 ------------ 11,548,743 ------------ Total Common Stocks (Cost $133,654,779)...... 177,213,684 ------------ PRINCIPAL AMOUNT IN THOUSANDS VALUE ------------------------------------------------------ Short-Term Investment (1.4%) Repurchase Agreement $2,555 Joint repurchase agreement account 1.02% due 06/01/04 (dated 05/28/04; proceeds $2,555,288)(a) (Cost $2,555,000)....... $ 2,555,000 ------------
Total Investments (Cost $136,209,779)(b)...... 99.9% 179,768,684 Other Assets in Excess of Liabilities................. 0.1 85,586 ----- ------------ Net Assets.................. 100.0% $179,854,270 ===== ============
--------------------------------------------------- REIT Real Estate Investment Trust. * Non-income producing security. (a) Collateralized by federal agency and U.S. Treasury obligations. (b) The aggregate cost for federal income tax purposes approximates the aggregate cost for book purposes. The aggregate gross unrealized appreciation is $47,377,607 and the aggregate gross unrealized depreciation is $3,818,702, resulting in net unrealized appreciation of $43,558,905.
6 See Notes to Financial Statements Morgan Stanley Real Estate Fund FINANCIAL STATEMENTS Statement of Assets and Liabilities May 31, 2004 (unaudited) Assets: Investments in securities, at value (cost $136,209,779)....................................... $179,768,684 Receivable for: Investments sold........................................ 398,986 Dividends............................................... 90,292 Shares of beneficial interest sold...................... 66,423 Prepaid expenses and other assets........................... 90,170 ------------ Total Assets............................................ 180,414,555 ------------ Liabilities: Payable for: Shares of beneficial interest redeemed.................. 284,008 Investment management fee............................... 145,440 Distribution fee........................................ 92,559 Accrued expenses and other payables......................... 38,278 ------------ Total Liabilities....................................... 560,285 ------------ Net Assets.............................................. $179,854,270 ============ Composition of Net Assets: Paid-in-capital............................................. $130,850,569 Net unrealized appreciation................................. 43,558,905 Undistributed net investment income......................... 426,746 Accumulated undistributed net realized gain................. 5,018,050 ------------ Net Assets.............................................. $179,854,270 ============ Class A Shares: Net Assets.................................................. $7,681,928 Shares Outstanding (unlimited authorized, $.01 par value)... 539,700 Net Asset Value Per Share............................... $14.23 ============ Maximum Offering Price Per Share, (net asset value plus 5.54% of net asset value)......... $15.02 ============ Class B Shares: Net Assets.................................................. $99,405,874 Shares Outstanding (unlimited authorized, $.01 par value)... 7,012,287 Net Asset Value Per Share............................... $14.18 ============ Class C Shares: Net Assets.................................................. $12,800,556 Shares Outstanding (unlimited authorized, $.01 par value)... 902,667 Net Asset Value Per Share............................... $14.18 ============ Class D Shares: Net Assets.................................................. $59,965,912 Shares Outstanding (unlimited authorized, $.01 par value)... 4,209,787 Net Asset Value Per Share............................... $14.24 ============
7 See Notes to Financial Statements Morgan Stanley Real Estate Fund FINANCIAL STATEMENTS continued Statement of Operations For the six months ended May 31, 2004 (unaudited) Net Investment Income: Income Dividends (net of $17,422 foreign withholding tax).......... $ 4,831,678 Interest.................................................... 19,336 ----------- Total Income............................................ 4,851,014 ----------- Expenses Investment management fee................................... 951,693 Distribution fee (Class A shares)........................... 9,324 Distribution fee (Class B shares)........................... 541,790 Distribution fee (Class C shares)........................... 65,467 Transfer agent fees and expenses............................ 227,624 Shareholder reports and notices............................. 39,147 Professional fees........................................... 31,439 Registration fees........................................... 17,582 Custodian fees.............................................. 7,516 Trustees' fees and expenses................................. 2,975 Other....................................................... 4,122 ----------- Total Expenses.......................................... 1,898,679 ----------- Net Investment Income................................... 2,952,335 ----------- Net Realized and Unrealized Gain: Net realized gain on investments............................ 4,984,213 Capital gain distributions received......................... 26,400 ----------- Net Realized Gain....................................... 5,010,613 ----------- Net change in unrealized appreciation....................... 4,621,710 ----------- Net Gain................................................ 9,632,323 ----------- Net Increase................................................ $12,584,658 ===========
