NexPoint Residential Trust - Q2 2024

Transcript

Operator (participant)

Thank you for standing by. My name is Christina, and I'll be your conference operator today. At this time, I would like to welcome everyone to the NexPoint Residential Trust second quarter 2024 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star one. I will now turn the floor over to Kristen Thomas, Investor Relations. Kristen, you may begin the call.

Kristen Thomas (Head of Investor Relations)

Thank you. Good day, everyone, and welcome to NexPoint Residential Trust conference call to review the company's results from 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 Bonner McDermott, Vice President, Asset and Investment Management. As a reminder, this call is being webcast through the company's website at nxrt.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 most recent 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 any forward-looking statements. The statements made during this conference call speak only as of today's date and, except as required by law, NXRT does not undertake any obligation to publicly update or revise any forward-looking statements. 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 earnings release 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)

Thanks, Kristen. Welcome to everyone joining us this morning. Appreciate your time. I'm Brian Mitts. I will be joined today by Matt McGraner and Bonner McDermott. I'll start the call and cover our Q2 results, updated NAV and guidance outlook for the year. Then I'll turn it over to Matt and Bonner to discuss some of the specifics in the leasing environment and metrics driving our performance and guidance. Results for the second quarter are as follows. Net income for the second quarter is $10.6 million or $0.40 per diluted share on total revenue of $64 million. This includes an $18.7 million gain on the sale of Radbourne Lake that was completed on April 30. The $10.6 million net income for the quarter compares to a net loss of $4 million or $0.15 loss per diluted share for the same period in 2023, when total revenue was $69.6 million.

For the second quarter of 2024, NOI was $38.9 million on 36 properties, compared to $42 million for the second quarter of 2023 on 40 properties. For the quarter, same-store rent decreased 1%, while same-store occupancy held stable at 94.1%. This, coupled with an increase in same-store revenues of 2.3%, led to an increase in same-store NOI of 2.4% as compared to Q2 2023. As compared to Q1 2024, rents for the second quarter on the same-store portfolio were up 0.4% or $6 sequentially. We reported Q2 core FFO of $18 million or $0.68 per diluted share, compared to $0.77 per diluted share in Q2 of 2023. During the second quarter, for the properties in our portfolio, we completed 59 full and partial upgrades and leased 56 upgraded units, achieving an average monthly rent premium of $240 and a 20.1% return on investment.

Since inception for the properties currently in our portfolio, we've completed 8,271 full and partial renovations, 4,659 kitchen and laundry appliance installs, and 11,389 technology package installs, resulting in $175, $48, and $43 average monthly rental increase per unit and a 20.8%, 62.9%, and 37.2% return on investment, respectively. NXRT paid a second-quarter dividend of $0.46 per share of common stock on June 28. Since inception, we've increased our dividend 124.5%. For the second quarter, our dividend was 1.48 times covered by Core FFO, with a payout ratio of 68%. During the second quarter, NXRT completed the sale of Radbourne Lake for a sales price of $39.25 million. This generated $18.6 million of net sales proceeds and resulted in a 19.2% levered IRR and 3.6x the multiple on invested capital. The second quarter, the company purchased and subsequently retired $14.6 million of its common stock.

The retired stock was purchased at a weighted average price of $33.19 per share, which represented an attractive 37% discount to the midpoint of our Q1 2024 NAV range. On June 27, NXRT used cash on hand to retire the $15.3 million mortgage on the Stone Creek at Old Farm property. As of June 30th 2024, we had $21.3 million of cash and $350 million of available liquidity on the corporate credit facility. Turning to NAV, based on our current estimate of cap rates in our markets and forward NOI, we're reporting an NAV per range as follows, per share range as follows: $49.77 on the low end, $61.97 on the high end, and $55.87 at the midpoint.

