Earnings Call Transcript - NXRT Q1 2024

Operator, Operator

Good day. My name is Ellie, and I will be your conference operator for today. At this time, I'd like to welcome everyone to the NexPoint Residential Trust First quarter 2024 Earnings Call. I'd now like to hand over the call to Kristen Thomas, Investor Relations. You may now begin the conference.

Kristen Thomas, Investor Relations

Thank you. Good day, everyone, and welcome to the NexPoint Residential Trust conference call to review the company's results for the first quarter ended March 31, 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 McDermett, 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, CFO

Thank you, Kristen, and welcome to everyone joining us this morning. I'm Brian Mitts, and I'm joined today by Matt McGraner and Bonner McDermett. I will begin by covering our Q1 results, our updated NAV, and our guidance for the rest of the year, which we are reaffirming. After that, I will hand over to Matt and Bonner to discuss the specifics of our performance and guidance. Our Q1 results are as follows: Net income for the first quarter was $26.3 million or $1 per diluted share, with total revenue of $67.5 million. This includes a $31.7 million gain from the sale of Old Farm, which was completed on March 1, 2024. The $26.3 million net income for this quarter compares to a net loss of $4 million, or $0.15 per diluted share, for the same period in 2023, on total revenue of $69.2 million. For the first quarter of 2024, NOI was $41.1 million across 37 properties, compared to $41.1 million for the same quarter in 2023 across 40 properties. During this quarter, same-store rent decreased by 0.4%, while same-store occupancy increased by 0.3% to 94.7%. This, along with a $3.6 million increase in same-store expenses, equated to a 1.8% rise in expenses, while same-store NOI increased by 4% compared to Q1 2023. Compared to Q4 2023, rents for Q1 2024 in the same-store portfolio declined by 0.1% or $2 sequentially. Reported Q1 core FFO was $19.6 million or $0.75 per diluted share, which compares to $0.71 per diluted share in Q1 2023. During the first quarter, we completed a total of 59 full and partial upgrades and leased 59 upgraded units, achieving an average monthly rent premium of $240 and a 21.8% return on investment. Since inception, properties currently in our portfolio have undergone 8,593 full and partial renovations, 4,829 kitchen and laundry plant appliance installations, and 11,614 technology packages, resulting in average monthly rent increases of $170, $39, and $43 per unit, with returns on investment of 20.9%, 51.4%, and 37.8%, respectively. NXRT paid a first-quarter dividend of $0.46 per share on common stock on March 28, 2024. Since inception, we have increased our dividend by 124.5%. For Q1, our dividend was covered 1.61 times by core FFO, resulting in a payout ratio of 56.3%. During this quarter, NXRT completed the sale of Old Farm for $103 million, generating $49.4 million in net sales proceeds, a 22.1% levered IRR, and a 2.98x return on invested capital. On March 5, 2024, NXRT fully repaid the remaining balance of $24 million on its corporate credit facility. As of March 31, 2024, we had $37.1 million in cash and $335 million in available liquidity on the corporate credit facility. We are also pleased to announce that we are scheduled to complete the sale of Radbourne Lake in Charlotte, North Carolina later today, with gross sales proceeds of $39.25 million. This sale is expected to eliminate $20 million in property-level debt and generate $18.8 million in net sales proceeds, with an anticipated 19.3% levered IRR and a 3.64x return on invested capital. Given the success of our recent pending sales and our increasing liquidity position, we also see an attractive public-private market arbitrage opportunity, with our stock trading above a 7% implied cap rate compared to mid- to upper fives for private market transactions. It's worth noting Blackstone's recent purchase of AIR Communities. We have initiated a share buyback program to acquire up to $25 million in our shares. So far this quarter, we have bought approximately 8.5 million shares at an average price of $31.75 per share, which represents approximately a 40% discount to the midpoint of our Q1 NAV estimate. As for our NAV, based on current cap rate estimates in our markets and forward NOI, we're reporting an NAV per share ranging from $45.91 at the low end to $58.97 at the high end, resulting in a midpoint of $52.44. These estimates are based on average cap rates of 5.5% at the low end and 6% at the high end, which have remained stable quarter-over-quarter. Moving to our guidance, NXRT is reaffirming our 2024 guidance ranges for earnings per diluted share, core FFO per diluted share, same-store rental income, same-store total revenue, same-store total expenses, same-store NOI, and interest expense along with its components. The guidance includes core FFO per diluted share ranging from $2.60 to $2.85, with a midpoint of $2.72; same-store rental income increasing by 1.4% at the low end to 3.2% at the high end, achieving a midpoint increase of 2.3%; and same-store NOI showing a decline of 2% at the low end to a 2% increase at the high end, with a midpoint of 0%. That wraps up my prepared remarks. Now I'll turn it over to Matt and Bonner for their commentary.

