By contrast, over the same period of time, the S&P 500 had a cumulative return of just 21.6%, punctuated by annual returns ranging from a high of 26% in 2003 to a low of minus 23% in 2002. While predicting future returns of the MFSI and the S&P 500 is impossible, the spread between the dividend yield available on the MFSI and on Treasury securities is informative. A year ago the spread suggested a sizeable decline in the MFSI, and it came to pass. Now it is suggesting that the worst may well be behind us.    

Historical Review

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. 

Since then, the MFSI has increased by slightly over 175%, for a compound rate of return of 11.3% per year. During the same nine-and-a-half years, the S&P 500 with dividends reinvested increased by slightly less than 22% for a compound rate of return of slightly more than 2% per year. In other words, since December 1998, the compound rate of return for the MFSI has been more than nine 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 $2,758, but an investor would have only $1,216 had that thousand dollars been invested in the S&P 500 with dividends reinvested. 

Six Month Review

Over the past six months, the MFSI and the S&P 500 with dividends reinvested enjoyed significantly divergent rates of return. The MFSI returned exactly 4%, while the S&P with dividends posted a return of -11.91%; a difference of almost 16 percentage points. The year began with the MFSI 92% higher than the S&P 500, and while that margin grew to 136% in March, it declined slightly since and now stands at 127%. What is most impressive is that despite numerous negative shocks to the economy—including the credit crunch, house price declines, persistent job losses and the high price of energy—the MFSI has held up relatively well. During the first six months of the year, the MFSI declined only in the months of February and June, while the S&P 500 with dividends reinvested declined four times during the same period.        

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 the performance of the MFSI can be roughly split into two main periods: December 1998 through the end of 2006; and from the start of 2007 through June 2008. During the first period the performance gap between the two indices continually widened with very few exceptions. In particular, from the end of May 2000 through September 2002, during a severe bear market, the S&P 500 declined by about 40% while the MFSI increased by almost 20%. Since then, the MFSI has continued to outperform the S&P 500 but by a much smaller amount.    

Since the end of 2006, however, the gap between the two indices has narrowed considerably, primarily due to a substantial decline in the MFSI.  Since the start of 2007, the MFSI has declined by 28.3% while the S&P 500 has fallen by only 8.4%. 

Figure 2 looks at the same data but only reports the level of the indices on last day of each year for each of the past nine-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 very large by the end of 2002. From then through the end of 2006 the gap grew still larger, but both indices went up—the MFSI by 133%, and the S&P 500 with dividends reinvested by about 85%. Since the start of 2007, however, the MFSI has performed very poorly, falling from roughly 3,850 to about 2,800. 

These results are further explained by looking at Figure 3, which shows the 12-month rate of return for each of the past nine-and-a-half years. For the years ending December 31 2000, 2001, and 2002, the MFSI dramatically outperformed the S&P 500, but only in the first of these three years did the MFSI post 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. 

For the four years ending December 31, 2006, both indices had positive returns in each year with the S&P 500 slightly outperforming the MFSI during 2003 and the reverse being the case in 2004, 2005, and 2006. Note that the MFSI dramatically outperformed the S&P 500 in both 2004 and 2006.                 

Since the start of 2007 things have been much more volatile. In 2007 the MFSI had its worst performance ever, declining by almost 25%, while the S&P 500 posted a solid 5.5% return. In 2007, not only did the MFSI end the year in the red for the first time since 2002, more importantly it significantly underperformed the S&P 500 for the first time since 1999. By contrast, through the first six months of 2008 it is the MFSI that has outperformed the S&P 500.

Relative Interest Rates and Performance

While the performance of the MFSI may be attributable to a number of factors, one likely explanation for at least part of its performance is due to interest rates. In particular, the difference between the interest rate on U.S. Treasuries and the dividend yield available for 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 visa versa. Over the past decade, the spreads between these two yield measures have changed, and those changes offer potential clues into the future performance of the MFSI.         

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 nine-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% a year ago. Over the same time period, the 5-year Treasury increased from a low 2.27% to 5.03%, while the 10-year went from a low of 3.33% to 5.10%. 

Moreover, note that from December 1999 through early 2003, the yield of the MFSI slowly drifted upwards while yields on Treasury securities declined steadily. As a result, by early 2003 the yield spread, which was negligible several years earlier, ranged from 6.5 percentage points on 1-Year Treasuries to 4% on 10-Year Treasuries. This increasingly large difference may well have been part of the reason the MFSI defied the bear market of 2001 and 2002.  

Starting in late 2002 or early 2003 and extending through very early 2007, yield spreads between Treasuries and the MFSI began to reverse themselves. Over that roughly four-year time period, Treasury yields consistently increased while there was 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 2002 when it briefly hit 7.96%. From then through January 2007, it steadily declined to a low of 3.09%— not coincidentally, precisely when the MFSI was at its peak. 

The prolonged rise in Treasury rates and the near simultaneous decline in the dividend yield of the MFSI was such that over the approximately four-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 1.67% in January of 2007—a change of 5.69 percentage points—with the change in the interest rate spread between the MFSI and shorter term Treasury securities being still larger.¹

Since then, the dividend yield of the MFSI has risen substantially from a low of 3.09% in January 2007 to 7.06% 18 months later. At the same time, the yield on the 10-Year Treasury has fallen from 4.76% to 4.10%. As a result, the spread has swung from 1.67% to 2.96%—a swing of more than 4.6 percentage points—which approaches the all-time high set in January 2003. Interestingly, the dividend yield is within striking distance of its highest point ever—7.96% set in October of 2002.             

While rising interest rates affect the entire economy, their effect on home building 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. By contrast, lower interest rates increase profits.    

Interest rate changes also alter corporate valuations. Given the generally low interest rate environment of the last few years, the high dividends available on REITs were very attractive to an unusually broad class of investors. However, given the magnitude of the changes in the yield rate spreads between Treasuries and the MFSI, it is hard to imagine them 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 light gray), the performance of the MFSI deteriorates noticeably. By contrast, whenever the spread has been greater than 3% (the area shaded in dark grey) the MFSI has performed exceptionally well. Figure 5 suggests that at present we may be entering a favorable period. As such, particular attention to the earnings of residential REITs and the yield spread may be in order.  

Conclusion

Over the past nine-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. 

During 2007, the performance of the MFSI slipped and it posted its first negative return since 2002 and its largest decline ever. At least part of the explanation for this may be that the yield spread between the MFSI and the 10-year Treasury had grown unfavorably large and thus acted as a strong headwind. Recently, the spread between the yield on the MFSI and U.S. Treasuries has become very favorable. The last time the spread was this large, the MFSI performed very well.  

View the MFSI Index of 19 publicly traded US headquartered firms, including 16 REITs, principally involved in multifamily ownership and management.

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 (.548) than for the 5-year (.510) and the one-year (.520) Treasury securities, only results for the 10-year Treasury are shown. 

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