NexPoint Real Estate Finance - Q2 2024

Transcript

Operator (participant)

My name is Amy, and I will be your conference operator for today. At this time, I would like to welcome you to the NexPoint Real Estate Finance Q2 2024 Earnings Conference Call. Please note that all lines have been placed on mute to prevent any background noise. It's now my pleasure to turn the call over to Kristen Thomas, Investor Relations. Please begin.

Kristen Thomas (Investor Relations)

Thank you. Good day, everyone, and welcome to NexPoint Real Estate Finance Conference Call to review the company's results for the second quarter ended June 30, 2024. On the call today are Brian Mitts, Executive Vice President and Chief Financial Officer, Matt McGraner, Executive Vice President and Chief Investment Officer, and Paul Richards, Vice President, Originations and Investments. As a reminder, this call is being webcast through the company's website at nref.nexpoint.com. Before we begin, I would like to remind everyone that this conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, that are based on management's current expectations, assumptions, and beliefs.

Listeners should not place undue reliance on any forward-looking statements and are encouraged to review the company's annual report on Form 10-K and the company's other filings with the SEC for a more complete discussion of risks and other factors that could affect the forward-looking statements. The statements made during this conference call speak only as of today's date, and except as required by law, NREF does not undertake any obligation to publicly update or revise any forward-looking statement. This conference call also includes an analysis of non-GAAP financial measures. For a more complete discussion of these non-GAAP financial measures, see the company's presentation that was filed earlier today. I would now like to turn the call over to Brian Mitts. Please go ahead, Brian.

Brian Mitts (EVP and CFO)

Thank you, Kristen, and appreciate everyone joining us today. I'm going to briefly discuss our quarterly results and then, give our guidance for the next quarter before turning it over to the team for a detailed commentary on the portfolio and the macro lending environment. Q2 results are as follows: For the second quarter, we reported net income of $0.40 per diluted share, compared to net income of $0.33 per diluted share for the second quarter of 2023. The increase in net income for the quarter was due to the change in net assets related to consolidated CMBS VIEs, including the sale of CMBS B-Pieces for a realized gain of $6.2 million. Net interest income increased by $2.5 million-$6.7 million in the second quarter, from $4.2 million in the second quarter of 2023.

The increase was driven by an increase in interest income, which is driven by higher rates as well as lower interest expense from deleveraging that occurred in the first quarter this year. Earnings available for distribution was $0.68 per diluted share in Q2, compared to $0.50 per diluted share in the same period, 2023. Cash available for distribution was $0.64 per diluted share in Q2, compared to $0.53 per diluted share in the same period of 2023. The increase in earnings available for distribution was driven by the increase in net income for the quarter. We paid a regular dividend of $0.50 per share in the second quarter, and the board has declared a dividend of $0.50 per share payable for the third quarter of 2024.

Our regular dividend in the second quarter was 1.28 times covered by cash available for distribution. Book value per share decreased 1.1% from Q1 2024 to $16.51 per diluted share, with the decrease being primarily due to the decrease in fair value marks on our common stock investments. During the quarter, we funded $55.1 million on a drawable first mortgage on the life science development property in Cambridge. We originated a $150 million promissory note, funding $67.5 million, which yields 16.5%, and purchased a $31.9 million CMBS B-Pieces with a bond equivalent of 9.5%. During the quarter, we sold 1.5 million shares of our Series B Cumulative Redeemable Preferred for net proceeds of $32.6 million.

Our portfolio is comprised of 85 investments, with a total outstanding balance of $1.2 billion. Our investments are allocated across sectors as follows: 18.8% in single-family rental, 56.9% multifamily, 22.2% life sciences, 1.5% in storage, and 0.6% marina. Our fixed income portfolio is allocated across investments as follows: 11.5% senior loans, 36.7% CMBS B-Pieces, 20.7% preferred equity investments, 19.5% mezzanine loans, 4.2% IO strips, 1.6% MBS, and 5.8% promissory notes.

The assets collateralizing our investments are allocated geographically as well as 17% in Texas, 14% in Massachusetts, 8% California, 7% Florida, 6% Georgia, 4% Maryland, with the remainder across states with less than 4% exposure, reflecting our heavy preference for Sunbelt markets. Collateral on our portfolio is 80.3% stabilized, with a 62.3% loan-to-value and a weighted average DSCR of 1.52 times. We have $861 million in debt outstanding. Of this, $281 million or 32.6% is short-term debt. Our weighted average cost of debt is 6.2%, and has a weighted average maturity of 1.6 years.

