NexPoint Residential Trust, Inc. (NXRT) Q3 2022 Earnings Call Transcript

Hello and welcome to the NexPoint Residential Trust, Q3 2022 Conference Call. My name is Laura and I will be a coordinator for today’s event. Please note, this call is being recorded. I will now hand you over to your host Kristen Thomas to begin today’s conference. Thank you.

Thank you. Good day, everyone, and welcome to NexPoint Residential Trust’s conference call to review the company’s results for the third quarter September 30, 2022. On the call today are Brian Mitts, Executive Vice President and Chief Financial Officer; and Matt McGraner, Executive Vice President and Chief Investment Officer. 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 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.

Thank you, Kristen, and welcome to everyone joining us this morning. I appreciate your time and apologize for the technical issues you may have had dialing in. I’ll kick off the call and cover our Q3 year-to-date results, update our NAV calculation and then provide guidance. Results for Q3 are as follows: Net loss for the third quarter was $26 million or $0.02 per diluted share and total revenue of $68.1 million, as compared with a net loss of $5.4 million or $0.21 loss per diluted share in the same period in 2021, with total revenue of $56.4 million, which is a 21% increase in revenue. For the third quarter, NOI was $39.9 million on 41 properties, compared to $33.6 million for the third quarter of 2021 on 40 properties, a 19% increase in NOI. For the quarter year-over-year rent growth on renewals averaged 12% across the portfolio and year-over-year rent growth on new leases averaged 14.5%. Given where rental rates are in our markets for Class B apartments and equivalent single-family rental products, we believe there is ample room for future outsized rent growth. For the quarter, same-store rent reached 19.4% and same-store occupancy was down 130 basis points to 94% as we continue to focus more on rate than occupancy during the quarter. This coupled with an increase in same-store expenses of 16.9%, which was calculated by higher year-over-year expenses plus an increase in same-store NOI of 13.1%, which compared to Q3 2021. Rents for the third quarter of 2022 on the same-store portfolio were up 4.5% quarter-over-quarter. We reported Q3 core FFO of $21.8 million or $0.85 per diluted share, compared to $0.65 per diluted share in the same quarter 2021, for an increase of 31% on a per share basis. For the quarter, we completed 649 full and partial interior renovations and leased 592 upgraded units achieving an average monthly rent premium of $163 and a 24.3% ROI, which is 203 basis points higher than our long-term average ROI in renovation. Year to date in the current portfolio, we have completed 7,354 full and partial upgrades or 48% of the total units, 4,853 kitchen upgrades and washer dryer installs, and 10,451 technology package installations achieving an average monthly rent premium of $146, $49, and $44 respectively, with ROI of 22%, 69.3%, and 37.3% respectively, each of which helped to drive our NOI year-over-year higher by 19%. Results for the year are as follows: Our net loss for the year was $13 million or $0.51 loss per diluted share of total revenue of $194.6 million as compared to a net loss of $15.7 million or $0.62 loss per diluted share in the same period in 2021 and a total revenue of $160.7 million for an increase in revenue of 21%. Year to date NOI was $115.3 million on 41 properties as compared to $93.6 million on 40 properties for the same period in 2021 or an increase of 23%. For the year, same-store rent increased 19.9%, and same-store occupancy was down 140 basis points to 94%. This coupled with an increase in same-store expenses of 10.3% led to an increase in same-store NOI of 15.8% as compared with the same period in 2021. We reported year-to-date core FFO of 62.3 million or $2.43 per diluted share, compared to $1.78 per diluted share at nine months ended September 30, 2021 or an increase of 37%. For the year, we completed 1,834 parcel renovations, an increase of 101%. We're reporting NAV per share range as follows: $70.04 per share on the low-end, $83.47 per share on the high-end, and $76.75 per share at the mid-point. These are based on average cap rates ranging from 4.3% on the low-end to 4.7% on the high-end, which has increased approximately 44 basis points last quarter and 92 basis points year-to-date to reflect a rise in interest rates and considerable increases in cap rates in our markets. For the quarter, we paid a dividend of $0.38 per share on September 30. And this morning, we announced that the Board of Directors has approved an increase in the quarterly dividend of $0.04 per share or a 10.5% increase to $0.42 per share. This marks the company's seventh consecutive annual increase. Since inception, we've increased our dividend by 103.9%. Year to date, our dividend was 2.13x covered by core FFO with a payout ratio of 47% of core FFO. Finally, before we discuss guidance, today we are pleased to announce favorable improvements we are undertaking to de-risk our balance sheet, increase liquidity, and improve our financial outlook. First, we've executed a loan application and are in the process of refinancing 19 property level mortgages for KeyBank and Freddie Mac. In aggregate, this transaction refinanced 46.7% of the company's total outstanding debt and improved spread prices by 150 basis points over one month. Additionally, NXRT has executed a 12-month extension option on the revolving credit facility, extending that maturity to June 30, 2025. The company expects to use approximately $217 million of cash from mortgage refinancing proceeds to pay down an outstanding principal balance on the credit facility and most expensive debt on our balance sheet today. These maneuvers will increase the company's weighted average maturity to 6.4 years, up from 3.3 years as of September 30. Additionally, this refinancing is expected to reduce NXRT's weighted average interest rate on total debt by 39 basis points to 4.33%. Accounting for the hedging and path to the swaps, NXRT's adjusted weighted average interest rate is expected to be reduced to 3.29% to 2.78%. With the completion of refinancing, the company has no meaningful debt maturities until 2025. Turning to guidance, we’re revising guidance as follows: Same Store NOI, we're estimating 14.9% on the low-end, 16.1% on the high-end with a mid-point at 15.5%, which is a 30 basis point reduction from prior guidance of 15.8%, due to higher term costs. For our core FFO guidance, we're estimating $3.05 per share on the low-end, $3.11 per share on the high-end with a midpoint of $3.08, which is a $0.07 per share increase from the prior midpoint, a $3.08 per share that represents a 27% increase over 2021 core FFO of $2.43 per share. So with that, let me turn it over to Matt for his commentary.