8 See Notes to Financial Statements Morgan Stanley Real Estate Fund FINANCIAL STATEMENTS continued Statement of Changes in Net Assets
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED MAY 31, 2004 NOVEMBER 30, 2003 ------------ ----------------- (unaudited) Increase (Decrease) in Net Assets: Operations: Net investment income....................................... $ 2,952,335 $ 3,749,618 Net realized gain........................................... 5,010,613 3,619,379 Net change in unrealized appreciation....................... 4,621,710 40,547,114 ------------ ------------ Net Increase............................................ 12,584,658 47,916,111 ------------ ------------ Dividends and Distributions to Shareholders from: Net investment income Class A shares.......................................... (120,427) (175,671) Class B shares.......................................... (1,257,318) (2,035,063) Class C shares.......................................... (150,209) (211,573) Class D shares.......................................... (997,635) (1,327,311) Net realized gain Class A shares.......................................... (66,126) (116,098) Class B shares.......................................... (970,347) (1,865,703) Class C shares.......................................... (111,152) (186,465) Class D shares.......................................... (527,377) (749,540) ------------ ------------ Total Dividends and Distributions....................... (4,200,591) (6,667,424) ------------ ------------ Net increase (decrease) from transactions in shares of beneficial interest....................................... (15,876,696) 1,574,307 ------------ ------------ Net Increase (Decrease)................................. (7,492,629) 42,822,994 Net Assets: Beginning of period......................................... 187,346,899 144,523,905 ------------ ------------ End of Period (Including undistributed net investment income of $426,746 and $0, respectively)....................................... $179,854,270 $187,346,899 ============ ============
9 See Notes to Financial Statements Morgan Stanley Real Estate Fund NOTES TO FINANCIAL STATEMENTS - MAY 31, 2004 (UNAUDITED) 1. Organization and Accounting Policies Morgan Stanley Real Estate Fund (the "Fund") is registered under the Investment Company Act of 1940, as amended (the "Act"), as a non-diversified, open-end management investment company. The Fund's investment objective is to provide high current income and long-term capital appreciation. The Fund was organized as a Massachusetts business trust on November 23, 1998 and commenced operations on April 28, 1999. The Fund offers Class A shares, Class B shares, Class C shares and Class D shares. The four classes are substantially the same except that most Class A shares are subject to a sales charge imposed at the time of purchase and some Class A shares, and most Class B shares and Class C shares are subject to a contingent deferred sales charge imposed on shares redeemed within one year, six years and one year, respectively. Class D shares are not subject to a sales charge. Additionally, Class A shares, Class B shares and Class C shares incur distribution expenses. The following is a summary of significant accounting policies: A. Valuation of Investments -- (1) an equity portfolio security listed or traded on the New York Stock Exchange ("NYSE") or American Stock Exchange or other exchange is valued at its latest sale price prior to the time when assets are valued; if there were no sales that day, the security is valued at the mean between the last reported bid and asked price; (2) an equity portfolio security listed or traded on the Nasdaq is valued at the Nasdaq Official Closing Price; if there were no sales that day, the security is valued at the mean between the last reported bid and asked price; (3) all other portfolio securities for which over-the-counter market quotations are readily available are valued at the mean between the last reported bid and asked price. In cases where a security is traded on more than one exchange, the security is valued on the exchange designated as the primary market; (4) for equity securities traded on foreign exchanges, the last reported sale price or the latest bid price may be used if there were no sales on a particular day; (5) when market quotations are not readily available