NexPoint Residential Trust, Inc. (NXRT) Q2 2021 Earnings Call Transcript

Good day, and welcome to the NexPoint Residential Trust Second Quarter Conference Call. Today’s conference is being recorded. At this time, I would like to turn the call over to Jackie Graham, Director of Investor Relations and Capital Market. Please go ahead.

Thank you. Good day, everyone, and welcome to NexPoint Residential Trust’s conference call to review the company’s results for the second quarter ended June 30, 2021. 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 McDermett; Vice President, Asset 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 report that was filed earlier today. I would now like to turn the call over to Brian Mitts. Please go ahead, Brian.

Thank you, Jackie, and welcome to everyone joining us this morning. I appreciate your time. I’m Brian Mitts, and I’m here with Matt McGraner. I will start with some highlights from the quarter, then cover our financial results for the quarter and year, and conclude with our revised upward guidance. After that, Matt will discuss our portfolio and some of the metrics driving our performance, contributing to the increased guidance. As Matt will mention in his remarks, the acquisition environment remains challenging, but we have managed to find some opportunities. We completed the acquisition of two properties during the quarter, and Matt will provide more details on that later. However, regardless of the acquisition landscape, our growth and value creation strategies are not dependent on new purchases. We can significantly enhance value through our organic rehabilitation program, which has been actively ongoing during the second quarter and throughout 2021. Here are a few highlights for the second quarter and year-to-date. For the second quarter, our net loss was $3.4 million, equating to a loss of $0.14 per diluted share, compared to a loss of $9.3 million or $0.38 per diluted share in 2020. Same store Net Operating Income (NOI) rose by $179,000, or 0.6%, compared to the same quarter in 2020. We reported second quarter core Funds From Operations (FFO) of $14.2 million or $0.56 per diluted share, down from $0.59 per diluted share in the same quarter of 2020. We executed our value-add business plan by completing 336 full and partial renovations this quarter, which brought our total renovated units to 408, achieving an average monthly rent premium of $170 and a 20.5% return on investment for the quarter. Since the beginning of the current portfolio, we have completed 5,784 full and partial upgrades as of June 30, including 4,459 kitchen upgrades, washer and dryer installations, and 9,782 technology package installs, yielding average monthly rent premiums of $132, $48, and $43, respectively, with ROIs of 21.4%, 74%, and 33.8%. For the six months ended June 30, our net loss was $10.3 million or a loss of $0.41 per diluted share, compared to a gain of $18.7 million or $0.74 per diluted share in 2020. Same store NOI has increased by $86,000 or 0.2% compared to the same period in 2020, and we reported year-to-date core FFO of $28.3 million, which translates to $1.13 per diluted share, slightly up from $1.11 per diluted share in the year-ago period. Regarding our Net Asset Value (NAV), based on current cap rates and NOI, we are reporting a share range of $55.66 on the low end to $66.62 on the high end, with a midpoint of $61.14, using cap rates from 4% to 4.3%. In the second quarter, we paid a dividend of $0.34125 per share on June 30 to shareholders of record as of June 15. The Board has also declared a dividend of $0.34125 to be payable on September 30 to shareholders of record on September 15. Year-to-date, our dividend is covered 1.65 times by core FFO, resulting in a payout ratio of