NexPoint Residential Trust, Inc. (NXRT) Q3 2023 Earnings Call Transcript

Thank you. Good day everyone, and welcome to NexPoint Residential Trust's conference call to review the company's results for the third quarter ended September 30, 2023. 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 and Investment Management. As a reminder, this call is being webcast at 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.

Thank you, Kristen. Welcome to everyone joining us this morning. I'm joined here with Matt McGraner and Bonner McDermett. I will begin the call by reviewing our Q3 and year-to-date results, discussing our updated NAV calculation, and providing our revised guidance. After that, I'll hand it over to Matt and Bonner to delve into specifics regarding the portfolio lease environment metrics and the factors influencing our performance and guidance. Let's start with the Q3 results. Net income for the third quarter was $33.7 million, or $1.28 per diluted share, on total revenue of $69.8 million, compared to a net loss of $600,000, or $0.02 loss per diluted share, in the same period in 2022 on total revenue of $68.1 million, reflecting a 2.5% revenue increase across 39 properties versus 41 properties in the prior year. For the third quarter, NOI reached $42.1 million on 39 properties, up from $40 million for the third quarter of 2022 across 41 properties, representing a 5.3% NOI increase. During the quarter, same-store rent grew by 3.1%, while same-store occupancy decreased by 10 basis points to 93.9%. Coupled with a 7.7% rise in other income and a 0.3% decline in same-store expenses, this resulted in an 8% increase in same-store NOI compared to the third quarter of 2022. Compared to Q2 2023, rents for the third quarter on the same-store portfolio were down 40 basis points to $1,529 per unit per month. Our Q3 core FFO was $17.1 million, or $0.65 per diluted share, compared to $0.84 per diluted share in the third quarter of 2022. In this quarter, we completed 420 full and partial renovations and leased 330 renovated units, achieving an average monthly rent premium of $215 and a 23.6% ROI, slightly above our long-term average ROI on renovations. Year-to-date, we have completed 8,671 full and partial upgrades in the current portfolio, representing approximately 60% of the total units, including 4,812 kitchen upgrades and washer and dryer installations, and 12,285 technology package installations, yielding average monthly rent premiums of $168, $49, and $44, respectively, with returns on investment of 21%, 65.3%, and 37.8% respectively. NXRT paid a third quarter dividend of $0.42 per share on common stock on September 29. On October 30, the Board approved a 10.1% increase to the dividend to $0.46242 per share, payable beginning December 29. Since our IPO in 2015, we have increased the dividend by 124.5%. Looking at year-to-date results, net income was $25.9 million, or $0.99 per diluted share, on total revenue of $208.6 million, compared to a net loss of $13 million, or $0.51 per diluted share, during the same period in 2022 on total revenue of $194.6 million, reflecting a revenue increase of 7.2%. Year-to-date, NOI was $125.2 million on 39 properties, compared to $115.7 million on 41 properties in the same period of 2022, indicating an 8.2% increase. Year-to-date, same-store rent per unit rose by 3% to $1,524, and same-store occupancy decreased by 10 basis points to 93.9%. The increase in same-store other income was 4.7%, while same-store expenses rose by 6.7%, leading to a 9.5% increase in same-store NOI compared to the same period in 2022. We reported year-to-date core FFO of $56.1 million, or $2.14 per diluted share, compared to $2.38 per diluted share for the nine months ended September 30, 2022. Moving on to our balance sheet, as of September 30, we had $1.58 billion of mortgage debt, with $112 million held for sale and $41 million outstanding on our corporate credit facility. This is an improvement from mortgage debt of $1.61 billion as of December 31, 2022, which included $68.2 million held for sale and $74.5 million outstanding on our corporate credit facility. This represents a 1.8% reduction in mortgage debt and a 45% reduction in corporate debt year-to-date. Once we sell the four assets currently held for sale, our mortgage debt will decrease by $112 million and our corporate debt by $41 million, resulting in a total 9.7% reduction in leverage. As of September 30, we have swaps with a notional value of $1.17 billion, fixed rates ranging from 2% at the high end to 0.57% at the low end, and a weighted average fixed rate of 1.07%. Our swaps have a liquidation value of $98.6 million as of September 30. We also have interest rate caps covering $1.39 billion of notional debt, with strike prices from 6.82% at the high end to 2.7% at the low end, and a weighted average strike of 5.83%. As of September 30, 13 caps were above the reference rate of 5.32%, representing $418.4 million of notional value. For the third quarter, our swaps and caps reduced our interest costs by approximately $13.5 million. NXRT is currently 98.1% effectively fixed. Considering our swaps and caps alongside fixed debt, at current or increased rates, we are effectively fully hedged. Regarding our capital structure, the impact of the caps suggests that our interest expenses will remain flat or decrease in a rising rate environment. For example, if the reference rate increases by 50 basis points, our cash interest expense, net of swaps and caps, remains flat. An increase of 1% in the reference rate would lead to a decrease of 0.12% in our cash interest expense, reflecting a hedge of 106.6% as new caps come into play. Moving on to NAV per share, based on our current estimates of cap rates in our markets and projected NOI, we are reporting a NAV per share range from $48.77 on the low end to $60.14 on the high end, with a midpoint of $54.45. These estimates assume average cap rates from 5.5% on the low end to 6% on the high end, which indicates a 60 basis point increase over the prior quarter compared to 7 basis point movements in the five and 10-year treasury rates, respectively. For our full-year 2023 guidance, we are revising our core FFO and same-store NOI forecasts. For core FFO per diluted share, we expect a range of $2.95 at the high end to $2.81 at the low end, with a midpoint of $2.88. For rental revenue, we are guiding to a range of 7.7% at the high end and 7% at the low end, with a midpoint of 7.3%. For same-store expenses, our guidance is 4.8% at the high end and 5.7% at the low end, with a midpoint of 5.2%. This results in guidance of same-store NOI of 9.5% at the high end, 7.8% at the low end, and 8.7% at the midpoint. That concludes my prepared remarks. I will now turn it over to Matt.