or Morgan Stanley Investment Advisors Inc. (the "Investment Manager") determines that the latest sale price, the bid price or the mean between the last reported bid and asked price do not reflect a security's market value, portfolio securities are valued at their fair value as determined in good faith under procedures established by and under the general supervision of the Fund's Trustees. Occasionally, developments affecting the closing prices of securities and other assets may occur between the times at which valuations of such securities are determined (that is, close of the foreign market on which the securities trade) and the close of business on the NYSE. If developments occur during such periods that are expected to materially affect the value of such securities, such valuations may be adjusted to reflect the estimated fair value of such securities as of the close of the NYSE, as determined in good faith by the Fund's Trustees or by the Investment 10 Morgan Stanley Real Estate Fund NOTES TO FINANCIAL STATEMENTS - MAY 31, 2004 (UNAUDITED) continued Manager using a pricing service and/or procedures approved by the Trustees of the Fund; (6) certain portfolio securities may be valued by an outside pricing service approved by the Fund's Trustees; (7) short-term debt securities having a maturity date of more than sixty days at time of purchase are valued on a mark-to-market basis until sixty days prior to maturity and thereafter at amortized cost based on their value on the 61st day. Short-term debt securities having a maturity date of sixty days or less at the time of purchase are valued at amortized cost. B. Accounting for Investments -- Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined by the identified cost method. Dividend income and other distributions are recorded on the ex-dividend date. Discounts are accreted and premiums are amortized over the life of the respective securities. Interest income is accrued daily. C. Repurchase Agreements -- Pursuant to an Exemptive Order issued by the Securities and Exchange Commission, the Fund, along with other affiliated entities managed by the Investment Manager, may transfer uninvested cash balances into one or more joint repurchase agreement accounts. These balances are invested in one or more repurchase agreements and are collateralized by cash, U.S. Treasury or federal agency obligations. The Fund may also invest directly with institutions in repurchase agreements. The Fund's custodian receives the collateral, which is marked-to-market daily to determine that the value of the collateral does not decrease below the repurchase price plus accrued interest. D. Multiple Class Allocations -- Investment income, expenses (other than distribution fees), and realized and unrealized gains and losses are allocated to each class of shares based upon the relative net asset value on the date such items are recognized. Distribution fees are charged directly to the respective class. E. Federal Income Tax Policy -- It is the Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute substantially all of its taxable income to its shareholders. Accordingly, no federal income tax provision is required. F. Dividends and Distributions to Shareholders -- Dividends and distributions to shareholders are recorded on the ex-dividend date. G. Use of Estimates -- The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and disclosures. Actual results could differ from those estimates. 11 Morgan Stanley Real Estate Fund NOTES TO FINANCIAL STATEMENTS - MAY 31, 2004 (UNAUDITED) continued 2. Investment Management and Sub-Advisory Agreements Pursuant to an Investment Management Agreement, the Fund pays the Investment Manager a management fee, accrued daily and payable monthly, by applying the annual rate of 1.0% to the net assets of the Fund determined as of the close of each business day. Prior to February 27, 2004, under a Sub-Advisory Agreement between Morgan Stanley Investment Management Inc. (the "Sub-Advisor") and the Investment Manager, the Sub-Advisor provided the Fund with investment advice and portfolio management relating to the Fund's investments. As compensation for its services provided pursuant to the Sub-Advisory Agreement, the Investment Manager paid the Sub-Advisor compensation of $185,533 for the period December 1, 2003 through February 26, 2004. 