By contrast, over the same time period, the S&P 500 had a cumulative return of negative 10.2%, punctuated by annual returns ranging from a high of 26% in 2003 to a low of negative 37% 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. That spread is now suggesting that the worst may be over.       

Historical Review

In January 2002, the 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 more than 71%, for a compound rate of return of 5.3% per year. During the same ten-and-a-half years, the S&P 500 (with dividends reinvested) decreased by slightly more than 10% for a compound rate of return of about negative 1% per year. In other words, since December 1998, the compound rate of return for the MFSI has been more than six 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 $1,717 – but it would have been only $898 had it been invested in the S&P 500 with dividends reinvested.

The Most Recent Six Months

Over the past six months, however, the MFSI and the S&P 500 with dividends reinvested enjoyed significantly divergent rates of return. The MFSI return dropped to almost a negative 13%, while the S&P with dividends posted a return of slightly better than 3%, or a difference of almost 16 percentage points. The year began with the MFSI 126% higher than the S&P 500 and, while that margin fluctuated between January and June, it was never that high again and now stands at 91%. 

Despite the recent setbacks, what is most impressive is that despite numerous negative shocks to the economy — including an ongoing severe credit crunch, continued house  price declines, persistent job losses, wild fluctuations in the price of energy, and a sharp decline in equity values — the MFSI has held up relatively well. During the first six months of the year, the MFSI declined in the months of January, February and June, while the S&P 500 with dividends reinvested declined in January and February, and was flat in June.         

Back to History

The very different historical rates of return exhibited by these two indices can be seen by looking at 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 2009.  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%. From September 2002 through the end of 2006, the MFSI 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 55.4% while the S&P 500 has fallen by only 32.4%. Since October 2007, when the S&P 500 peaked, it has fallen by 38.2%.          

Figure 2 looks at the same data, but reports only the level of the indices on last day of each year for each of the past ten-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 1,700.

These results are further explained by looking at Figure 3, which shows the 12-month rate of return for each of the past ten-and-a-half years. For the years ending on the last day of December 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 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, however, things have been much more volatile. In 2007, the MFSI had a dreadful year, 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. In 2008, both the MFSI and the S&P 500 did very poorly, with the MFSI falling by 26% and the S&P 500 by almost 50% more, or 37%. So far, 2009 is shaping up to be a replay of 2007. For the six months ending June 31, 2009, the MFSI is down almost 13 percentage points while the S&P 500 is up by about three.         

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 the interest-rate factor – 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 dramatically, 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 ten-and-a-half years. While the rates for all three Treasury securities have not moved in lock-step, from December 1999 through early 2003, yields on Treasury securities declined steadily while the yield of the MFSI slowly drifted upwards. 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 early 2003 and extending through very early 2007, yield spreads between Treasuries and the MFSI reversed themselves.  Over that roughly four-year time period, Treasury yields consistently increased while there was steady erosion in the dividend yield of the MFSI. The most pronounced increase occurred in the 1-year Treasury note, which increased from a low of 1.01% in June of 2003 to 4.96% two years 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%.

Figure 4 also shows that the dividend yield on the MFSI was very high near the end 2002, when it briefly hit a then-record 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, coupled with 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 for the first time), to a negative 1.67% in January 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 even larger.¹ 

In early 2007, this relationship reversed again. Since then, the dividend yield of the MFSI has risen from a low of 3.09% in January 2007 to 7.06% in mid-2008, and briefly to an all-time high of more than 16% in early 2009, and now stands at 12.08%. At the same time, the yield on the 10-Year Treasury fell from 4.76% to 4.10% and now stands at slightly below 4%. As a result, the spread between the two has swung from -1.67 in January 2007 to 2.96 in June 2008, to 8.36 today — a swing of more than 10 percentage points — which approaches the all-time high set three months ago. Note that the dividend yield during February and March of 2009 was about twice as high as its previous all-time high of 7.96 percent, set in October of 2002.

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. By contrast, lower interest rates increase profits.     

Interest rates 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 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.

Traditionally, as long as the yield spread is positive (the area shaded in dark gray) the MFSI generally does well. By contrast, when the yield spread is negative (the area shaded in light gray), the MFSI generally moves sideways. However, these historical relationships were clearly broken starting in very late 2007, which neatly coincides with the start of the current recession and the severe credit crunch (which is making it difficult for REITs to refinance their properties).

This suggests two things; the performance of the MFSI and the spread between the MFSI and Treasuries may be an economic indicator. When this recession ends, if the historic relationships return and if the yield spreads persist, the MFSI may experience a period of pleasant price appreciation. As such, particular attention to the earnings of residential REITs and the yield spread between it and Treasuries may be in order.  

Conclusion

Over the past ten-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, 2008 and the first half of 2009, the performance of the MFSI slipped and it posted its first ever back-to-back negative returns and its worst one-year decline in history. Traditionally, at least part of the explanation for the recent poor performance of the MFSI would have been that the yield spread between the MFSI and the 10-year Treasury had grown unfavorably large and thus acted as a strong headwind. However, over the past few years the spread between the yield on the MFSI and U.S. Treasuries has been very favorable. This suggests that during recessions, this relationship is weakened, and that when the recession ends, the MFSI may regain its winning ways.          

View The MFSI Chart: The MFSI is an index of 19 publicly traded US headquartered firms, including 16 REITs, principally involved in multifamily ownership and management.

¹Since 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 own.  [ return to top ]