Multifamily Stock: Troubled Times Ahead?
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 eight-and-a-half years, enjoying a cumulative return of 232.8%. Moreover, this performance has been quite consistent—the MFSI has declined just twice: in 2002 by just 4%, and during the first six months of this year by 5.5%. By contrast, over the same period of time, the S&P 500 had a cumulative return of just 22.3%, punctuated by annual returns ranging from a high of 26% to a low of minus 23%. While predicting future returns of the MFSI and the S&P 500 is impossible, the combination of historically very low dividend yields for the MFSI and the increasingly attractive interest rates available on Treasury securities suggests that the MFSI is unlikely to perform as well in the near future as it has in the past.
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, 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. [View companies currently being tracked at this link.]
Since then, the MFSI has increased by slightly over 230%, for a compound rate of return of 15.2% per year. During the same eight-and-a-half years the S&P 500 with dividends reinvested increased by just 40% for a compound rate of return of 4% per year. That is, since December 1998 the compound rate of return for the MFSI has been 11.2 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 $3,328 —but it would be worth only $1,400 had it been invested in the S&P 500 with dividends reinvested.
Six-Month Review of Both Indexes
Over the past six months, the MFSI and the S&P 500 with dividends reinvested enjoyed strikingly divergent rates of return. The MFSI returned a negative 5.4%, while the S&P with dividends posted a return of almost 7% — a difference of slightly more than 12 percentage points. The year began with the MFSI 169% higher than the S&P 500, and while that margin grew to a record 190% in January, it declined in four of the next five months and now stands at 138%, a level not seen since December 2005. Given the steep decline in the MFSI since January 2007, it may be that the 190% mark reached in January will be the high watermark for the MFSI for some time to come.
A Longer-Term Historical Review
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 indexes has continually widened with few exceptions.
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 indexes have increased handsomely, with the MFSI rising by 133.7% and the S&P 500 by about 101%.
Figure 2 looks at the same data but only reports the level of the indexes on last day of each period shown for each of the past eight-and-a-half years. Here the divergent growth rates exhibited by the MFSI and the S&P 500 are even more pronounced.
While the indexes 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 indexes grew increasingly large by the end of 2002. From then through the end of 2006, the gap grew still larger as the MFSI increased by 133%, while the S&P 500 increased by slightly more than 85%. Since the start of 2007, however, the MFSI has performed very poorly, falling from roughly 3,850 to about 3,300.
These results are further explained by looking at Figure 3, which shows the 12-month rate of return for the past eight years and the 6-month rate of return for this year.
For the years ending December 31st in 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 suffered declines of roughly 10% and 20% respectively.
Since 2002, the S&P has regained its footing and has registered a positive return every year, and looks poised to register its fifth consecutive year of positive returns in 2007. By contrast, the MFSI, which outperformed the MFSI in every year since 2000 with the exception of 2003, looks to end the year in the red for the first time since 2002 and, more importantly, may significantly underperform the S&P 500 for the first time since 1999.
Relative Interest Rates and Performance
While the recent downturn in the performance of the MFSI may be attributable to any number of factors, a possible explanation for at least part of its recent decline may be the prolonged and steady rise in interest rates coupled with the near simultaneous decline in the dividend yield of the MFSI. The dividend yield is defined as the annual dividend per share divided by the price per share. As a result, as share prices rise,dividends yields fall. And because the MFSI has performed so well over the last eight years or so, its dividend yield is now very low.
Figure 4 charts the dividend yield of the MFSI as well as the interest rate on 1-Year, 5-Year and 10-Year Treasury securities over the past seven-and-a-half years.
While the rates for all three Treasury securities have not risen in lock-step, since mid 2003 there has been a dramatic increase across all three instruments. The most pronounced increase has occurred in the 1-year Treasury note, which increased from a low of 1.01% in June of 2003 to 4.96% most recently. The 5-year Treasury increased from a low 2.27% to 5.03%, while the 10-year has risen from a low of 3.33% to 5.10%.
Moreover, while Treasury yields have been increasing, there has been steady erosion in the dividend yield of the MFSI. Figure 4 also shows that the dividend yield on the MFSI was highest near the end of 2002, when it briefly hit 7.96%. Since then it has steadily declined to a low of 3.09% in January of this year – not coincidentally, precisely when the MFSI was at its peak. Since then, the dividend yield has risen somewhat as the MFSI has pulled back from its highs, and the dividend yield now stands at 3.66, which is still a whopping 4.3 percentage points lower than its peak.
The rise in interest rates and the near simultaneous decline in the dividend yield of the MFSI has been such that over a four-and-a-half-year period the interest rate spread between the dividend yield of the MFSI and the 10-year Treasury bond went from positive 4.02% in October 2002 to zero in January 2006 (where all four lines intersect), to negative 1.46% in June of 2007; a change of 5.48 percentage points; with the change in the interest rate spread between the MFSI and shorter Treasury securities being still larger. 1
While rising 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, which in turn reduces dividends.
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. However, given the size of the change in the yield rate spread between Treasuries and the MFSI, it is hard to imagine it not exerting some impact on MFSI performance. Figure 5 compares the performance of the MFSI (in gray and on the right hand axis) to the yield spread between the MFSI and the 10-year Treasury bond (in black and on the left hand axis). The results are striking.
As long as the yield spread is not much worse than negative 1.5%, the MFSI appears to not be adversely affected. By contrast, when the yield spread exceeds that amount (the area shaded in gray), the performance of the MFSI deteriorates noticeably. Figure 5 suggests that at present we may be in such a situation. With that in mind, particular attention to the earnings of residential REITs and the yield spread may be in order.
Rough Sailing Ahead
Over the past eight-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, and again between August 2004 and January 2007, the relative performance of the MFSI compared to the S&P 500 was outstanding.
Recently the performance of the MFSI has slipped dramatically with the MFSI in danger of posting a negative return for the first time since 2002. At least part of the explanation for this may be that the yield spread between the MFSI and the 10-year Treasury has grown unfavorably large and is thus acting as a strong headwind.
1. Since the correlation between MFSI performance and yield spread between the dividend yield of the MFSI and various interest rates is slightly higher for the 10-year Treasury bond (.682) than for the 5-year (.635) and the one-year (.636) Treasury securities, only results for the 10-year Treasury are analyzed.
return to top ]