3. Plan of Distribution Shares of the Fund are distributed by Morgan Stanley Distributors Inc. (the "Distributor"), an affiliate of the Investment Manager. The Fund has adopted a Plan of Distribution (the "Plan") pursuant to Rule 12b-1 under the Act. The Plan provides that the Fund will pay the Distributor a fee which is accrued daily and paid monthly at the following annual rates: (i) Class A -- up to 0.25% of the average daily net assets of Class A; (ii) Class B -- up to 1.0% of the average daily net assets of Class B; and (iii) Class C -- up to 1.0% of the average daily net assets of Class C. In the case of Class B shares, provided that the Plan continues in effect, any cumulative expenses incurred by the Distributor but not yet recovered may be recovered through the payment of future distribution fees from the Fund pursuant to the Plan and contingent deferred sales charges paid by investors upon redemption of Class B shares. Although there is no legal obligation for the Fund to pay expenses incurred in excess of payments made to the Distributor under the Plan and the proceeds of contingent deferred sales charges paid by investors upon redemption of shares, if for any reason the Plan is terminated, the Trustees will consider at that time the manner in which to treat such expenses. The Distributor has advised the Fund that such excess amounts totaled $5,959,359 at May 31, 2004. In the case of Class A shares and Class C shares, expenses incurred pursuant to the Plan in any calendar year in excess of 0.25% or 1.0% of the average daily net assets of Class A or Class C, respectively, will not be reimbursed by the Fund through payments in any subsequent year, except that expenses representing a gross sales credit to Morgan Stanley Financial Advisors or other selected broker-dealer representatives may be reimbursed in the subsequent calendar year. For the six months ended May 31, 2004, the distribution fee was accrued for Class A shares and Class C shares at the annual rate of 0.23% and 1.0%, respectively. 12 Morgan Stanley Real Estate Fund NOTES TO FINANCIAL STATEMENTS - MAY 31, 2004 (UNAUDITED) continued The Distributor has informed the Fund that for six months ended May 31, 2004, it received contingent deferred sales charges from certain redemptions of the Fund's Class A shares, Class B shares and Class C shares of $19, $130,203 and $3,321, respectively and received $49,893 in front-end sales charges from sales of the Fund's Class A shares. The respective shareholders pay such charges which are not an expense of the Fund. 4. Security Transactions and Transactions with Affiliates The cost of purchases and proceeds from sales of portfolio securities, excluding short-term investments, for the six months ended May 31, 2004 aggregated $10,393,075 and $23,717,186, respectively. Morgan Stanley Trust, an affiliate of the Investment Manager, Sub-Advisor and Distributor, is the Fund's transfer agent. Effective April 1, 2004, the Fund began an unfunded Deferred Compensation Plan (the "Compensation Plan"), which allows each independent Trustee to defer payment of all, or a portion, of the fees he receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 5. Federal Income Tax Status The amount of dividends and distributions from net investment income and net realized capital gains are determined in accordance with federal income tax regulations which may differ from generally accepted accounting principles. These "book/tax" differences are either considered temporary or permanent in nature. To the extent these differences are permanent in nature, such amounts are reclassified within the capital accounts based on their federal tax-basis treatment; temporary differences do not require reclassification. Dividends and distributions which exceed net investment income and net realized capital gains for tax purposes are reported as distributions of paid-in-capital. As of November 30, 2003, the Fund had temporary book/tax differences attributable to capital loss deferrals on wash sales. 13 Morgan Stanley Real Estate Fund NOTES TO FINANCIAL STATEMENTS - MAY 31, 2004 (UNAUDITED) continued 6. Shares of Beneficial Interest Transactions in shares of beneficial interest were as follows:
FOR THE SIX FOR THE YEAR MONTHS ENDED ENDED MAY 31, 2004 NOVEMBER 30, 2003 ------------------------- ------------------------- (unaudited) SHARES AMOUNT SHARES AMOUNT ---------- ------------ ---------- ------------ CLASS A SHARES Sold................................................. 183,883 $ 2,604,833 221,459 $ 2,653,238 Reinvestment of dividends and distributions.......... 11,728 164,454 24,014 263,633 Redeemed............................................. (199,220) (2,806,866) (306,839) (3,592,457) ---------- ------------ ---------- ------------ Net decrease - Class A............................... (3,609) (37,579) (61,366) (675,586) ---------- ------------ ---------- ------------ CLASS B SHARES Sold................................................. 589,968 8,427,192 1,720,447 20,200,314 Reinvestment of dividends and distributions.......... 130,915 1,824,086 290,602 3,155,716 Redeemed............................................. (1,743,811) (24,239,658) (3,016,795) (34,686,436) ---------- ------------ ---------- ------------ Net decrease - Class B............................... (1,022,928) (13,988,380) (1,005,746) (11,330,406) ---------- ------------ ---------- ------------ CLASS C SHARES Sold................................................. 149,345 2,110,434 231,244 2,720,208 Reinvestment of dividends and distributions.......... 