Multifamily Stock Index: An Overview
Publicly traded corporations, limited partnerships, and Real Estate Investment Trusts involved primarily in the business of multifamily (ownership, development, and management) continue to do well on Wall Street. In fact, the 28 companies tracked by NAHB's Multifamily Stock Index (MFSI)* have — as a group — increased in value more than 70% over the past five years, significantly outperforming the S&P during this same time period. Despite a good year in 2003, the S&P 500 (with dividends reinvested) actually lost 3% of its value over the past five years.

The Year in Review 

Unlike 2002, which saw the S&P 500 decline by more than 22% and the MFSI fall by 6%, 2003 was an excellent year for the stock market as a whole and for the MFSI. The MFSI jumped almost 24% last year. What's really remarkable, however, is that this large gain is broad-based — it's not the result of a few companies doing particularly well while the others struggling. As can be seen in Table 1, 25 of the 28 companies that comprise the MFSI saw their stock prices rise during 2003. Investors Real Estate Trust (IRETS), one of the three firms that saw their stock price decline in 2003, was down less than 1%. For the other two, the drop was a bit more significant: Apartment Investment and Management Company (AIV) was down 7.95% and Transcontinental Realty Investors, Inc. was down 5.16%.

The S&P 500 (with dividends reinvested) also performed well in 2003, jumping 28.68%, nearly 5 percentage points more than the MFSI. Given the poor performance of the S&P 500 in 2000, 2001, and 2002, the fact it outperformed the MFSI in 2003 is not only not surprising, but arguably expected. After all, the MFSI cannot outpace the S&P 500 every year.

Looking Back Five Years 

From December 31, 1998 through December 31, 2003 the total return posted by all 28 MFSI firms was 76.86%. By contrast, the S&P 500 with dividends reinvested lost 2.8%.  As a result, the MFSI offered an annual compound rate of return experienced of slightly more than 12%, while the S&P 500 experienced a negative 0.6% - a difference of 12.6%. Since August 2000, when the S&P 500 reached its peak of over 1,500, investors in multifamily investment and management firms have seen their portfolios increase by an additional 33%, while the S&P 500 with dividends reinvested has fallen by a staggering 23%.     

Looking at Figure 1, we see that the performance of the MFSI can be cut into three distinct periods.  From December 1998 through March 2000, the MFSI did well. It began the period at 1,000 and ended it at 1,110 - an increase of 11%, about as well as the S&P 500.

While 11% may not have been much compared to the increases being registered by the NASDAQ index, it was an excellent rate of return. However, from the end of March 2000 through August 2001, a time span of only 17 months, the MFSI rose spectacularly, climbing an eye-popping 44%. This result is all the more amazing as it coincided with the start of the long decline experienced by the S&P that lasted through March of 2003. Since then, the MFSI has increased by an additional 11%, but no clear trend is visible. At times, the MFSI has done well, as has been the case of late, but at other times it has performed quite poorly.

2003: Increases and Consolidation

Returning once again to Figure 1, we see clearly that the performance of the MFSI during 2003 can be split into two distinct periods. From January through August, the Index went up almost 21%. However, since August 31, 2003, the MFSI increased by only three percentage points. Clearly, the factors driving the MFSI up have waned. By contrast, the S&P 500 fell by almost 3% in January, and almost 2% more in February, so that by the end of February the S&P 500 was down almost 4% for the year. However, since then, the S&P 500 has been virtually unstoppable, increasing by almost 34%. It may be that changing economic conditions, including the recent rise in the S&P and  continued low interest rates, have caused investors to take money out of REITs and put it into other sectors. 

Relative performance

Figure 2 graphs the relative performance of the MFSI compared to the S&P 500 with dividends. Through early 2000, the MFSI underperformed the S&P 500 by about 5%.

However, from April 2000 through September 2002 the MFSI's relative performance was spectacular. It started the period about even with the S&P 500, and ended it 100% higher than the S&P 500 - this was due to a huge surge in the MFSI, coupled with a dramatic decline in the S&P 500. Since September 2002, the MFSI has fallen by about 20% compared to the S&P 500, but is still 80% higher than the S&P 500.                         

Dividend Tax Cut Impact 

One year ago there was palpable concern among REITs about the impact that the passage of President Bush's economic stimulus package (formally known as the Jobs and Growth Tax Relief Reconciliation Act of 2003 (P.L. 108-27)) would have on REIT prices because of the possible elimination of taxes on corporate dividends. In the bill that was eventually passed by Congress and signed into law by the President on May 28, 2003, dividends are taxed at capital gains rates, not as ordinary income (which was the original proposal). In the same bill, capital gains rates were reduced to 5% for taxpayers in the 10% or 15% tax brackets, and 15% for those in higher tax brackets. Thus, in the final analysis, taxation of corporate dividends was reduced by slightly more than 50%, but not eliminated - as had been initially feared by the REIT industry.

While the impact of a tax rate reduction of this magnitude cannot be ignored, it is clear that its impact has been muted. Simply put, there has been no dramatic decline in REIT prices. On the contrary: Since September 1, 2002, when talk of reduction or elimination of all corporate dividend taxation began, the MFSI has risen 24%, while the S&P 500 has increased by almost 40%. While the MFSI has risen steadily over this time, the S&P 500 did not increase in two consecutive months until April 2003, by which time the contours of the tax relief bill headed for the President's signature were already well known to investors.