approximately 61%. Before moving on to the numbers and guidance, I want to highlight our position in the market. With net migration continuing into our core Sunbelt areas and the demand for affordable, high-quality products, we believe NXRT is well-positioned to deliver high returns to our investors. The ongoing migration into our markets is strong, which is reflected in our revised NAV calculation showing historic lows in cap rates. With population growth and job creation, competition for desirable properties is rising. Since our public offering, we have developed a cost of capital advantage over many competitors, allowing us to aggressively bid for top assets, as Matt will outline regarding our recent acquisitions. Our growth potential does not rely on acquisitions alone; our value-add strategy enables us to achieve significant returns by moving cap rates 75 to 150 basis points over three to five years from acquisition, which makes us less sensitive to current cap rate levels. The ongoing shortage of affordable housing, particularly acute in our Sunbelt markets, is worsening as new household formation outpaces new housing. This gives us ample opportunity for our value-add strategy across both our existing portfolio and new acquisitions. Increased net migration combined with the housing shortage has led to record-high occupancy in our portfolio, setting us up to push rates aggressively for the remainder of the year, as seen in Q2, which Matt will discuss in detail. The current environment also affords us the chance to sell fully renovated assets for a premium and reinvest that capital into new value-add projects to achieve greater returns. Now, I will quickly summarize the key financial numbers for the second quarter and the first half of 2021. Total revenues were $52.6 million, a 3.7% increase from $50.7 million in the second quarter of 2020. Our net loss for the second quarter was $3.4 million, compared to a $9.3 million loss in the same quarter a year earlier. Core FFO was $14.2 million for the second quarter, or $0.56 per diluted share, compared to $14.5 million in the same quarter of 2020, reflecting a $0.03 decrease. Our same store pool comprises 35 properties with 13,544 units, and same store rent increased by 3.6%. On average, same store occupancy rose to 96% in the second quarter of 2021, up from 95.3% in 2020, a 70 basis point improvement. Same store NOI was $28.7 million, compared to $28.5 million in Q2 last year, marking a 0.6% increase. For the year ending June 30, our revenues reached $104.4 million in 2021, compared to $103.3 million in 2020, resulting in a 1.1% increase. We experienced a net loss of $10.3 million in the first six months of 2021, contrasted with a net gain of $18.7 million in 2020. Core FFO for the second quarter of 2021 was $28.3 million or $1.13 per diluted share, an increase from $28.1 million in 2020, which is up $0.02 per share. Our same store pool remains at 35 properties with 13,544 units. Same store rent increased by 3.6%, while occupancy climbed 70 basis points to 96%. Same store NOI rose 0.2% to $56.9 million for the first half of the year. Looking forward to the remainder of 2021, we are revising guidance to reflect core FFO on a diluted share basis between $2.30 on the low end and $2.41 on the high end, with a midpoint of $2.35, up from $2.29 previously, representing a 2.6% increase. We expect same store revenue growth to be between 4.2% and 5%, with a midpoint of 4.6%. Our same store expenses are projected to rise by 6.4% on the low end and 4.8% on the high end, with a midpoint increase of 5.6%. We anticipate same store NOI growth to be between 2.7% and 5.2%, with a midpoint of 4%, which is an increase of 40 basis points from our prior guidance of 3.6%. Now, I will turn it over to Matt.