Our debt is collateralized by $1.1 billion of collateral, with a weighted average maturity of 4.9 years, and our debt-to-equity ratio is 1.78 times. Moving to guidance for the second quarter, we are guiding to earnings available for distribution and cash available for distribution as follows: earnings available for distribution of $0.50 per diluted share at the midpoint, with a range of $0.45-$0.55. Cash available for distribution of $0.45 per diluted share at the midpoint, with a range of $0.40 on the low-end, and $0.50 high-end. So with that, I'd like to turn it over to Paul for discussion of our portfolio.

Paul Richards (VP of Originations and Investments)

Thanks, Brian. The second quarter results exhibited strong performance across each of our investment sectors. Our approach continues to center on areas where our expertise in owning and operating commercial real estate provides a distinct advantage. This dual role as both owner and lender allows us to effectively leverage information to assess and identify value across the entire capital stack, aiming to deliver outside risk-adjusted returns. Our investment strategy continues to focus on credit investments and assets that are stable or nearly stabilized, prioritizing careful underwriting, minimal leverage, and a moderate debt basis. We also emphasize lending to reputable sponsors to consistently provide dependable value to our shareholders.

In the second quarter, despite improving, yet still less than ideal conditions in the commercial real estate market, we were able to deploy capital in accretive investments, as well as take advantage of strong bids in the secondary bond market and recycle more seasoned bonds into other opportunities. Our loan portfolio continued to remain stable, comprising of 85 individual assets with approximately $1.2 billion in total outstanding principal. The portfolio is geographically diverse, with a preference towards Sunbelt markets. From the beginning of the first quarter through today, the company has been very active in underwriting and deploying capital. During the quarter, we completed the purchase of a new issue, five year fixed Freddie Mac B-Piece investment with attractive metrics. The securitization has high 50% LTV, 1.3x plus DSCR, and a diverse geographical footprint with great sponsorships.

The B-Piece will yield an all-in unlevered fixed rate of 9.5%, and with utilizing reasonable leverage, we expect to generate a mid-teen lever return on a strong collateral pool. The company also funded an additional $55 million of life science senior loan, which bears an interest rate of SOFR + 900. On the disposition loan repayment side, as mentioned, we sold a bond which generated a very healthy gain, which was redeployed into newly originated and accretive deals. At the end of the quarter, we remained committed in maintaining a cautious approach to the repo financing, with the leverage standing in the 60% loan-to-value range and de-levering our repo lines by approximately $60 million, and further decreasing our overall debt to book the value ratio to 1.78x from over 2.0x from the prior quarter.

We consistently engage in communications with our repo lending partners, discussing the market conditions and the status of our finance CMBS portfolio. In summary, we are consistently identifying appealing investment opportunities across our target markets and asset classes. We are committed to meticulously evaluating these opportunities to enhance shareholder value. We have a strong confidence in the resilience of the residential sector, particularly given the current interest rate climate. Our investments in the multifamily and single-family verticals are considered secure, as evidenced by the historical performance and current rent versus ownership dynamic, providing a long-term sector tailwind. Additionally, we continue to be very enthusiastic about our investment pipeline in the life science CDMO sector. To finalize our prepared remarks before we turn it over for questions, I'd like to turn it over to Matt McGraner.

Matt McGraner (EVP and CIO)

Appreciate it, Paul. As he just mentioned, Q2 was an active investment quarter in which we originated $200 million worth of deals across multifamily and life science verticals. $150 million bridge loan originated during the quarter is emblematic of great opportunities in the market to earn outsized risk-adjusted returns. We are seeing wonderful opportunities to make senior secured loans on new construction, redevelopment, and increasingly last mile TI funding in the life sciences sector at great basis fees. These loans are underwriting to mid-50% LTVs with all-in mid-double-digit returns. The other material investments made during the quarter were in the Freddie Mac K Program, where multifamily credit quality and underlying performance continues to outperform expectations, even in the face of record supply.

Same story on YoY growth continues to improve in the residential sector broadly, with demand being quite exceptional during the first half of the year. Supply is expected to peak in the second half of the year, and I'd like to share a couple stats from our research tracking starts and deliveries. Annual starts in the multifamily sector are now at their lowest level in ten years, approximately 280,000 units per year. The year-over-year drawdown in starts from 2023 is approximately 40%. 2Q 2024 quarterly starts came in at just 38,000 units nationally, which would represent an annual run rate of 150,000 new units or 50% of the trailing ten-year average.