Thanks, Brian. Let me start by going over our third-quarter same-store operational results. For the quarter, we achieved a 58.3% same-store NOI margin, down 100 basis points year-over-year driven by lower retention and higher turn costs, but still near historical highs for our company. Rental revenue showed 11.3% or greater growth in all markets except Houston, whose performance lagged a bit as we shifted focus to promote occupancy during the disposition marketing process. While same-store average effective rent growth achieved 19.4%, eclipsing our recent high watermark of 19.3% last quarter. Every market achieved effective rent growth of 12.4% or higher with Houston once again lagging the field. Excluding Houston, the weighted average would have topped 20% for the quarter. Our markets in Florida registered growth from 18.7% to 26.2%. Our third quarter same-store NOI growth was special across the board with the portfolio averaging 13.1%, driven by continued acceleration in total revenues, which hit 15% growth for the period, up 80 basis points sequentially over Q2. Seven out of ten same-store markets achieved year-over-year NOI growth of 14.7% or greater. Operating expense growth picked up again in the seasonally active third quarter registering 16.9% growth overall, largely driven by increases in R&M and turnover. Retention for the third quarter came down year-over-year to 48.8%, which led to a spike in turns to make ready. While we did see elevated overall turnover expenses, our turn costs registered $525 per unit, largely in line with budget expectations. Operationally, the portfolio experienced continued positive growth in Q3 2022 with 9 out of our 10 markets achieving growth of at least 11.3% or better. Again, Houston lagged as a result of the divergent operating strategy promoting high occupancy and stable cash flow ahead of the anticipated disposition of those assets. Our top five markets were South Florida, Tampa, Nashville, Phoenix, and Atlanta. Our occupancy strategy for Q3 focused on pushing rents to force turnover to achieve two goals: Firstly, to narrow the gap on loss to lease down to 7.6% from 12.5% in Q2; and secondly, to renovate more interiors. Our occupancy strategy also led to the completion of 649 rehabs during the quarter, generating an average 24% return on investment and our second highest rehab output since the inception of the company. As we move into the rest of the year, we'll continue to emphasize occupancy and expect continued strength in rents in the low-to-mid teens for the remainder of this year and high single-digit growth in 2023. To give some insight into October to date, we continue to see healthy leasing activity across our markets with blended 9% growth on both new leases and renewals on roughly 800 leases. Turning to 2022 guidance, the strength of rent rolls and total revenues allowed us to increase same-store revenue guidance again for the third time this year to a range of 12.7% to 13.1% with a midpoint of 12.9%, up 90 basis points from 12% in Q2. Elevated new balance in the resulting term costs led to upward revisions in same-store expense growth. We were able to tighten our full-year same-store NOI guidance to a range of 14.9% to 16.1% with a mid-point of 15.5%. Turning to investment activity, the transaction market has closed significantly due to market volatility and current negative leverage in most commercial real estate property types. That said, we've marketed our Houston portfolio for sale with the intention to generate approximately $100 million of net proceeds to pay down our credit facility and/or buy back our stock. Pricing from bidding is coming in around a 4.3% tax adjusted in-place cap rate, solving to an estimated 23% levered IRR. This level of execution, coupled with our balance sheet renewing, will provide greater strategic flexibility, increased liquidity and further de-risking of our balance sheet. Regarding balance sheet maneuvers, it's essential in this current interest rate shock environment. Our analysis of the company has not captured these moves adequately, so we are communicating our forward curves of SOFR and LIBOR as applicable. In fact, from Q1 of 2020 to Q3 of 2022, on over 8,500 same-store units, we have not had one quarter of decreasing rent growth over that period, cumulatively increasing rents by 27.6%. We believe our current projections through 2024 will see net debt to EBITDA organically narrowing to the high single digits by 2025 before any dispositions. After this planned refinancing and Houston dispositions, the only two assets with debt maturities through 2024 will be Cornerstone in Orlando and The Venue on Camelback in Phoenix, both slated to be refinanced in Q1 as part of this larger effort. In closing, we appreciate the balance sheet concerns and are focused on addressing them while continuing to emphasize our core strengths in same-store NOI growth, earnings growth, and dividend growth. Thank you.

