Multifamily Stock: Surprising Strength
by Elliot Eisenberg, Ph.D.
Share prices of the publicly-traded multifamily companies tracked by the NAHB for its Multifamily Stock Index (MFSI) have performed incredibly well over the past seven-and-a-half years, declining only in 2002, and then by only 4% percent, for a cumulative return of 206%. By contrast, over the same period of time, the S&P 500 has had a cumulative return of 3.3%, punctuated by annual returns ranging from a high of 26% to a low of negative 23%.

While predicting future returns of the MFSI and the S&P 500 is impossible, the MFSI has shown that it can perform relatively well in both increasing and decreasing interest rate environments. Moreover, due to the significant role dividend payments play in most MFSI firms, it is highly probable that the MFSI will continue to be less volatile than the market as a whole.

Background: Why and How We Track This

In January 2002, NAHB introduced the MFSI to help the multifamily industry and investors better track the performance of public firms principally involved in multifamily ownership and management (currently numbering 24) and to allow for comparisons between the MFSI and other major stock indices. In order for meaningful historical comparisons to be made, we set the starting point for tracking the performance of all the firms that qualified for inclusion in the MFSI at December 31, 1998. 

Since then, the MFSI has increased by slightly over 200%, for a compound rate of return of 16.1% per year.  During the same seven-and-a-half years, the S&P 500 with dividends reinvested increased by just 16% for a compound rate of return of just 2% year. That is, since December 1998 the compound rate of return for the MFSI has been 14.1 percentage points higher than the S&P 500 with dividends reinvested. As a result, $1,000 invested in the MFSI at the end of 1998 would now be worth $3,063, but only $1,161 if it had been invested in the S&P 500 with dividends reinvested.

Over the past six months, the MFSI and the S&P 500 with dividends reinvested have enjoyed very divergent rates of return, with the MFSI consistently outperforming the S&P 500. The year began with the MFSI 130% higher than the S&P 500, and that margin grew in five of the last six months, setting four new records along the way. The MFSI ended June 164% higher than the S&P 500, the highest relative performance differential ever recorded.

A Quick Historical Review

Over the past six months, the MFSI and the S&P 500 with dividends reinvested have enjoyed very divergent rates of return, with the MFSI consistently outperforming the S&P 500. The year began with the MFSI 130% higher than the S&P 500, and that margin grew in five of the last six months, setting four new records along the way. The MFSI ended June 164% higher than the S&P 500, the highest relative performance differential ever recorded.

The very different historical rates of return exhibited by these two indices can be seen by looking a Figure 1. It shows that since the middle of 2000 the performance gap between the two indices has continually widened. 

In particular, from the end of May 2000 through September 2002 the S&P 500 declined by about 40% while the MFSI increased by almost 20%. Since then, both indices have increased, with the MFSI rising by 115% and the S&P 500 by about 67%.

Figure 2 looks at the same data but only reports the level of the indices on last day of each period shown for each of the past seven-and-a-half years. Here the divergent growth rates exhibited by the MFSI and the S&P 500 are even more pronounced.

While the indices moved in tandem through 1999, over the next three years the S&P 500 continually fell while the MFSI held steady around the 1,500 point mark. As a result, the performance gap between the two indices grew increasingly large by the end of 2002. Since then, the gap has grown still larger as the MFSI has roughly doubled over the past three-and-a-half years, while the S&P 500 has increased by slightly more than 60%.       

This result is further explained by looking at Figure 3, which shows the 12-month rate of return for the past seven years and the six-month rate of return for this year.

For the years ending December 31, 2000, 2001 and 2002, the MFSI dramatically outperformed the S&P 500, but in only the first of these three years did the MFSI have a significantly positive return. In the latter two years the MFSI was virtually stagnant while the S&P 500 performed remarkably poorly. Since 2002, the S&P has regained its footing and has registered a positive return every year; however, the MFSI has outperformed it each year except 2003.  

Interest Rates Affect Relative Performance

We can now examine Figure 4, which compares the cumulative relative percentage performance between the MFSI and the S&P 500 since December 1998 (on the left hand axis), and the interest rate on 10-year Treasuries (on the right hand axis). Recall that when the relative performance line goes up, the MFSI is outperforming the S&P 500, and when the line falls, the opposite is true. 

Figure 4 shows that the past seven-and-a-half years can be neatly separated into four distinct performance periods. The first period ends in early 2000 and is characterized by movement of the relative performance line around zero, suggesting that both indices exhibited similar behavior. The second period runs from March 2000 through September 2002. During that period, the relative performance line rose by 110 percentage points, from a starting point of negative 10% to a peak of about 100%, which means that the MFSI dramatically outperformed the S&P 500.  For purposes of comparison, during the third performance period, between September 2002 and August 2004, the relative performance line barely budged, as both indices again tracked each other in lock step. Since then, however, the MFSI has again consistently outperformed the S&P 500 with dividends reinvested. As a result, the relative performance line now stands at an all-time high of 164%.        

A key difference between these four periods is interest rates. During the first period, the interest rate on 10-year Treasury bonds rose by about 200 basis points, and both indices moved sideways. During the second period, the interest rate on 10-year Treasuries tumbled by about 250 basis points in an effort by the Federal Reserve to get the U.S. economy out of recession. In retrospect, it is now clear that a recession beginning without a prolonged series of large interest rate hikes set the stage for the superior relative performance of the MFSI starting in March 2000 when rates began their descent to historically low levels.

During the third period, interest rates moved sideways and both indices performed equally well, as is seen in the lack of direction of the relative performance line.

Most interesting is that during the fourth period, which we are now in, interest rates have been on the rise, yet the MFSI has continued to strongly outperform the S&P 500. This suggests that increasing rate environments are not necessarily harmful to the relative performance of the MFSI. 

When Less Is More: Volatility

While the future behavior of the MFSI in unknown, the MFSI should remain less volatile than the rest of the market. This is because of the significant role dividend payments play in most MFSI firms. To understand why dividends are so important in reducing volatility, consider how interest rate movements effect the price of two 10-year bonds — a zero-coupon bond, which behaves similarly to a non dividend paying stock, and a bond that pays interest on an annual basis, and which approximates the behavior of a REIT. This is relevant, since on a capitalization basis, REITs represent well over 95% of the MFSI. 

Because the zero-coupon bond pays all interest and principle at the end of the 10-year period, every interest rate change dramatically alters the present value of the zero-coupon bond, because all the money is discounted 10 years each time the interest rate changes. By contrast, because the traditional bond pays interest annually, it has only the principal amount and the 10th interest payment due at the end of the tenth year, and thus is less affected by changes in interest rates. That is, because the first nine interest payments are all due before the 10th year, interest rate changes affect those nine payments less than if they were due at the end of the 10th year.

And the Winner Is: MFSI

Over the past seven-and-a-half years the MFSI has dramatically outperformed the market as a whole, as measured by the S&P 500 with dividends reinvested. However, the relative performance of the MFSI has not been consistent. Between March 2000 and September 2002, during which time interest rates were declining, and again between August 2004 and today, when interest rates have been increasing, the relative performance of the MFSI compared to the S&P 500 was excellent. Outside those two time periods, however, both indices have performed equally well.

This demonstrates that the MFSI is able to perform relatively well both when interest rates are declining and when they are rising, putting the lie to the conventional wisdom that REITs do not perform well in increasing rate environments. This finding, along with the fact that the MFSI should remain considerably less volatile than the market as a whole because of the importance of dividends, suggests that those who held MFSI component stocks in a diversified investment portfolio did quite well. [ return to top ]