Matthew McGraner, CIO

Thanks, Brian. Let me start by going over our first quarter same-store operational results. Same-store rental revenue was 3.6% for the quarter, with 7 out of our 10 markets averaging at least 3% growth with our Charlotte and South Florida assets leading the way at 8.6% and 7.6% growth, respectively. We're also pleased to report some continued moderation in expense growth for the quarter. First quarter same-store operating expenses were up just 1.9% year-over-year. Of note, marketing and payroll declined 8.4% and 6.2% respectively year-over-year, and R&M expense growth continued to moderate just up 2.9% from the first quarter of 2023. Five out of our ten markets achieved year-over-year NOI growth of at least 5.9% or greater, with Orlando and South Florida leading the way at 12.3% and 9.9% growth, respectively. Our Q1 same-store NOI margin registered a healthy 61.9%. That's up 24 basis points from the prior year. Now turning to components of Q1 performance. With peak deliveries in most of our markets occurring in Q3 of this year, as detailed on Page 5 of the supplemental, we continue to focus our operational efforts on maximizing resident retention, reducing our exposure to rising turnover costs and further centralizing labor. Maintaining and building occupancy has remained a key focus. The portfolio registered 94.6% occupancy to close the quarter. And as of this morning, the portfolio is 94.7% occupied and 93% leased. On the rental revenue side, new lease growth remains constrained due to near-term concentrated supply in our markets, but there are signs that the deceleration in new lease growth is bottoming. New leases for the quarter improved 130 basis points to negative 6.5% from negative 7.8% quarter-over-quarter. And April is trending better than Q1 by 80 basis points. Renewals are also positive for the quarter at 92 basis points and have accelerated sequentially since the third quarter of last year to 1.4% as we said in April. Bad debt is also trending in a positive direction, improving quarter-over-quarter. Q3 2023 was 3.2%. Q4 was 2% and Q1 was down to 1.8%, trending approximately 90 basis points better than our expectations. On the value-add front, during the first quarter, as Brian said, we completed 59 full and partial interior upgrades, achieving an average monthly rent premium of $240 and 21.8% ROI. We also installed 68 washer and dryer sets for an average monthly rent premium of $48 and a 54.6% ROI. Lastly, we completed bespoke upgrades on an additional 55 units with average rent premiums of $56 per unit. And for the remainder of 2024, we intend to complete an additional 352 full or partial upgrade interior upgrades, 465 washer and dryer sets and 318 bespoke upgrades in units where we see demand to drive rental income. On the expense side, we completed our insurance renewal at the end of March, and I'm happy to report that our premiums will remain flat, which aligns with our midpoint guidance expectations. On the transaction front, we continue to actively monitor the investment sales market for opportunities and price discovery. While apartment transaction volume is at the lowest point in the past decade, over the last 60 days, private equity investors have aggressively priced over $15 billion of housing product in the low five in-place cap rate range. Over $240 billion of North American focused real estate closed-end fund dry powder remains on the sidelines in search of 13% to 20% levered IRRs according to industry estimates. Against this backdrop, and even with the near-term elevated supply picture, our strategically positioned Sunbelt Portfolio screens attractively, particularly given in our in-migration and demographic backdrop. Indeed, as you can see from the supplemental according to Costar, one out of every two jobs are expected to be created in NXRT markets through 2027. Now with the sale of Old Farm closed and with the closing of Radbourne later today, we will have roughly $36 million of cash to continue to buy back shares and/or pay down debt. And given our current cost of capital, we have prioritized this balance sheet cleanup and share buybacks over external growth pursuits. At current levels, NXRT's implied cap rate remains north of 7.5% and with a constructive view on when supply will wane, we believe repurchasing our shares at these levels makes the most sense. In closing, we are happy with the start of 2024 through late April. We will remain focused on occupancy and controlling expenses to maximize NOI growth. In the long term, we remain bullish on our Sunbelt market as we expect to outpace northern and coastal cities and population, job and wage growth. In the short term, we expect to see modest growth, specifically in the second half of the year as supply growth begins to decline. That's all I have for prepared remarks. Thanks to our teams here at NexPoint BH for continuing to execute. Now I'd like to turn it over to the operator for Q&A.