16,190 226,036 31,673 345,975 Redeemed............................................. (176,251) (2,438,719) (214,676) (2,495,731) ---------- ------------ ---------- ------------ Net increase (decrease) - Class C.................... (10,716) (102,249) 48,241 570,452 ---------- ------------ ---------- ------------ CLASS D SHARES Sold................................................. 358,980 5,083,708 2,257,903 25,925,778 Reinvestment of dividends and distributions.......... 93,537 1,313,656 156,629 1,739,143 Redeemed............................................. (579,544) (8,145,852) (1,254,577) (14,655,074) ---------- ------------ ---------- ------------ Net increase (decrease) - Class D.................... (127,027) (1,748,488) 1,159,955 13,009,847 ---------- ------------ ---------- ------------ Net increase (decrease) in Fund...................... (1,164,280) $(15,876,696) 141,084 $ 1,574,307 ========== ============ ========== ============
7. Legal Matters The Investment Manager, certain affiliates of the Investment Manager, certain officers of such affiliates and certain investment companies advised by the Investment Manager or its affiliates, including the Fund, are named as defendants in a number of similar class action complaints which were recently consolidated. This consolidated action also names as defendants certain individual Trustees and Directors of the Morgan Stanley funds. The consolidated amended complaint generally alleges that defendants, including the Fund, violated their statutory disclosure obligations and fiduciary duties by failing properly to disclose (i) that the Investment Manager and certain affiliates of the Investment Manager allegedly offered economic incentives to brokers and others to recommend the funds advised by the Investment Manager or its affiliates to investors rather than funds managed 14 Morgan Stanley Real Estate Fund NOTES TO FINANCIAL STATEMENTS - MAY 31, 2004 (UNAUDITED) continued by other companies, and (ii) that the funds advised by the Investment Manager or its affiliates, including the Fund, allegedly paid excessive commissions to brokers in return for their efforts to recommend these funds to investors. The complaint seeks, among other things, unspecified compensatory damages, rescissionary damages, fees and costs. The defendants have moved to dismiss the action and otherwise vigorously to defend it. While the Fund believes that it has meritorious defenses, the ultimate outcome of this matter is not presently determinable at this early stage of the litigation, and no provision has been made in the Fund's financial statements for the effect, if any, of this matter. 15 Morgan Stanley Real Estate Fund FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE PERIOD FOR THE SIX FOR THE YEAR ENDED NOVEMBER 30, APRIL 28, 1999* MONTHS ENDED -------------------------------------------------- THROUGH MAY 31, 2004 2003 2002 2001 2000 NOVEMBER 30, 1999 ------------ -------- -------- -------- -------- ----------------- (unaudited) Class A Shares Selected Per Share Data: Net asset value, beginning of period.... $13.58 $10.59 $11.39 $10.51 $ 8.63 $10.00 ------ ------ ------ ------ ------ ------ Income (loss) from investment operations: Net investment income++............ 0.25 0.32 0.29 0.35 0.31 0.21 Net realized and unrealized gain (loss).............. 0.73 3.20 (0.17) 0.93 2.00 (1.38) ------ ------ ------ ------ ------ ------ Total income (loss) from investment operations............. 0.98 3.52 0.12 1.28 2.31 (1.17) ------ ------ ------ ------ ------ ------ Less dividends and distributions from: Net investment income.............. (0.21) (0.32) (0.28) (0.35) (0.33) (0.20) Net realized gain... (0.12) (0.21) (0.64) (0.05) (0.04) -- Paid-in-capital..... -- -- -- -- (0.06) -- ------ ------ ------ ------ ------ ------ Total dividends and distributions.......... (0.33) (0.53) (0.92) (0.40) (0.43) (0.20) ------ ------ ------ ------ ------ ------ Net asset value, end of period................. $14.23 $13.58 $10.59 $11.39 $10.51 $ 8.63 ====== ====== ====== ====== ====== ====== Total Return+........... 7.38%(1) 34.61% 0.88% 12.38% 27.46% (11.88)%(1) Ratios to Average Net Assets(3): Expenses................ 1.58%(2) 1.62% 1.63% 1.54% 1.71% 1.81%(2) Net investment income... 3.52%(2) 2.77% 2.52% 3.19% 3.20% 3.59%(2) Supplemental Data: Net assets, end of period, in thousands... $7,682 $7,378 $6,401 $7,860 $9,943 $5,634 Portfolio turnover rate................... 6%(1) 23% 28% 40% 57% 27%(1)
--------------------------------------------------- * Commencement of operations. ++ The per share amounts were computed using an average number of shares outstanding during the period. + Does not reflect the deduction of sales charge. Calculated based on the net asset value as of the last business day of the period. (1) Not annualized. (2) Annualized. (3) Reflects overall Fund ratios for investment income and non-class specific expenses.