Yes, let's turn it over for questions.

Thank you. We'll now take our first question from Buck Horne of Raymond James. Your line is open. Please go ahead.

Hey, thanks guys. Good morning and appreciate all that extra color, that's extremely helpful. Question about, I mean, I'm just curious about understanding the language of you guys saying you've executed a loan application. I guess with your lenders and Fannie. So, I'm curious, I mean rates have been changing so rapidly here, is there any risk that the application gets revised or that this planned refinancing needs additional modification?

No, it's a good question, Buck. No, it's locked in and committed. So, we're just working through the loan documents, which are pretty customary for us at this point given our relationship with Freddie. We have a great deal of confidence here.

Okay, okay. That's helpful. And just in terms of like rent growth seems to be decelerating everywhere across a lot of markets. Can you provide a little additional color in terms of even your new lease and renewal rate growth to be decelerating through October so far, what is it like in terms of the competitive landscape right now? Are you still seeing the same flow of new lease applications coming in or how are you planning on managing occupancy through the end of the year?

Yes. As we stated, we're going to put more focus on occupancy through the seasonally less active traffic season. We are still seeing great demand. We do think that there's a little bit of hit to consumer confidence across the board with the recession fears and talks, which may account for some of the lower demand in our numbers. However, recall our numbers are against tough comparisons. Our rents started to accelerate in Q2 and Q3 of last year. Overall, leasing activity remains strong. The inflation we are seeing across the board on contract labor is helping on the one hand to our expense side, but we are seeing the ability to successfully push those rents in the double digits moving forward.

Appreciate that. If I can sneak one last one. There's just a striking disconnect right now between public market perception of where cap rates are headed or maybe where they're at currently versus, kind of the numbers you guys are quoting and maybe what you're seeing in the bidding process for your assets right now. What do you think explains that disconnect and does it make sense, if you have a high degree of confidence that your NAV is correct, does it make sense to further accelerate stock repurchases with some of the refinancing proceeds?

That's a great question. I think if you look at all the long-term analyses of cap rates, it's really driven by capital flows and GDP growth, and less on long-term interest rates. In the short run, interest rates affect transaction activity, especially given the rapid increase we've seen from the Fed. There's really not a true transaction environment where sellers are willing to part with their assets. If they don't have to sell, they're holding off unless under duress. For us, I believe the disconnect is pronounced through the leverage profile, which we're addressing. That being said, with the proceeds from Houston, we will prioritize paying down the revolver, and if we choose to leverage again or sell more, it would be to buy back stock rather than adding debt.