Thank you, Brian. I will begin by discussing our Q2 operational results. Our cash collections are strong compared to NMHC comparisons, with 99.2% of Q2 rents collected. Federal stimulus and local rental assistance programs have contributed, but overall demand for upgraded affordable housing in the Sunbelt remains at historic highs. Population growth in our Sunbelt communities is also reaching new records. As we move past the pandemic, we are seeing notable trends in our markets, including a 35% rise in out-of-state applications quarter-over-quarter and a 29% boost year-to-date. Net migration from California and New York continues to lead our leasing applications year-to-date, with increases of 52% and 19% year-over-year respectively. Low migration outflows from our markets, coupled with consistent resident retention, clarify the strong operational performance we've experienced in the quarter and first half of the year. Our communities are achieving record occupancy levels. Our Q2 same-store occupancy reached 96.1%, up 80 basis points from the previous quarter, and as of July 26, the portfolio is 95.8% occupied and 98.3% leased, maintaining a 94.2% trend. These historically strong occupancy rates are enabling substantial rent increases in most of our markets. For instance, same-store revenue growth exceeded 2.2% in 7 out of our 10 markets in Q2, with positive rental growth in every market. Leasing activity picked up significantly in June, surpassing our expectations. New leases ended the quarter at an impressive 14%, while renewals concluded with a positive 6%, resulting in a blended rental growth rate of 9.9% for Q2. Monthly figures show acceleration, with April's new leases rising by 10.8% and renewals at 5.1%, resulting in a blended increase of 7.85%. In May, new leases were up 13.4% with renewals at 5.8%, resulting in a blended increase of 9.3%. June saw an 18.4% increase in new leases and a 6.7% rise in renewals, leading to a blended increase of nearly 12%. Q2 new lease growth was strongest in Atlanta, Tampa, South Florida, Phoenix, and Vegas, each showing at least 15% growth. In July, new leases are up 24.4% with renewals at 8.2%, indicating a blended increase of 15.8% on over 1,000 leases signed. Notably, our total revenues did not decline in 2020 and had a positive 2.6% in Q4 last year. We anticipate this leasing performance will lead to significant revenue growth in the latter half of the year. On the transaction side, we launched a public marketing campaign for Beachwood and Cedar Point on July 7, and it has garnered considerable interest with over 125 parties signing confidentiality agreements and more than 20 property tours conducted. We plan to invite offers in the first week of August, spurred by strong Q2 and early Q3 financing results. Early indicators suggest pricing could trend towards or exceed the 4% nominal cap rate threshold. These disposals will help fund our reverse 1031 into our two new Charlotte acquisitions, Creekside at Matthews and the Verandas at Lake Norman, while also reducing our revolver draw by $30 to $35 million. Regarding Creekside at Matthews and the Verandas, we acquired Creekside for $58 million, yielding a year-one economic cap rate of 4.5%. We aim to upgrade 193 units at an average cost of $12,000 per unit, expecting premiums of $151 per unit and returns of about 15%. We also intend to install washers and dryers and Smart Tech packages in every unit, anticipating monthly premiums of $45 per unit for these amenities. Consequently, our projected three-year average same-store NOI growth for this asset is 7.7%. Currently, Creekside is 97.1% occupied, fully leased, and shows a trend of 95%. We also acquired the Verandas at Lake Norman for $63.5 million, with a year-one economic cap rate of 4%. The upgrade plans for this property are particularly promising, as the interiors are entirely classic units in a strong demographic area. We plan to upgrade 212 units at an average cost of $10,600 per unit, generating premiums of $177 per unit and returns of around 20%. Similar to Creekside, we will install washers and dryers and Smart Tech packages at the Verandas, expecting monthly premiums of $45 per unit as well. Our projected three-year average same-store NOI growth for this asset is a robust 9.6%. Currently, the Verandas is 98.5% occupied, 99.6% leased, and has a trend of 98%. As Brian mentioned on July 12, we entered into a purchase and sale agreement to acquire six properties in the Research Triangle area for approximately $75 million, with a year-one economic cap rate of 4%. We recognize Research Triangle's strong and growing tech and life science sector, making these assets very attractive. At the six properties, we aim to fully upgrade 111 units at an average cost of $13,200 per unit, generating premiums of $198 per unit, and returns of about 18%, as well as partially upgrade 148 units at an average cost of $5,500 per unit, yielding premiums of $82 per unit, with expected NOIs of approximately 18%. We will also install washers and dryers here to generate monthly premiums of $45 per unit. Overall, our projected three-year average same-store NOI growth for this asset is 5.1%. The heightened investor interest, along with affordable financing and capital inflows into our sectors, is increasingly driving asset values higher. We expect this trend to continue as positive net migration and job growth in the Sunbelt accelerate. An interesting point for our NAV assessment is a large $1.2 billion portfolio expected to trade in Q3. It encompasses over 4,000 units with similar property types and an average vintage of 1993. Reports suggest it may trade at a 3.5% cap rate based on in-place figures, averaging $275 per unit. Shifting to our full-year 2020 guidance, we are pleased to announce a significant increase in core FFO to a midpoint of $2.35 per share. This improvement is mainly driven by acquisitions and expense savings, with potential upside as new leases and renewals impact our income statements. On the expense front, we observe modest reductions in both controllable and non-controllable expenses, while maintaining a robust property tax budget. We are still waiting on property values for 12 out of 39 assets, including all eight properties and four North Carolina assets, which encompass the two new acquisitions. We are appealing or disputing values on 21 out of 27 property valuations we have received and remain hopeful for favorable adjustments, but we haven’t altered our conservative initial tax projections for these properties. With these adjustments, new acquisitions, and notably strong operational performance trends, we are raising the low-end and midpoint of our same-store NOI guidance to 2.8% and 4%, respectively. That concludes my prepared remarks. Thank you to the NexPoint BH teams for their ongoing execution efforts.