These are based on average cap rates ranging from 5.25%-5.75%, which we revised down 25 basis points this quarter based upon recent market intelligence and transaction activity. NXRT is updating 2024 guidance range for core FFO per diluted share, same-store revenue, same-store expenses, and same-store NOI as follows. Core FFO per diluted share: $2.66 on the low end, $2.79 on the high end, and a midpoint of $2.72. Total revenue: 1.3% increase in low end, 2.2% increase on the high end, and 1.7% increase at the midpoint. Total expenses: 4.4% increase on the low end, 3.7% or sorry, 3% increase on the high end, and a midpoint of 3.7%. In same-store NOI, a negative 0.6% increase in the low end, or sorry, decrease, 1.6% increase on the high end, and a 0.5% increase at the midpoint.

That completes my prepared remarks. I'll now turn it over to Matt.

Matt McGraner (EVP and Chief Investment Officer)

Thanks, Brian. Let me start by reviewing our second quarter same-store operational results. Same-store rental revenue was 2.6%, with 5 of 10 markets averaging at least 2% growth, while our Las Vegas and Atlanta markets led the way at 9.2% and 6.6% growth, respectively. Total same-store revenues for the portfolio were up 2.3% year-over-year. We're also pleased to report some continued moderation in expense growth for the quarter. Second quarter same-store operating expenses were up just 1.2% year over year. Specifically, marketing and payroll declined 5.2% and 80 basis points, respectively. Year over year, our R&M expense growth continued to moderate, up just 80 basis points from Q2 2023. And we finalized several prior-year property tax appeals, resulting in 1.6% reductions year over year, and are still in active property tax appeals on 14 assets.

Second quarter same-store NOI maintained a healthy growth in our markets, with the portfolio averaging 2.4%. Five of 10 markets achieved year-over-year NOI growth of 3.7% or greater, with Las Vegas and Atlanta leading the way at 12.3% and 9.6% growth, respectively. Our Q2 same-store NOI margin registered a healthy 61.1%, which was up 10 basis points from the prior year. Operationally, on the income front, the portfolio experienced continued positive revenue growth in Q2, with five out of our 10 markets achieving growth of at least 2.3% or better. Our top five markets were Las Vegas at 8.4%, Charlotte at 6.8%, Atlanta at 5.5%, South Florida at 4%, and Raleigh at 2.4%. Renewal conversions for eligible tenants were 65% for the quarter, with eight out of 10 markets executing renewal rate growth of at least 1.1% and a blended average of 2.11%.

On the occupancy front, the portfolio registered a healthy 94.1% as of the close of the quarter, and as of today, remains 94.1% occupied, 96.5% leased, and a healthy trend, a healthy 60-day trend of 92%. Operationally, heading into the second half of the year, as Brian mentioned, we have bumped higher. While supply continues to be a challenge, demand outperformed expectations in the first half of the year and was really exceptional on a historic basis. Even so, we have still seen resistance to growing rents and a focus on occupancy to grow revenue. Demand has stayed resilient going into the second half of the year, but we expect seasonality to play a role as deliveries peak throughout the rest of 2024.

Also, positive evictions continue to come down, and we're optimistic that we will see bad debt surprise to the upside in the second half of the year also. In addition, supply-demand imbalances continue to favor landlords as we will enter 2025 and beyond. Some notes on starts from our quarterly updates with RealPage and consultants tracking starts and deliveries are as follows. Annual starts are now at their lowest level in 10 years, approximately 280,000 units on a run rate. The year-over-year drawdown in starts from 2023 is approximately 40%. Q2 2024 starts came in at just 38,000 units, which would represent an annual run rate of 150,000 units or 50% of the trailing 10-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 the 2020s peak, with Sunbelt markets down 54%.

Finally, RealPage forecasts a return of normal 2%-4% annual rent growth in 2025. Turning to perhaps one of the bigger items, the balance sheet, on the heels of deleveraging and retiring the entire credit facility, and as we alluded to at Nareit, we have been working to take advantage of the spread tightening in the real estate debt markets broadly. Today, we're pleased to announce we have signed an application with JPMorgan and Freddie Mac to refinance 17 properties at SOFR plus 109 basis points, 49 basis points below the portfolio average spread of 158. We're also in agreement with Freddie to refinance the remaining portfolio at the same terms by the end of 2024, thereby refinancing the entirety of our first mortgage debt. By executing this strategy, we would bring our weighted average interest rate spread to 109 basis points.