16 See Notes to Financial Statements Morgan Stanley Real Estate Fund FINANCIAL HIGHLIGHTS continued
FOR THE PERIOD FOR THE SIX FOR THE YEAR ENDED NOVEMBER 30, APRIL 28, 1999* MONTHS ENDED ---------------------------------------------------- THROUGH MAY 31, 2004 2003 2002 2001 2000 NOVEMBER 30, 1999 ------------ ----------- ----------- --------- --------- ------------------ (unaudited) Class B Shares Selected Per Share Data: Net asset value, beginning of period.... $13.53 $10.55 $11.36 $10.49 $ 8.62 $ 10.00 ------ ------ ------ ------ ------ ------- Income (loss) from investment operations: Net investment income++............ 0.19 0.24 0.20 0.27 0.24 0.16 Net realized and unrealized gain (loss).............. 0.74 3.19 (0.17) 0.92 1.99 (1.37) ------ ------ ------ ------ ------ ------- Total income (loss) from investment operations............. 0.93 3.43 0.03 1.19 2.23 (1.21) ------ ------ ------ ------ ------ ------- Less dividends and distributions from: Net investment income.............. (0.16) (0.24) (0.20) (0.27) (0.27) (0.17) Net realized gain... (0.12) (0.21) (0.64) (0.05) (0.04) -- Paid-in-capital..... -- -- -- -- (0.05) -- ------ ------ ------ ------ ------ ------- Total dividends and distributions.......... (0.28) (0.45) (0.84) (0.32) (0.36) (0.17) ------ ------ ------ ------ ------ ------- Net asset value, end of period................. $14.18 $13.53 $10.55 $11.36 $10.49 $ 8.62 ====== ====== ====== ====== ====== ======= Total Return+........... 6.93%(1) 33.64% 0.15% 11.41% 26.41% (12.27)%(1) Ratios to Average Net Assets(3): Expenses................ 2.35%(2) 2.37% 2.38% 2.36% 2.46% 2.56 %(2) Net investment income... 2.75%(2) 2.02% 1.77% 2.37% 2.45 2.84 %(2) Supplemental Data: Net assets, end of period, in thousands... $99,406 $108,680 $95,343 $86,479 $75,101 $59,645 Portfolio turnover rate................... 6%(1) 23% 28% 40% 57% 27 %(1)
--------------------------------------------------- * Commencement of operations. ++ The per share amounts were computed using an average number of shares outstanding during the period. + Does not reflect the deduction of sales charge. Calculated based on the net asset value as of the last business day of the period. (1) Not annualized. (2) Annualized. (3) Reflects overall Fund ratios for investment income and non-class specific expenses.