Thank you, Brian. I will begin by reviewing our operational results for the third quarter. Same-store effective rents reached $1,529 per unit per month, reflecting a 3.1% increase year-over-year. Among our 10 markets, seven saw growth of at least 3%, with South Florida and Raleigh leading at 8.1% and 5.5% growth, respectively. The same-store rental revenue growth for this period was 4.6%, with Florida markets showing notable performance at 10.3%, 8.2%, and 4.6% in South Florida, Tampa, and Orlando, respectively. The Dallas-Fort Worth area reported a commendable growth of 7.3%. Overall, total same-store revenues increased by 4.6% year-over-year. We are happy to report a slowdown in expense growth this quarter, with same-store operating expenses down by 40 basis points year-over-year. Payroll growth was only 60 basis points in Q3, a significant drop from 15.3% and 6.9% in the first and second quarters, respectively. Repair and maintenance expense growth decreased by 6.6% compared to the previous period, following a spike post-COVID in 2022. Real estate taxes have also eased, with true-ups booked in Q3 indicating a downward adjustment in our overall real estate tax forecast for the year. Year-to-date, same-store tax growth dropped to 6% year-over-year. Insurance expense growth stabilized at 6% in Q3 following a successful negotiation during Q2 renewal. In terms of NOI, our portfolio experienced strong same-store NOI growth of 9.5% for the third quarter, and our NOI margin improved to 61.4%. Control over nominal NOI increased quarter-over-quarter, as mentioned by Brian, due to our teams operating more efficiently. Six out of ten same-store markets recorded year-over-year NOI growth of 8.7% or more, with South Florida leading at an impressive 18.4%. Regarding our operating performance and future strategy, our average effective monthly rents per unit at the end of Q3 were $1,497, a 3.5% increase year-over-year. However, new leases were negative for the quarter, decreasing by $60 per unit or 4.6% on a lease-over-lease basis. Similar to other Sun Belt peers, new supply, tenant skips, evictions, and fraud are currently exerting downward pressure on total financial occupancy. Regarding the new supply, the robust job market and significant concessions for new builds have led consumers to expect concessions even for Class B products, as Class B renters shift to Class A housing. In this interest rate climate, even Class B property owners are becoming more cautious, prioritizing occupancy over revenue while anticipating interest rate increases. We expect these trends to settle by the end of the first half of next year, as Class C renters use their wage increases to improve their housing situations, along with moderating inflation and delivery rates. We anticipate that pricing power will return to Class B assets, supported by ongoing net migration to the Sun Belt, especially since 67.5% of total U.S. households can afford to live in an NXRT community. Significantly, in 20 of NXRT's 39 submarkets, supply growth over the upcoming three years is projected to be less than 6%. While deliveries in 2023 have been notable, the forecast for total deliveries for the year has decreased by 17% from earlier estimates due to a challenging financing environment. Furthermore, we plan to exit two of our few supply-heavy markets following the planned sales in Charlotte, which I will discuss shortly. As mentioned in the previous quarter and reported widely by other Sun Belt-focused REITs, skips and evictions remain an issue in several key markets, particularly in Atlanta, Charlotte, and Las Vegas. The positive news is that Atlanta has begun addressing its backlog of cases, as has Las Vegas. For Charlotte, over 70% of evictions are linked to one asset, Timber Creek, which is currently under contract for sale with a $1.5 million nonrefundable earnest money deposit. Given these temporary challenges, we will focus on prioritizing occupancy, closing the backdoor on skips and evictions, and attracting qualified tenants. Our portfolio reported a 94% occupancy rate at the end of the quarter and has improved to 96.24% leased as of this morning, achieving a healthy 60-day trend of 93%, the highest rate in several quarters as we approach the winter months. Additionally, our three-year same-store effective rent growth is now compounding at 9.6%, and we anticipate same-store NOI growth will conclude the year in the high single digits. This growth, combined with our ongoing focus on deleveraging, has informed our recommendation for an eighth consecutive dividend increase to the Board. If we are successful in these strategies, which we believe we will be, we expect earnings growth to pick up again in 2024, maintaining our core FFO payout ratio at 54% for 2023 and under 60% for preliminary estimates for 2024. Our confidence in our strategy is bolstered by our ability to identify liquidity amidst a scarcity of it. With our debt being fully pre-payable and our NOIs growing, our assets remain very liquid. Our aim, as management and large shareholders, is to enhance NOIs through targeted value-add initiatives, secure those gains, and maintain a strong liquidity profile so we can capitalize on future opportunities when liquidity returns to the market. For instance, during the quarter, we successfully sold Silverbrook, one of our first acquisitions, at a 4.6% cap rate. This transaction brought in $19.5 million in net proceeds, yielding a 34% levered IRR at a 6.14x multiple on invested capital. We allocated $16 million of the net sales proceeds to reduce the drawn balance on our credit facility to $41 million. At the same time, Timber Creek in Charlotte is under contract for sale for $49 million, and we expect net proceeds of $23.8 million from this sale, which would provide a 25% levered IRR and a 4.3x multiple on invested capital. We anticipate this sale to close in Q4. Lastly, we also plan to sell Old Farm in Houston this year. A replacement buyer has already been found for this asset, and it is under contract for $103 million. This sale is expected to yield $47 million in net proceeds with a 22% levered IRR and a 2.9x multiple on invested capital. The sales of Old Farm and Timber Creek will fully pay down the remaining balance on our credit facility, allowing us to further strengthen our balance sheet, positioning us as fully hedged heading into 2024. That concludes my prepared remarks. I would like to express my gratitude to our teams for their continued efforts in navigating this challenging environment. Back to you, Brian.