We expect the first tranche of refinancing is to close by October 1 of this year, and the remaining assets will be refinanced shortly after their lockup period expires on November 1st. The four-year core earnings benefit is forecasted to provide $0.15-$0.20 of earnings annually. One significant added benefit to this refinancing initiative, beyond extending maturity to another seven years, is to offset the expected impact of our interest rate swaps maturing over the next three years. As we project Core FFO into the future, it is our expectation that we can, at a minimum, maintain our 2024 core performance throughout swap expirations by achieving at least a 3% compounded annual growth in NOI, a metric we have historically doubled over our operating history.

We see this initiative bolstering our balance sheet, shoring up core FFO estimates in the out years and positioning the company for future success and growth. Importantly, these refinancings remain flexible and allow us to sell assets with minimal breakage fees and no defeasance and/or yield maintenance penalties. And as always, we'll look to hedge this exposure opportunistically on a laddered basis as inflation expectations moderate. Finally, on the NAV, as Brian mentioned, our new NAV midpoint is $55.87 per share using a 5.5% cap rate on a revised 2024 NOI. We made a 25 basis point downward adjustment to our cap rate assumption to 5.25%-5.75% based upon current knowledge of successful trades on comparable assets in our markets. In addition, the Blackstone AIR deal and the Lennar transaction with KKR, both of which were struck in the low 5%-5.25% cap rate range.

At today's prices, our implied Cap Rate is roughly 6.22%. And as we've routinely done in the past, and to the extent we stay at these levels, we'll use our NAV as our guidepost and utilize free cash flow and/or look to sell assets to free up liquidity, buy back stock at a discount, or purchase new assets utilizing a 1031 Exchange. In closing, I'll just reiterate, we're excited about the near-term outlook for the company, our current refinancings, and we'll work hard to generate another year of outperformance. That's all I have for prepared remarks. Thanks to our teams here at NexPoint and BH for continuing to execute. Brian?

Brian Mitts (EVP and CFO)

Appreciate it, Matt. Let's open it up for questions.

Operator (participant)

Thank you. As a reminder, if you would like to ask a question, please press star, then the number one on your telephone keypad. Again, that's star one to ask a question. And we'll pause for just a moment to compile the Q&A roster. Thank you. Your first question comes from the line of Kyle Katorincek from Janney Montgomery Scott. Your line is open.

Kyle Katorincek (VP and Equity Research Analyst)

Hey, good morning, guys. You noted that Raleigh real estate taxes accounted for 33% of your total expenses year to date due to the four-year reassessment. Did that come in materially higher than you guys initially estimated?

Bonner McDermott (VP of Asset and Investment Management)

Yeah. So right now in Raleigh, it's kind of a tale of two deals, right? The Six Forks asset, we actually came in ahead of our consultants' estimates. We're pretty satisfied with that outcome. The Mooresville asset, the High House asset, that one we're having to do a little bit more fighting. So you see us still accruing at a higher rate. We think that there's savings there. If you look at our spread for four-year numbers, there's about a $500,000 range of outcomes. Matt referenced the 14 deals that are actively in protest for 2024. The High House asset there is one of those, and that could be one of the more material drivers if we can get that down. So we're still working on that.

It certainly is a big impact, but as you mentioned, it's kind of a four-year opportunity, bite at the apple, and then it'll be fixed for the next three. So we're going to do everything we can with the consultant to control that outcome, but hopefully have more to report come Q3.

Kyle Katorincek (VP and Equity Research Analyst)

Okay. And then are there any other multi-year tax reassessments, maybe including that 14 and in your larger markets that are going to be coming up within the second half of 2024?