17 See Notes to Financial Statements Morgan Stanley Real Estate Fund FINANCIAL HIGHLIGHTS continued
FOR THE PERIOD FOR THE SIX FOR THE YEAR ENDED NOVEMBER 30, APRIL 28, 1999* MONTHS ENDED -------------------------------------------------- THROUGH MAY 31, 2004 2003 2002 2001 2000 NOVEMBER 30, 1999 ------------ -------- -------- -------- -------- ----------------- (unaudited) Class C Shares Selected Per Share Data: Net asset value, beginning of period........................ $13.53 $10.55 $11.36 $10.50 $ 8.62 $10.00 ------ ------ ------ ------ ------ ------ Income (loss) from investment operations: Net investment income++.... 0.19 0.23 0.20 0.27 0.26 0.16 Net realized and unrealized gain (loss)................ 0.74 3.20 (0.17) 0.91 1.98 (1.38) ------ ------ ------ ------ ------ ------ Total income (loss) from investment operations.................... 0.93 3.43 0.03 1.18 2.24 (1.22) ------ ------ ------ ------ ------ ------ Less dividends and distributions from: Net investment income...... (0.16) (0.24) (0.20) (0.27) (0.27) (0.16) Net realized gain.......... (0.12) (0.21) (0.64) (0.05) (0.04) -- Paid-in-capital............ -- -- -- -- (0.05) -- ------ ------ ------ ------ ------ ------ Total dividends and distributions................. (0.28) (0.45) (0.84) (0.32) (0.36) (0.16) ------ ------ ------ ------ ------ ------ Net asset value, end of period........................ $14.18 $13.53 $10.55 $11.36 $10.50 $ 8.62 ====== ====== ====== ====== ====== ====== Total Return+ 6.94%(1) 33.54% 0.15% 11.39% 26.50% (12.29)%(1) Ratios to Average Net Assets(3): Expenses....................... 2.35%(2) 2.37% 2.38% 2.36% 2.46% 2.56 %(2) Net investment income.......... 2.75%(2) 2.02% 1.77% 2.37% 2.45% 2.84 %(2) Supplemental Data: Net assets, end of period, in thousands.................. $12,801 $12,359 $9,129 $7,504 $6,759 $7,698 Portfolio turnover rate........ 6%(1) 23% 28% 40% 57% 27 %(1)
--------------------------------------------------- * Commencement of operations. ++ The per share amounts were computed using an average number of shares outstanding during the period. + Does not reflect the deduction of sales charge. Calculated based on the net asset value as of the last business day of the period. (1) Not annualized. (2) Annualized. (3) Reflects overall Fund ratios for investment income and non-class specific expenses.
18 See Notes to Financial Statements Morgan Stanley Real Estate Fund FINANCIAL HIGHLIGHTS continued
FOR THE PERIOD FOR THE SIX FOR THE YEAR ENDED NOVEMBER 30, APRIL 28, 1999* MONTHS ENDED -------------------------------------------------- THROUGH MAY 31, 2004 2003 2002 2001 2000 NOVEMBER 30, 1999 ------------ -------- -------- -------- -------- ----------------- (unaudited) Class D Shares Selected Per Share Data: Net asset value, beginning of period........................ $13.59 $10.59 $11.40 $10.53 $ 8.64 $ 10.00 ------ ------ ------ ------ ------ ------- Income (loss) from investment operations: Net investment income++.... 0.26 0.34 0.30 0.37 0.27 0.15 Net realized and unrealized gain (loss)................ 0.74 3.22 (0.16) 0.93 2.08 (1.30) ------ ------ ------ ------ ------ ------- Total income (loss) from investment operations......... 1.00 3.56 0.14 1.30 2.35 (1.15) ------ ------ ------ ------ ------ ------- Less dividends and distributions from: Net investment income...... (0.23) (0.35) (0.31) (0.38) (0.36) (0.21) Net realized gain.......... (0.12) (0.21) (0.64) (0.05) (0.04) -- Paid-in-capital............ -- -- -- -- (0.06) -- ------ ------ ------ ------ ------ ------- Total dividends and distributions................. (0.35) (0.56) (0.95) (0.43) (0.46) (0.21) ------ ------ ------ ------ ------ ------- Net asset value, end of period........................ $14.24 $13.59 $10.59 $11.40 $10.53 $ 8.64 ====== ====== ====== ====== ====== ======= Total Return+.................. 7.50%(1) 34.92% 1.14% 12.58% 27.88% (11.69)%(1) Ratios to Average Net Assets(3): Expenses....................... 1.35%(2) 1.37% 1.38% 1.36% 1.46% 1.56 %(2) Net investment income.......... 3.75%(2) 3.02% 2.77% 3.37% 3.45% 3.84 %(2) Supplemental Data: Net assets, end of period, in thousands..................... $59,966 $58,930 $33,652 $14,349 $5,193 $26 Portfolio turnover rate........ 6%(1) 23% 28% 40% 57% 27 %(1)
--------------------------------------------------- * Commencement of operations. ++ The per share amounts were computed using an average number of shares outstanding during the period. + Calculated based on the net asset value as of the last business day of the period. (1) Not annualized. (2) Annualized. (3) Reflects overall Fund ratios for investment income and non-class specific expenses.
