Apartment Companies Doing Well on Wall Street
Elliot Eisenberg, Ph.D.
Publicly-held companies whose primary business involves developing, owning or managing apartments have done well over the last half-decade. In fact, they’ve done amazingly well, compared with the stock market as a whole. NAHB tracks the stock performance of 28 such firms, and compares them to the rest of the market in the Multifamily Stock Index — the MFSI. A closer look at this period of strong performance gives us some answers as to what’s taken place in the recent past, and what’s likely to happen next.

Over the last five-and-a-half years, three things about the MFSI have consistently stood out. First, it has performed very well despite a recession, a terrorist attack, two wars, adverse tax law changes, and — until recently — relatively high vacancy rates.  Any of these could have derailed the MFSI, but did not. By contrast, this combination of events has depressed the performance of the S&P 500. Second, the superior performance of the MFSI has been very broadly based, with every firm in the index having performed well.  Lastly, the performance of the MFSI has been closely linked to interest rates. 

Performance Trend is Upward 

While the MFSI has had its ups and downs since 1998 (see Figure 1), it has clearly and steadily trended upward over the entire period.

Figure 2 puts these movements into sharp perspective by comparing the annual performance of the MFSI to the S&P 500 with dividends. In 1999, the last year of the long bull market, both indices performed well, with the MFSI rising by a respectable 10% while the S&P 500 rose by an impressive 21%.

Since then, however, the MFSI has almost always bested the S&P 500 — at times by significant amounts. For example, in 2000, the MFSI rose an amazing 34% while the S&P 500 fell by slightly more than 9% — a difference of almost 45 percentage points. Part of the reason for this profoundly large performance difference is that during 2000 many investors began rotating funds out of other industry sectors and into REITs — including multifamily REITs. Since the multifamily REIT sector is relatively small, the added demand raised MFSI member firm share prices.      

In 2001, the MFSI once again outperformed the S&P 500 — albeit by only 15.5 percentage points. While very large by historical terms, that number pales in comparison to the dramatic performance gap recorded in 2000. In particular, during 2001 the MFSI rose by almost 4% while the S&P 500 declined by almost 12%. Surprisingly, the relative performances of both indices were almost unchanged in 2002. That year the MFSI fell by a modest 6% — the only year it has declined since the MFSI began tracking this sector — while the S&P 500 dropped by 22%, for a difference of 16 percentage points.
   
Since the MFSI so dramatically outperformed the S&P 500 in 2000, 2001, and 2002, it was not completely unexpected that in 2003 the pendulum swung back, with the S&P 500 outperforming the MFSI. What was surprising, however, was that while the S&P 500 had a breakout year, rising by nearly 29% for its biggest increase in years, the MFSI also rose, and by a very strong 24%. As a result, the relative performance advantage of the S&P 500 was only five percentage points. Through August of this year, the MFSI is up another 15%, while the S&P has neither gained nor lost value. 

The upshot of these prolonged and wide performance disparities is that $1,000 invested in the MFSI in December 1998 would now be worth $2,026; if invested in the S&P 500, it would be worth only $976. Put slightly differently, the compound annual rate of return for the MFSI is 13.27%, but a negative 0.5% for the S&P 500.

This brief historical review suggests that, at least for the 1998-2004 period, whenever the overall market (as measured by the S&P 500) rises, so does the MFSI. But when the market declines, the MFSI does so very grudgingly. As a result, the correlation between the two indices is only .40. This suggests that while these indices generally move in the same direction, they do not move in lock step.               

Broad-Based Gains Among Companies in the Index

One reason for the strong performance of the MFSI is that nearly every company that was in the index in December 1998 and remains in the index today has seen its stock price rise. This can be seen clearly by looking at Figure 3, which shows the stock price performance of all MFSI firms ranked by rate of return from highest to lowest.  (While New England Realty Associates has seen the largest percentage increase, it has a market capitalization of less than $15 million). Of all the firms in the MFSI, only five have seen their shares prices decline, and only three firms have experienced a price decline of 10% or more. 

Collectively, MFSI firms have enjoyed a price increase of about 60% on average, with the remaining increase in the index coming from dividends. Since dividends are such a large component of the total return, it is important to note that even among the few firms that saw their share prices fall, the total return for each firm is positive if dividends are included.  For example, the share price of Post Properties fell by $8.04 since December 1998, but that firm paid $15.43 in dividends over that time period. Thus, the total return to investors of Post Properties stock has been about 19%, far superior to the -2.5% for the S&P 500 with dividends reinvested.                         

Interest Rates Make a Big Difference

While interest rates affect the entire economy, their effect on homebuilding and real estate is disproportional. For smaller builders, rate hikes make construction financing more costly. Similarly, multifamily developers see higher rates reducing profit margins, since more must be spent on financing.

Interest rates also alter corporate valuations. Given the historically low interest rate environment of the last few years, the high dividend yields on REITs have been very attractive to an unusually broad class of investors. But as rates rise, Treasury securities will become increasingly attractive relative to REITs, unless REIT yields keep pace. For that to happen, however, REIT prices must fall. Furthermore, as interest rates rise, single family house price increases may slow, or even stop. This would put more downward pressure on REIT demand, because investors who bought REITs largely because of the dramatic run-up in their own home prices will shift their focus to other securities. For these reasons, the relationship between the MFSI and interest rates may deserve particularly close scrutiny, especially given the anticipated up-tick in interest rates over the next 12 to 24 months.  

Figure 4 charts 1-year and 10-year Treasury rates (on the left hand side) against the MFSI (on the right hand side). The results, not surprisingly, show that the MFSI has tended to move in the opposite direction of interest rates.

Between December 1998 and early 2000, when rates were rising, the MFSI barely moved. Between early 2000 and late 2003, when rates were mostly falling, the MFSI performed admirably. Since then, rates have been edging up. Yet the MFSI has — defying recent history — continued to climb. At least part of the explanation for this may be that rates are still at or near historic lows, and thus the yield spread between REITS and other investment vehicles remains very attractive.  

It’s interesting to note that the correlation between the MFSI and 10-year, 5-year, and 1-year Treasuries is -0.62, -0.68, and -0.75, respectively. This suggests that the MFSI is more closely tied to short term interest rates than to long term rates, and that an inverse relationship between the MFSI and interest rates is not likely to be a coincidence. As such, the continued rise in the MFSI deserves close scrutiny, as it may be nearing an end.  [ return to top ]