Right. Thank you. We’ll turn it over for questions.

Thank you. We will take our first question from Amanda Sweitzer from Baird.

Thanks. Good morning, all.

Good morning.

I wanted to start on your same store rental income guidance. It’s coming down marginally. And it certainly doesn’t seem to have been driven by lease rates. Is that being predominantly caused by some of the casualty events that you mentioned or any changes in your assumptions on bad debt for the rest of the year?

Yes. I’ll start, Amanda, it’s Matt. We have booked, as the moratoriums ended here in the coming months, we’ve decided to take a write-off of bad debt that’s backward-looking, so to speak. So, the change isn’t really forward-looking, it’s just revisions to the annual number which we could expect to recapture some of that income later on in the second half of the year. So, it’s not really forward-looking, it’s just a revision. And then I think that’s primarily it. But Mitts, if you have anything else.

Yes, we've found ourselves in a challenging situation. Normally, when dealing with tenants, we would proceed to evict them, which either prompts payment or results in their departure, allowing us to balance accounts and potentially recover funds later. However, currently, we have been maintaining balances for tenants we cannot evict. While these tenants remain, instead of writing off a significant amount, we have taken a cautious approach as some tenants have been making payments over time, although the reasons for their payments vary. As Matt mentioned, with the end of the moratorium approaching, we are beginning to develop a plan for evictions and to attempt to collect some of these outstanding balances. We believe it makes sense to start writing off specific balances where tenants appear likely to face eviction. This is a conservative estimate. Regarding casualty losses, while they do have an impact, the insurance proceeds we receive for business interruptions are categorized as other income and do not affect our rental revenue. We are beginning to bring those units back into service, which should help clarify our situation and is part of the reason for our anticipated increases throughout the year.

That’s helpful and makes sense. And then as you think about blended lease rates going forward. Do you think there is still room here to increase renewal rates and further narrow that gap to new lease rates? Are you getting to the point where you think turnover will increase if you push renewal rates further?

Yes. I think there is definitely room to see them kind of converge. Right? So, obviously, we can’t time 25% new leases every quarter, probably going forward, but we do expect to see those two numbers converge. I mean if you look back in 2016 and 2017, the portfolio regularly had double-digit renewal increases during peak leasing season. So, so far we’re optimistic. As I said in July, we were at 24.4% new leases, 8.18% renewals on almost 1100 leases. Every single market is in double digits on the new lease front and then high single digits on the renewals. So, I think, as the markets are as healthy as they’ve ever been on the leasing front, we expect this to continue through the second half of the year.

Okay. Thanks. Appreciate the time, guys.

Thanks, Amanda.

Thank you. We’ll take our next question from John Massocca with Ladenburg Thalmann.

Good morning. Can you hear me?

Good morning, John.

Maybe just following up on that last point, I mean, I guess given the health of the leasing market, is the expectation as you think about guidance going into the end of the year that you can kind of hold occupancy at that 96% level even as we see kind of the eviction moratorium roll?

Yes, we believe so. We've organized this effort into tiers. Currently, we are identifying candidates for immediate eviction as part of one of our ongoing projects. Our plan involves rehabilitating those units or offering them under standard terms. The total number of affected units is just 123, which represents the majority of disrupted units we anticipate in Q3 or Q4. This small figure gives us confidence that we can maintain our numbers, and our trends remain as strong as ever. So, we think we can manage it.

Okay. And then the other kind of component of the change to guidance was with a decrease in kind of the total expense expectations. You kind of touched on the fact that it seems like your tax expectations are kind of remaining the same and you’re on a kind of conservative basis there. I guess what’s kind of driving that 100 basis point decline in kind of total same store expense if it doesn’t seem like it’s a change in tax expectation?

I believe the savings are coming from other categories of repairs and maintenance, as well as payroll. The increase in repairs and maintenance during the second quarter was primarily due to a low comparison from the same period last year. We didn’t significantly address the units, and there was a lot of defense, which led to work orders being postponed on the maintenance side. We managed to handle a lot of that in the second quarter, and we anticipate that we won’t see those elevated numbers again in the second half of the year.