Operator, Operator

Our first question comes from Kyle Katorincek from Janney.

Kyle Katorincek, Analyst

What does concession usage look like across the portfolio? Is concession usage picking up in April versus Q1 '24?

Matthew McGraner, CIO

Yes. I don't have anything to add, but concession usage is expected to increase in the second quarter and continue into the third quarter before decreasing in the fourth quarter. This is one reason we are maintaining our guidance until July, allowing us to better understand how supply affects market rents. We believe that blended rents have likely stabilized. The use of concessions, such as providing a couple of weeks free or waiving normal fees, has started to decrease. While we are still factoring this into our plans, we hope to avoid needing concessions in the future.

Bonner McDermott, VP, Asset and Investment Management

Yes. And just to quantify it a little bit. So first quarter concession use was about 24 basis points on TPR. It's not in every market. We see it more in the high supply markets. Having been out and seeing some sites, we're talking more in a couple of areas of Phoenix, a couple of areas of Charlotte. Broadly, areas where we have more new supply delivering. There's sort of a market expectation for a concession, but we're trying to maintain about 2 to 4 weeks free where the new development, particularly in the highest supplied areas, are two and even after three months free.

Kyle Katorincek, Analyst

Okay. And then how far are you guys to the various upgrade opportunities within the portfolio? Just trying to get a sense of the runway left ahead of you versus all the units you've already done. Are you basically done with the technology package upgrades at this point, having done more than 12,000 of them?

Matthew McGraner, CIO

Yes. We're basically done with the tech packages. There's low-hanging fruit, as we mentioned, on the washer and dryers, which we will hit this year. And then as it relates to the full interior package, we go in and audit on an annual basis what kind of bespoke upgrades we can do. And then tailor-make those upgrades as we go throughout the year, depending on how the asset, in particular, is performing. But as kind of like a Gen 2, I think we have roughly 5,000 to 5,500 units still to do, which gives us another about 1.5 to 2 years of internal growth to go pursue as the supply picture wins, and we can be more competitive. That's another key component why we've paused and hit the brakes a little bit versus years prior. But as the supply starts to dissipate in Q4 and certainly into '25, you'll see us ramp those upgrades pretty quickly.

Operator, Operator

Our next question comes from Tayo Okusanya from Deutsche Bank.

Omotayo Okusanya, Analyst

Wow, Deutsche Bank. Okay. So a quick question on guidance. Again, very strong quarter, again, understand you're going to have the asset sales, which are somewhat dilutive to earnings as the year progresses. Could you walk us through, again, 4% same-store NOI in Q1, but full year guidance somewhere between negative 2% and 2%. Again, what's causing some of that deceleration? Is it just overall concerns about supply and the impact on portfolio performance? And then also just guidance range still remains pretty wide. So is the thought to get through the spring leasing season, have better clarity, and then maybe at that point, start to narrow the guidance range?

Matthew McGraner, CIO

Yes, that's exactly right, Tayo. We feel positive about our first quarter results. Absorption exceeded our expectations. Bad debt was 90 basis points better than anticipated and occupancy also surpassed our projections. Renewal rates are around negative 5% to 6% on new leases. As we move into the second and third quarters, we're still forecasting a slight increase to lease, and for gross potential rent, we're projecting a decrease of another 90 basis points in the second quarter, followed by a sequential decrease of 40 basis points in the third quarter and another 90 basis points in the fourth quarter. If that trend changes, we would be pleased to report a more refined range and possibly raise our guidance as we advance through the second quarter. This caution is the main reason for our current approach.