That's it. We'll open up for questions.

Okay. Good morning, guys. What's driven the decision to raise the dividend by 10% versus buying back stock or paying down additional debt at this time?

Hey, Kyle. The incremental dividend on a nominal dollar basis is $4 million roughly. And at a current share price of $25, $26, it's about 130,000 shares of stock to repurchase. Our strategy has always been to generate high single-digit same-store NOI growth, earnings growth and dividend growth. We think that's an important aspect of our strategy. Given that we have these dispositions on tap for Q4 and early Q1 to retire all the remaining unhedged debt and enter the '24 year with the ability to reaccelerate earnings. We just thought that was the better use of capital and just an effective tenet of our strategy for the last eight years.

Okay. Thank you. And then related to the Atlanta/Las Vegas markets. You had mentioned last quarter that Atlanta courts opened in Q2. So where do those backlogs stand today versus where they were last quarter?

I think the Atlanta backlog was about 70,000 skips and evictions. Is that right, Bonner?

Across the Atlanta market for seven months this year, it's on about 70,000 evictions. When you look at our AR balances and our actual net bad debt, we've seen, I think, the peak for net bad debt at June of this year. We think that continues to moderate and we close the year sub-3% bad debt there. So it's getting better. It's also getting better in Vegas as well. We've seen, I think, a healthier balance there as well. So getting better. It's been a bit of a struggle, but we see some positive momentum heading into the end of the year in '24.

And then one last one for me. What does unit turnover been for this quarter and last quarter? And where does that compare to historical levels?

Yes. It's been fairly stable in the low 50% range, with turnover in the mid to high 40s and retention in the low 50s. Our approach for Q4 and Q1 is to focus on renewals, and as I noted earlier, we aim to keep any exits to a minimum.

Okay. Thanks, guys. Appreciate it.

Great. Thank you. Appreciate everyone's time. I'll probably see some of you at NAREIT in a few weeks. Thank you.

I would like to thank our speakers for today's presentation, and thank you all for joining us. This now concludes today's call. You may now disconnect.