Beginning the analysis of the impact of dividend tax relief nine months before the bill was signed into law is important. Why? Because once investors believed reduced dividend taxation was likely, the increased dividend stream resulting from reduced dividend taxation was immediately capitalized into share prices, with the amount capitalized changing as expectations as to the amount of relief in the final bill changed.  
        
The Amount Capitalized

To get an estimate of the magnitude of the one-time price increase resulting from capitalization of dividend tax relief is straightforward. Assuming the average price per share in the S&P 500 is $40.00, and that the average dividend rate in late 2002 and early 2003 was about 1.5%, the dividend payment was sixty cents per year per share. If the federal tax on the dividend payment was (.35 X 60 cents =) 21 cents before passage of the new law, and fell to (.15 X 60 cents =) nine cents after passage, the savings is 12 cents per year.

If investors assume the savings will remain indefinitely, and that the inflation rate is 3% per year, the fully capitalized value of the savings is $4.00, or 10% of the initial share price.  This suggests that roughly one quarter of the rise in the S&P 500 since September 2002 is probably attributable to the Jobs and Growth Tax Relief Reconciliation Act of 2003.   

However, the above analysis does not account for all effects.  First, to the extent that this law has increased investor emphasis on corporate dividends, it has almost certainly boosted shareholder interest and awareness of REITs. As a corollary, with financial advisors repeatedly predicting reduced capital gains during the next decade or two, there has been added investor awareness about the role of dividends in a diversified portfolio. 

Second, even after the most recent tax law changes, after-tax REIT dividends still are about three times greater than the S&P 500 average. Thus, for investors seeking high dividends, REITs remain a key component of any portfolio. Third, the number of companies that offer dividends that exceed 5% is no more than 3-4% of all public companies. Fourth, as part of the economic stimulus package, marginal income tax brackets were also reduced, enhancing the after-tax return of REITs. Lastly, this analysis ignores state taxation of corporate dividends, which varies substantially from state to state.   

Dividends and the MFSI

Given the key role dividends played in the above debate, it is interesting to note that the MFSI is composed of 28 companies, 24 of which are REITs which pay dividends, and four of which are corporations which pay no dividends. Among REITs, Associated Estates Realty Corporation (AEC) currently has the highest dividend yield at 9.3%.  By contrast, Century Realty Trust has the lowest yield in the MFSI at only 3.01%.  However, both these REITs are very small, as indicated by their combined market capitalization of slightly more than $150 million, or slightly less than 0.5% of the market capitalization of the MFSI. Among larger companies - defined as companies with a market capitalization of greater than $500 million, Apartment Investment and Management Company (AIV) currently pays the highest dividend at 8.87%, while Essex Property Trust (ESS) offers a dividend that is slightly more than half as much, at only 4.84%. 

Given such diversity in dividend rates and market capitalization, it is difficult to generalize about the role dividends play in the total rate of return for any one company by simply looking at the MFSI. However, it is possible and informative to see how much of a contribution dividends have made to the total rate of return of the MFSI over the last five years, compared to the S&P 500.

Because the MFSI includes dividends, the index rises as long as the dividend rate is greater than the overall price decline of the stocks in the index. Since the dividend yield is quite high, the price of the shares must fall by about 7% over any one-year period for the MFSI to decline. By stripping away the impact of dividends, we can examine the price performance of the underlying shares in isolation. 

Dividends: A Great Return

Figure 3 compares the MFSI with dividends (what we usually refer to as the MFSI) to the MFSI without dividends and compares the S&P 500 with dividends to the S&P without dividends.

As expected, the gap between the MFSI with and without dividends, and the gap between the S&P 500 with and without dividends widens over time. In the case of the MFSI, the gap widens quite dramatically since the dividends rate is about three times as high as for the S&P 500. 

More interesting, however, is that 61% of the total return of the MFSI over the past five years it attributable to dividends. That is, starting at a base of 1,000 on December 31, 1998, the MFSI with no dividends increased to 1,291, while with dividends the MFSI stands at 1,768.60. The difference between 1,768.6 and 1,291 is solely attributable to dividends.     

Figure 3 also allows us to distinguish periods in which stock price appreciation has been the major contributor to total return from periods in which dividends have the chief provider of MFSI appreciation. From December 1998 through August 2001, the MFSI without dividends rose almost uninterrupted from 1,000 to an all-time high of slightly more than 1,300. However, from the end of August 2001 to October 2002, share prices declined to the point where, absent dividends, the MFSI would have been slightly below 1,100. Since then, however, share prices have rebounded strongly and share prices for the 28 companies that make up the MFSI are almost back to where they were in August 2001. 

Dividends Make the Difference

One of the main reasons for the outstanding absolute performance of the MFSI - and its relative performance compared to the S&P 500 - is the high dividend yield of REITs. Absent dividends, the MFSI would be up only about 30% over the past five years, not 75% as is the case. Analysts have also suggested that the reduction in corporate dividend taxation probably resulted in a one-time 10% boost to the S&P.

But since December 1998, the overall performance of the MFSI has been excellent, especially considering the wide range of financial conditions that have prevailed over that period of time.

*To more easily track the performance of public firms involved in multifamily housing, the NAHB created and introduced the Multifamily Stock Index (MFSI) two years ago.  To allow historical comparisons to be made between the MFSI and other financial indices, the starting point for tracking performance data for these publicly traded firms was set at December 31, 1998. 

  [ return to top ]