Bonner McDermott (VP of Asset and Investment Management)

No, that's the one. So Charlotte, Mecklenburg County was last year, Nashville last year as well. So those are the three with kind of odd tax situations, but we're dealing with Raleigh now. I think we're pleasantly surprised with Six Forks' outcome, and we think we can, through some sale comp data, some income approach, get the High House result down.

Kyle Katorincek (VP and Equity Research Analyst)

Okay. Thank you. And then could you guys provide an update on the sales process with Stone Creek in Houston? Should we still expect it to close before year-end 2024?

Matt McGraner (EVP and Chief Investment Officer)

Yeah. We're still marketing it and negotiating with a couple of different buyers. Do have offers, attractive offers that we think we can execute on and believe we can transact before year-end.

Kyle Katorincek (VP and Equity Research Analyst)

Okay. Sounds good. Thanks, guys. Appreciate it.

Matt McGraner (EVP and Chief Investment Officer)

You bet.

Operator (participant)

Your next question comes from the line of Omotayo Okusanya from Deutsche Bank. Your line is open.

Omotayo Okusanya (Senior Research Analyst)

Yes. Good morning, everyone. Just in terms of the refinancing of the debt, one, could you talk about any fees or prepayments you may have to deal with now as it pertains to kind of refinancing these assets, if that exists? And then second of all, the ongoing process to refinance. I know sometimes with HUD and GSC debt, it can take a while. There's a lot of paperwork. It can be very administrative. Just kind of talk us through a little bit about how easy that process will be to kind of get it done.

Matt McGraner (EVP and Chief Investment Officer)

Yeah. Hey, Teo. It's Matt. So the fees, because we're sticking with in our the Freddie Mac currently has, I think, all the debt on the portfolio. It's really considered a modification versus a complete refinancing for accounting purposes. There's going to be some breakage costs, but they're negligible, $10 million-$15 million that can be amortized over the life of the seven years. So that's that. And then the execution on the Freddie side with JPMorgan. JPMorgan's a current lender. And then Freddie Mac, obviously, is we're a select sponsor with Freddie and have refinanced and financed with them, I think, over $6 billion in the history of the company. So we're in a very good cadence with them. We have signed applications.

We'll be working through third parties over the next 30 days, and would like to and believe we can close by the end of the third quarter on the first tranche and work concurrently while we're doing the first tranche, work concurrently on the second tranche, and then close that a month later. And so we expect this to be pretty routine for us. And again, pretty excited about it.

Omotayo Okusanya (Senior Research Analyst)

That's helpful. And then the same-store revenue guidance, oh, sorry, same-store revenue in second quarter. Again, it seems like occupancy was somewhat flat this year-over-year. Rents, again, were kind of down a little bit. But your same-store revenue numbers, I think for the quarter, you were up. You were up a little bit. Just curious, again, is that ancillary income doing better? Is that bad debt doing better? Could you talk a little bit through that and potential implications for the rest of the year?

Brian Mitts (EVP and CFO)

Yeah. Bonner, you can give me the specifics, but I think a lot of it is bad debt. And as we go forward, the second half of the year, we were underwriting a GPR reduction of roughly $2 million, but also lower vacancy loss of about $300,000 and then better bad debt of upwards of $800,000. And I think that's what drove the income total revenue for the first half of 2024.

Bonner McDermott (VP of Asset and Investment Management)

Yeah. And I think one of the things that might get lost in translation here. So we report 6/30 physical occupancy at 94.1% for the same-store pool. The full quarter effective occupancy, financial occupancy was 94.9%. We carried pretty strong occupancy into the quarter, and the average occupancy throughout was higher. So overall, we had to pick up an occupancy. We also have our bad debt is down about 1.7% year-over-year. So we're pleasantly surprised there. I think we've done well to work through kind of the eviction activity overhang from COVID. And so the quarter, we did 1.9% growth in revenue. A lot of that is in, I think, a pickup in occupancy and bad debt.

Omotayo Okusanya (Senior Research Analyst)

Thank you.