Hey, Buck. It's Brian. I also note that the board increased our share buyback to $100 million.

Got it. Very helpful guys. Appreciate the color.

Thanks, Buck.

Thank you. We'll now move on to our next question from Rob Stevenson of Jeannie. Your line is open. Please go ahead.

Good morning, guys. Have you seen any uptick in bad debt or delinquencies over the last few months?

Not realized bad debt. There are, I'd say over the past quarter or two, there are some slow payers, but ultimately they pay. I'd say it's not meaningful though, it’s around 25 basis points to 40 basis points.

Okay. And then we've been hearing from some of the smaller private operators and some third party property managers who have been trying to push up their fees given the inflationary cost pressures. Are you seeing this with your property management company? Is there any increase there going to happen there going forward? You obviously are bigger in size.

Yes. We maintain that. Yes, we don't see any increase.

Okay. And then the dividend increase, were you up against taxable earnings, that sort of forced you to do that or was that just something the Board wanted to do?

It’s something we've done every year during this quarter and so we want to maintain that consistency. And our coverage is fairly low. So...

Okay. How did you guys evaluate increasing the dividend versus using those funds to buy back stock?

Yes. I think given the nominal dollar amount and the principles of our company, we thought the risk-reward was to continue showing dividend growth and then to the extent that we wanted to buy back stock at the Houston and then further dispositions will fuel that.

Okay. Thanks guys. Appreciate it.

Thank you. We'll now take our next question from Mike Lewis of Truist Securities. Your line is open. Please go ahead.

Great. Thank you. I have some questions about interest expense and the refinancing. So, first, in the third quarter, your interest expense was about $11.8 million. It looks like your guidance for 4Q is $18 million, I assume maybe that 18 million includes the cost of swaps or fees with the new loans. How do I reconcile those two numbers?

Well, I think the value for swaps is flowing through into the FFO. Is that what you're getting at?

Yes. I mean, I would guess, right, that the 11.8 million in 3Q, there's a benefit from the swaps that's offsetting. Still that was considerably lower than you guys guided to. And then the 18 million for 4Q, I don't think that’s a run rate, but how much – what's in that 18 million for 4Q?

Yes. Let us look into that and come back to it. I don't want to get the wrong answer.

Okay. And then just on the all-in cost of the refinancing after the swap, so you're talking about your weighted average cost of debt down to something with a two handle. When I look at the refinancing, right, SOFR plus 155, that's all-in above 5%. I don't know what swaps cost, but, you know, maybe help me out there because that sounded like a pretty low interest rate refinancing, especially in this environment?

Yes. So, you recall the swaps that we have in place are not tied to any specific deal. They are corporate level swaps. They were paying a forward rate that we locked in years ago at an average of around 1%. I can pull it up.

Yes, I'd say that in your case. So, you're not putting – are you not putting a new swap on for the...

No, the swaps remain in place. Given the lack of financing in the second and third quarter, Freddie and Fannie are both behind their production caps. Therefore, there are not a lot of borrowers looking for floating-rate debt in a rising interest rate environment, so the spreads, we were able to negotiate down and still have the benefit of our swaps, which are specific to our company only. So, we were able to generate that sub 3% all-in interest rate for the next few years.

Okay. I'll follow up on the 4Q interest expense. And then just lastly, I wanted to ask, you mentioned about higher expenses and you specifically noted repairs and maintenance; you know I've had people ask me about insurance costs after the hurricane, any other color you could add on just expense pressures?

Yes. Our biggest expense pressure right now is contract labor on the R&M and turnover side. Finding qualified trades when needed is the hardest part. That specific category is the leader in expense inflation for us at over 25%. So, that's driving a lot of those R&M and turnover costs. Our insurance, I'll let Mitts speak to, but I think it’s fairly stable.

Yes. We just renewed earlier this year with pretty favorable rates. We're starting the new renewal process for next year, and it doesn't look like it's going to be out of control.

Okay, great. Thank you, guys.

You bet.

Thank you. Sounds like we're done. Again, I apologize for the technical difficulties here to switch companies and a little hiccup, but appreciate everyone joining.

Thank you very much. Ladies and gentlemen, this concludes today's call. Thank you for joining today's call. Stay safe. You may now disconnect.