19 See Notes to Financial Statements TRUSTEES Michael Bozic Charles A. Fiumefreddo Edwin J. Garn Wayne E. Hedien James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael E. Nugent Fergus Reid OFFICERS Charles A. Fiumefreddo Chairman of the Board Mitchell M. Merin President Ronald E. Robison Executive Vice President and Principal Executive Officer Barry Fink Vice President Joseph J. McAlinden Vice President Stefanie V. Chang Vice President Francis J. Smith Treasurer and Chief Financial Officer Thomas F. Caloia Vice President Mary E. Mullin Secretary TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 INVESTMENT MANAGER Morgan Stanley Investment Advisors Inc. 1221 Avenue of the Americas New York, New York 10020 The financial statements included herein have been taken from the records of the Fund without examination by the independent auditors and accordingly they do not express an opinion thereon. This report is submitted for the general information of shareholders of the Fund. For more detailed information about the Fund, its fees and expenses and other pertinent information, please read its Prospectus. The Fund's Statement of Additional Information contains additional information about the Fund, including its trustees. It is available, without charge, by calling (800) 869-NEWS. This report is not authorized for distribution to prospective investors in the Fund unless preceded or accompanied by an effective Prospectus. Read the Prospectus carefully before investing. Investments and services offered through Morgan Stanley DW Inc., member SIPC. Morgan Stanley Distributors Inc., member NASD. (c) 2004 Morgan Stanley [MORGAN STANLEY LOGO] MORGAN STANLEY FUNDS Morgan Stanley Real Estate Fund Semiannual Report May 31, 2004 [MORGAN STANLEY LOGO] 36068RPT-RA04-00341P-Y05/04 Item 2. Code of Ethics. Not applicable for semiannual reports. Item 3. Audit Committee Financial Expert. Not applicable for semiannual reports. Item 4. Principal Accountant Fees and Services Not applicable for semiannual reports. Item 5. Audit Committee of Listed Registrants. Not applicable for semiannual reports. Item 6. [Reserved.] Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies. Not applicable for semiannual reports. Item 8. [Reserved.] Item 9 - Controls and Procedures (a) The Fund's principal executive officer and principal financial officer have concluded that the Fund's disclosure controls and procedures are sufficient to ensure that information required to be disclosed by the Fund in this Form N-CSR was recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, based upon such officers' evaluation of these controls and procedures as of a date within 90 days of the filing date of the report. There were no significant changes or corrective actions with regard to significant deficiencies or material weaknesses in the Fund's internal controls or in other factors that could significantly affect the Fund's internal controls subsequent to the date of their evaluation. (b) There were no changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal half-year (the registrant's second fiscal half-year in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. Item 10 Exhibits (a) Code of Ethics - Not applicable for semiannual reports. (b) A separate certification for each principal executive officer and principal financial officer of the registrant are attached hereto as part of EX-99.CERT. 2 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Morgan Stanley Real Estate Fund /s/ Ronald E. Robison Ronald E. Robison Principal Executive Officer July 20,2004 Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ Ronald E. Robison Ronald E. Robison Principal Executive Officer July 20, 2004 /s/ Francis Smith Francis Smith Principal Financial Officer July 20, 2004 3