And I guess, sorry, I missed it. But the change in expectations, kind of now versus maybe at 1Q kind of thought some of that 2020 roll off would have been known. I guess, is it just you’re not seeing cost inflation like you were expecting or?

Yes. I mean, it’s cost inflation. It’s the fact that we just haven’t turned. We don’t think we’ll turn as many units and have the turn costs, our resident retention is higher, people are accepting new renewals. So, based on our trends and what we think the leasing performance will be in the second half of the year, there’s just lower CapEx, recurring CapEx.

I apologize if I missed it, but how have the expectations changed now compared to the first quarter? It seems like some aspects of the 2020 rollout were unexpected. Are you not experiencing the cost inflation you anticipated?

Yes. The Charlotte deals reflect a blended four in a quarter cap rates. We anticipate disposing of the Nashville deals at a four, which will provide an arbitrage opportunity without diluting our earnings through a reverse 1031 exchange. More generally, I mentioned a portfolio from an institutional seller, with units primarily located in Texas and Florida, which we know are under contract at a 3.5% cap rate. The market remains competitive; however, due to inexpensive financing and limited growth in other commercial real estate sectors, this area is attracting significant interest. As Mitts mentioned at the beginning of the call, we've identified three acquisitions in our target markets that present good opportunities for both disposition and capital recycling, and we are eager to expand, especially in the Research Triangle.

That’s it for me. Thank you very much for taking the questions.

Thanks, John.

Thank you. We’ll take our next question from Michael Lewis with Truist Securities.

Great, thank you. You answered most of mine, but I wanted to circle back to the issue of the eviction moratorium getting lifted. I think you said you have about 123 units where you’d want to evict pretty quickly. So, maybe a two-parter on this. Could you talk a little bit maybe about that process, how quickly you get them out if you think maybe there’s higher CapEx on those units? And then as the second part of that question, do you anticipate any impact on market fundamentals as you kind of not just you but others kind of release all of a sudden available inventory into the market, do you think that slows things down a little bit in your markets?

Yes. Those are great questions, Michael. Currently, we have 123 units classified as Tier 1, which either haven't been responsive or have stopped making payments. Many of these have been served notice, and eviction proceedings are underway. We believe we can take possession of these units quickly. We plan to renovate about half of them, and we have detailed plans for each unit regarding flooring and layouts. Our teams are ready to start renovations and release these units into the market promptly, especially given the favorable conditions as the eviction moratorium concludes. Most institutional owners tend to avoid renting to tenants who have been evicted for any reason, as they typically require proof of income and conduct credit and background checks. While we understand the challenging circumstances brought on by the pandemic, tenants who have been working to pay rent or set up payment plans will usually receive support. However, those who have gone unresponsive might not receive the same consideration for new leases. I expect that evicted tenants will likely move to lower-quality units.

There has been a lot of discussion about the Delta variant recently. I don’t think anyone would leave their apartment unless they were in dire circumstances. However, do you believe that if we experience another wave of coronavirus and the Delta variant becomes a more significant issue, there is a risk to apartment fundamentals or your business? Or do you feel somewhat insulated from that situation in your operations?

Yes. I mean I think that our geographies are and have been sort of the most, I don’t say lenient, but the most progressive in terms of letting folks get out and work and go to restaurants, etc. So, the economic activity in the Sunbelt, in the Southwestern and Southeastern United States has kind of led the nation. So, that’s kind of a mitigating factor in terms of the new variant. I think that it’d be hard for us to see, Governor Abbott of Florida, for example, put the brakes on reopening and go backwards. So, I think that that’s something in our markets favor that will allow us to continue to hopefully operate as we have been and even in Las Vegas, where there is temporary mask, reissuances or reorders of wearing masks. They’re largely not being, I guess, prosecuted or enforced. So, I think for our markets we feel pretty good, but who knows what California and New York will do. Those are wildcards.

Thank you.

Thank you, everyone. We have no more questions. I’ll hand the call back to management for their closing remarks.

Yes. Thank you. Appreciate everyone’s participation this morning. Great questions, and we’ll see you next quarter.

This concludes today’s call. Thank you for your participation. You may now disconnect.