Omotayo Okusanya, Analyst

Got you, that's helpful. If I could ask one more question, regarding the swaps that will expire this year, around $385 million worth. How should we consider their current favorable position as they expire? Will you be replacing them with new swaps at higher rates or switching to floating rate debt?

Matthew McGraner, CIO

Yes, that's a great question. We focused on this in the first quarter and are closely monitoring the changes in interest rates. From our perspective, it doesn’t seem like the right time to add more swaps given that we believe interest rates are at their peak. The situation isn’t as dire as some may think. Our analysis indicates that we only need to achieve a compounded annual growth rate in net operating income of 5% over the next two years to maintain current funds from operations levels as all our swaps expire. This is assuming we can refinance our debt at the 5% rate. If we can achieve a higher growth rate, which we have historically done at rates of 6%, 7%, or 8%, and secure our debt at a rate lower than 5%, we could potentially reach a core funds from operations of around $3. Therefore, we will continue to monitor the yield curve. As rent growth slows, we expect these numbers to be reflected in the consumer price index, potentially leading to some easing. When that occurs, we’ll reassess our calculations. Importantly, we believe the company can grow same-store net operating income in the mid- to high single digits moving forward, particularly as supply diminishes, which is clear from the supplemental materials detailing upcoming deliveries in our submarkets. There will be no new supply in 2026, and by that time, our swaps will have expired. I expect our equity cost of capital to improve, and/or the company’s value to be higher than it is today.

Omotayo Okusanya, Analyst

Got you. And then what do you think you can actually raise fixed-rate paper today, whether it's 5-year or 10-year, unsecured?

Matthew McGraner, CIO

We don't have an unsecured rating, so that's not relevant for us. Fannie Freddie debt is currently priced in the 6% range for a 10-year fixed rate. As a selected sponsor of Freddie, we could probably do a bit better in the mid-5s, but that's the current situation if we were to attempt to improve everything.

Operator, Operator

Our next question comes from Barry Oxford from Colliers.

Barry Oxford, Analyst

On the interest line item quarter-over-quarter, can you talk about what drove the interest line item to be down as much as it was? And how should we think about that going forward?

Matthew McGraner, CIO

Yeah, Bonner, you can take that one.

Bonner McDermott, VP, Asset and Investment Management

Yes. I think given what we thought we were looking at the end of the year, looking at the forward curve, obviously, it was priced in a pretty significant amount, you know, five cuts. We were talking in Q4. Now that market is somewhere around two cuts, plus or minus. The SOFR curve at year-end is significantly steeper than it was expected to be when we talked two months ago. That has an impact on the fair value of the swaps. So there's some noncash mark-to-market activity that I think was a little bit more significant than we estimated. We got a benefit in the first quarter from that. I think that's the biggest differential you're probably seeing in the interest expense line.

Barry Oxford, Analyst

Right. So with the adjustments in the swap value?

Bonner McDermott, VP, Asset and Investment Management

That's right.

Barry Oxford, Analyst

Right. Okay. No, great. It's kind of what I thought it was, given your previous comments. But switching gears, you indicated that you were looking to buy back shares. Are you prioritizing the buyback of shares over acquisitions or not necessarily you could be doing both of them at the same time?

Matthew McGraner, CIO

Yeah, we're prioritizing the buybacks as it sits today because there's still a clear gap between public and private market values, like significance. Almost 150 to 200 basis points as it relates to our company. The Blackstone AIRC deal was 5.9% headline cap rate, but if you dig into it, it's 5.3%. That's a big bet. We can't find anything in the market, and the transaction volume is, again, the lowest it's ever been in the last decade. So it makes sense to buy a portfolio that we know and love in the sevens.

Operator, Operator

No further questions as of the moment. I'd now like to hand back over to the management for the final remarks.

Brian Mitts, CFO

Nothing further from us. I appreciate everyone's time and thoughtful questions. And we'll speak next quarter. Thank you.

Operator, Operator

Thank you, everyone, for attending today's call. We hope that you have a wonderful day. Stay safe, and you may now all disconnect.