Trailing 12-month starts are way down from the peak across all major metros, including Sunbelt markets, down anywhere from 40%-60% versus 2020's peak. Finally, Real Page forecasts to return to normal 2%-4% annual organic rent growth in 2025. Meanwhile, we remain pleased with our solid Q2 results, especially on a relative basis. Our portfolio continues to perform exceptionally well, and despite these short-term supply challenges in multifamily, underlying performance in multi, SFR, storage, and life sciences remain stable. To close, we're excited about these opportunities in the coming quarters and pleased with the company's continued stability and the opportunity to go on offense in this environment. As always, I wanna thank the team for their hard work, and now we'd like to turn the call over to the operator for questions.

Operator (participant)

Thank you. The floor is now open for questions. As a reminder, if you would like to ask a question, please press star and the number one on your telephone keypad. If you would like to withdraw your question, again, press star and the number one. We'll pause for just a moment to compile the Q&A roster. The first question comes from the line of Stephen Laws with Raymond James. Your line is now open.

Stephen Laws (Managing Director of Mortgage REITs and Real Estate Finance)

Hi, good morning.

Matt McGraner (EVP and CIO)

Good morning.

Stephen Laws (Managing Director of Mortgage REITs and Real Estate Finance)

Nice, nice quarter. Appreciate the comments and the guidance as always. I wanted to touch base just how you think about, you know, the capital raising with the perpetual Series B as well as the funding of the life sciences investment. Do those two things sort of match up as the drawdown matches the capital raising? And then, you know, outside of that, you know, where do you stand on redeploying the capital that was supporting the large repayment that occurred in Q1?

Matt McGraner (EVP and CIO)

Yeah. Hey, Stephen. I'll start. It's Matt, good morning. On the capital raising front with the Series B, it's actually matching up pretty well. We're raising roughly, you know, $15 million or so approximately a month, and that fairly matches draws of about $15 million-$20 million a month. So from a timing perspective, it's actually working out really well, and one reason why we think the or why we, you know, are forecasting guidance covering our dividend going into the second half of the year and feel good about that.

And then in terms of redeploying the payback from the loan payoffs, you know, we've largely delevered by that, and then we're reviewing, you know, several capital markets options on how best to relever the balance sheet, and match those new investments with those opportunities. But for now, the Series B is kinda, you know, making it easier and consistent for us to redeploy the capital and match fund the Cambridge loan.

Stephen Laws (Managing Director of Mortgage REITs and Real Estate Finance)

Great. And as a follow-up, you know, wanted to talk about the kind of, I hate to say transition, but, you know, a little bit of a shift in the portfolio, and probably the right time in the cycle to do it. I imagine, you know, it's a little less stabilized, a little lower DSCR, but it's also seen the LTV drop a good bit. So it seems like you're looking at, you know, maybe taking advantage of, you know, financing market inefficiencies and some people that have left the sector. But can you talk about kind of where you're seeing the most attractive, you know, risk-adjusted returns and kinda, you know, what's driving that focus, as you put new money to work today?

Matt McGraner (EVP and CIO)

Yeah, I mean, I think you're alluding to our activity increasing in the life sciences sector. And from our vantage point, it is just that. It's a retrenchment of a number of different types of lenders into the space at a time when you're really seeing, you know, not a hockey stick, but a resurgence of growth. You know, ARE's quarter in the second quarter, they had re-leasing of over 1 million sq ft, 300,000 sq ft in new development. And we're seeing some of the same things across, you know, our investments in life sciences without really any lender support. And so, you know, you have projects that were started in, you know, 2020, 2021, 2022, that raised a ton of capital.

We can come in and prime that capital that's been raised and fund the last dollars to finish out some of these TIs and other, you know, warm shell components, and be at a basis of, you know, $700-$800 a sq ft, on projects that are finished, that are worth $1,500-$1,600 a sq ft, all in with rates that are, you know, probably mispriced in a normalized environment. You know, meanwhile, on the multifamily side, you have, you know, a ton of liquidity coming into that space and spreads have, you know, dramatically come in.

We just announced yesterday or two days ago with NXRT, you know, a $1.5 billion refinancing at a borrower spread of 109 basis points over SOFR. You know, so that should, you know, give you some indication. Oh, as well as the Blackstone AIRC, you know, CMBS, CMBS deal, that's about to, you know, go off or just did. It was upsized by almost, you know, a third from $2.1 billion, I think, to $2.9 billion.

So the market is really, you know, is really there for certain property types right now, and, you know, we wanna take advantage of where it's not and, you know, have enough conviction and belief and see it on the ground that, you know, liquidity will return, you know, probably in 2025 and certainly 2026, and we can make investments today that will bear fruit over the long term for our shareholders.

Stephen Laws (Managing Director of Mortgage REITs and Real Estate Finance)

Appreciate the comments this morning, Matt.

Matt McGraner (EVP and CIO)

Thanks, Stephen.

Operator (participant)

Your next question comes from Jade Rahmani with KBW. Your line is now open.

Jade Rahmani (Managing Director and Equity Research Analyst of CRE Finance, Homebuilders, and Single-Family REITs)

Thank you very much. What are you seeing in terms of multifamily deal flow? Are you seeing any pickup from the agencies, and what do you think is driving their behavior this year?

Matt McGraner (EVP and CIO)

I missed the second part of the question, Jade, can you repeat that for me?

Jade Rahmani (Managing Director and Equity Research Analyst of CRE Finance, Homebuilders, and Single-Family REITs)

Please, and what do you think is driving their behavior this year? They seem somewhat conservative on multifamily lending.

Matt McGraner (EVP and CIO)

Yeah. I think, you know, from our perspective, it's just the deal flow. I guess the first part of your question answers the second part of the question. Yeah, the deal flow is still very, very muted. Negative leverage persists, cap rates for, you know, good quality product that agencies would typically finance are still, you know, 5% or, you know, we bid on a deal in South Florida that was 4.5% cap rate, or when ended up going off at a 4.5% cap rate. So, leverage is still negative in most cases, which is having some impact to deal flow.

That being said, you did, you know, see the KKR Lennar deal go off and, you know, obviously the $20 billion worth of private equity multifamily transactions in the first quarter. So large deals are getting done. I would say individual, you know, smaller deals, you know, are still, you know, down. I think the last stat I saw was it's 40%, again, year-over-year, down in transaction volume. So I think it's from an agency standpoint, not that they're being, you know, overly conservative, and Paul, I'll kick this to you after this for your comments, but, it's just there's just not a lot of product.

When we went to them with our pool of multifamily, you know, loans, the $1.5 billion, they were, you know, pretty, pretty excited about the opportunity because they haven't seen, haven't seen the, you know, the bulk, if you will. But Paul, if you have anything to add to that.

Paul Richards (VP of Originations and Investments)

Yeah, I think, you know, in the past, you saw a lot of, you know, 10-year fixed, seven-year floats. But we've been seeing new origination have been more five-year fixed, you know, as we close on two from this year alone. So, you know, a shorter term, but, you know, if you see treasury rates today, they're, you know, five years down to 3.85, and, you know, if that sticks, I think you might see some more deal flow, as treasuries continue to rally. But, you know, as of right now, it seems like, you know, it's unfun, but still a little, like, as Matt pointed out, a little tight in the agency space for deal flow.

Jade Rahmani (Managing Director and Equity Research Analyst of CRE Finance, Homebuilders, and Single-Family REITs)

The NXRT refinancing, that's at 100-110 basis points spread?

Matt McGraner (EVP and CIO)

It was 109 basis points over SOFR.

Jade Rahmani (Managing Director and Equity Research Analyst of CRE Finance, Homebuilders, and Single-Family REITs)

So in your mind, when you look at the weighted average cost of capital and maybe some expectation of rate moderation, what do you think the, how do you look at the all-in cost of capital of that debt deal?

Matt McGraner (EVP and CIO)

Well, that deal is sort of different because we have $1.25 billion of swaps at an average blend of 1.36%. So borrowing cost is just an additional 109 basis points over that. But the swaps are burning off in 2026. So for that company, it's, you know, amazingly accretive in keeping the, you know, keeping the flexibility on a floating rate to buy and refinance and have zero, you know, defeasance or yield maintenance penalties. So that's a one-off situation, but it does, I think, illustrate the, you know, the agencies, Freddie in particular, rolling up their sleeves, digging in, and trying to come up with a bespoke solution to one of their select sponsors.

Jade Rahmani (Managing Director and Equity Research Analyst of CRE Finance, Homebuilders, and Single-Family REITs)

More broadly, when you look at a multifamily acquisition, maybe for NXRT, you know, you mentioned bidding on something that sold at a 4.5%. Let's say you were bidding maybe at a 5%-ish. How are you looking at, you know, levered returns in that kind of situation?

Matt McGraner (EVP and CIO)

Yeah, I mean, I think it's all, you know, it depends on who you are. In our case, we're, you know, a public company that has an implied cap rate sitting out there at 6.25%, and, you know, the private transaction market is still tight at 5% or lower cap rates. So, you know, we have the opportunity to sell assets there and buy back stock, and, you know, that's what we, you know, continue to do.

But in terms of underwriting new levered returns, you know, the way that we look at it historically is try to, you know, go in at a ±5% cap rate and move that cap rate to a 6.5%-7% over the course of three or four years by, you know, adding value and, you know, renovating units and then deciding whether to sell or refinance.

Jade Rahmani (Managing Director and Equity Research Analyst of CRE Finance, Homebuilders, and Single-Family REITs)

Okay. And then lastly, on the book value per share, do you have a post, quarter or intra-quarter update? You know, how do you think it compares with, quarter end book value?

Matt McGraner (EVP and CIO)

Are you talking about from 6:30 to today, or?

Jade Rahmani (Managing Director and Equity Research Analyst of CRE Finance, Homebuilders, and Single-Family REITs)

Yeah. Yeah, just the mark-to-market impact of where book value might be, if there's been any improvement based on spreads?

Paul Richards (VP of Originations and Investments)

Yeah, that's a great question. Yeah, we are seeing, you know, more of a reflation this past month on mark-to-market, just from treasury rates alone on our, you know, on our mark-to-market book of CMBS. So yeah, you are seeing an uptick in those values. So, I would say that we have clawed back, you know, some percentage points this past month just on the mark-to-market of those CMBS positions.

Matt McGraner (EVP and CIO)

Yeah. It's a good question, Jade. And in addition, I wanted to mention that, you know, part of the book value decline was from our storage portfolio that, I think is, we're doing a pretty big refinancing there on some of the debt that we'll expect to accrete to value, you know, for the storage portfolio in a SASB later on in the year, probably in the third quarter, if not in the third quarter, late third quarter, early Q4. And that portfolio, I'm pleased to report, is, you know, for the first time in history, given, you know, it was all development back in 2017, 2018, 2019, is now 90% stabilized, 90% leased and occupied, and is performing well. So, we'd expect some, you know, some reflation in that mark as well.

Jade Rahmani (Managing Director and Equity Research Analyst of CRE Finance, Homebuilders, and Single-Family REITs)

Thank you. Just on the preferred issuance, I know that you're now excluding potential dilution from the share count. Just to, you know, reduce any confusion, you know, how do you think of that? Do you, do you believe that those shares would eventually be settled in cash, and so it makes sense to exclude the dilution?

Paul Richards (VP of Originations and Investments)

Yeah, and that's another good question. So there's a couple factors of, you know, how we came to, that, that methodology. First and foremost, there's a two-year lockout for the company to even redeem shares. The second point is, you know, there's a mechanism where, only 20% of the actual outstanding pref can be redeemed, per year. So there's a, there's a cap on it, so there wouldn't be any event where, the full pref would be fully redeemed at, you know, any one point in time. There's also large penalties for investors to redeem. That stair steps down over time, but currently there's, you know, I believe, an 11%, penalty for investors to redeem at this point in time.

The last point, you know, and I think that you guys have seen in NXRT and NREF, you know, all our vehicles, you know, our plan is never to dilute the company when we're trading below book value. It's just, it's not helpful, and so we would look to settle in cash in the future. So that's why we came to the conclusion of, you know, using this specific share count versus a fully diluted with the Series B shares included.

Jade Rahmani (Managing Director and Equity Research Analyst of CRE Finance, Homebuilders, and Single-Family REITs)

Thanks very much. That's helpful.

Paul Richards (VP of Originations and Investments)

Thanks, Jade.

Operator (participant)

Again, if you'd like to ask a question, press star and the number one on your keypad. At this time, there are no further questions, so I would like to turn the call back over to the management team for closing remarks.

Brian Mitts (EVP and CFO)

Thank you.

Paul Richards (VP of Originations and Investments)

Yeah, I-

Brian Mitts (EVP and CFO)

Oh, sorry, Matt, go ahead.

Paul Richards (VP of Originations and Investments)

No, go ahead. Appreciate it. Thanks. Thanks for everyone's time. We'll talk to you next quarter.

Operator (participant)

That concludes the call for today. Thank you so much. You may now disconnect.