Earnings Call Transcript - NXRT Q2 2023

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the NexPoint Residential Trust Q2 2023 Conference Call. I would now like to turn the call over to Kristen Thomas. Please go ahead.

Operator, Operator

Thank you. Good day, everyone, and welcome to NexPoint Residential Trust conference call to review the company's results for the second quarter ended June 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 to 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

Thanks, Kristen. Welcome to everyone joining us. I appreciate you participating. I'm going to kick off the call and cover our Q2 and year-to-date results. I'll talk about our updated NAV and then revise guidance before I turn it over to Matt to discuss some of our results and forward guidance in detail. Our results for the second quarter are as follows. Net loss for the second quarter was $4 million or $0.15 per share loss, and that's per diluted share on total revenue of $69.6 million as compared to a net loss of $7.8 million or a $0.30 loss per diluted share in the same period in 2022. That's on total revenue of $65.8 million, which is a 6% increase in revenue. The second quarter NOI was $42 million on 40 properties, compared to $39 million for the second quarter of 2022 on 41 properties, which is an 8% increase in NOI. For the quarter, same-store rent increased 7.9% and same-store occupancy was down 60 basis points to 93.8%. This coupled with an increase in same-store expenses of 7.7% led to an increase in same-store NOI of 7.6% as compared to Q2 2022. As compared to Q1 2023, rents for the second quarter on the same-store portfolio were up 0.7% quarter-over-quarter. We reported second quarter core FFO of $20.4 million or $0.77 per diluted share compared to $0.78 per diluted share in the second quarter of 2022. For the quarter, we completed 505 full and partial renovations, which is an increase of 2.2% from the prior quarter and leased 517 renovated units, achieving an average monthly rent premium of $224 and a 20.9% return on investment during the year, which is in line with our long-term average ROI and renovations. Inception to date, the current portfolio, we've completed 8,736 full and partial upgrades or about 58% of the total units, 5,091 kitchen upgrades, washer dryer installations and 10,753 technology package installations achieving an average monthly rent premium of $161, $49 and $45, respectively, and an ROI of 21%, 66.8% and 35.3%, respectively. NXRT paid a second quarter dividend of $0.42 per common share on June 30th of this year. Results year-to-date for 2023 are as follows. Net loss year-to-date was $7.8 million or a $0.31 loss per diluted share on total revenue of $138.8 million as compared to a net loss of $12.5 million or a $0.49 loss per diluted share in the same period in 2022. On total revenue of $126.6 million, which is an increase of 10% in revenue over the prior year. Year-to-date, NOI was $83.1 million on 40 properties as compared to $75.6 million on 40 properties for the same period in 2022 or an increase of 10%. Year-to-date same-store rent increased 7.9% and same-store occupancy was down 70 basis points to 93.7%. This, coupled with an increase in same-store expenses of 11.2% led to an increase in same-store NOI of 8.5% as compared to the same period in 2022. We reported year-to-date core FFO of $39 million or $1.49 per diluted share compared to $1.54 per diluted share in the six months ended June 30, 2022. For our NAV per share based on the current estimate of cap rates in our markets and forward NOI we’re reporting an NAV range as follows: $64.9 on the low end, $72.51 on the high end and $68.30 at the midpoint. These are based on average cap rates ranging from 5% on the low end to 5.3% on the high end, which remains unchanged from last quarter. To wrap up my comments, I'll go through full year 2023 guidance, which we're revising as follows; core FFO per diluted share, $2.90 on the low end; $3.05 on the high end with a midpoint of $2.98. Same-store revenue, 8.3% on the low end, 9.4% on the high end, and 8.8% at the midpoint. Same-store expenses, 7.3% on the low end, 6.8% on the high end, for a midpoint of 7% and same-store NOI is 9% on the low end, 11% on the high end with a midpoint of 10%. Our core FFO decrease from prior quarter guidance is based primarily on the Houston asset, which did not sell in the second quarter as we thought it would. But Matt's got more details on that and the other guidance. So with that, I'll turn it over to him.

Matt McGraner, CIO

Thanks, Brian. Let me start by going over our second quarter same-store operational results. Same-store effective rents ended the quarter at $1,510 per month per unit, up 7.9% year-over-year, with 9 out of our 10 markets averaging at least 5.1% growth. While our Florida markets led the way with Tampa at 12.9%, South Florida at 11.7% and Orlando at 11.5%. Our national assets just missed 10% growth, registering 9.8% over the prior year quarter. Same-store rental revenue growth was 7.6% for the period with a healthy 5.9% earn-in benefit from prior periods. Our Florida markets again paced the field at 12.8%, 12.2% and 11.1%, respectively, for South Florida, Tampa and Orlando. Again, 9 out of our 10 markets achieved at least 5.2% rental growth over the prior period. Renewal conversions were 60% for the quarter, with 7 out of our 11 markets executing renewal rate growth of at least 3.5%. Raleigh is at 6.4%, Orlando was at 4.8%, Dallas-Fort Worth was at 4.7%, Tampa at 4.3% and Atlanta at 3.99%. We're also pleased to report some moderating expense growth for the quarter. Second quarter same-store operating expenses were 7.7% higher year-over-year, a significant reduction from the 15.1% growth reported in Q1. Payroll growth was down from 15.3% in Q1 to 6.9% in Q2. Repairs and maintenance expense growth was more than halved from 22.4% down to 10% this quarter and real estate taxes were down to 8.1% from 15.7%. After that, insurance expense saw some relief as well after our April 1 renewal, realizing only 4% growth over the prior year period. Seven out of our 10 same-store markets achieved year-over-year NOI growth of 7.6% or greater, while South Florida set the tone at 14.4%. Our Q2 same-store NOI margin registered a healthy 6.4% while rent-to-income ratios continue to hold steady at a healthy 22% of household income. For the second half of the year, as Brian mentioned, we think revenue will moderate faster than we anticipated, mostly due to increased bad debt and higher vacancy. That said, we believe this moderation will be largely offset by expense savings in several categories, including labor, utilities and taxes, leading to a full year same-store NOI guidance of 9% to 11%, which should be at the top of the multifamily REIT peer group. Turning to capital markets activities, as you know, in November of 2022, we refinanced 22 properties and lowered our weighted average floating rate spreads while pushing out our maturity wall to another seven plus years. In total, we paid down $278 million of our corporate facility, which was and still is our highest cost of capital. The current balance of the credit facility is $57 million. As you also know, we've been working to dispose of our remaining two Houston assets to exit the market as it has been one of our lowest growth markets for some time due to continued high inventory, newly developed assets and non-controllable expense pressures. Our buyer for Old Farm in Stone Creek got caught between some regulatory uncertainty with the Houston Housing Authority, which it was relying on for some tax subsidies to complete the sale. Ultimately, they could not obtain approval and forfeited $250,000 of earnest money to us earlier this month. The good news is we are negotiating the sale to a repeat counterparty right now at approximately $103 million with $500,000 of nonrefundable earnest money day one with an outside closing date of October 1. In the meantime, we have re-launched Stone Creek, the smaller, more liquid of the two, and expect to transact on this asset in the fourth quarter at approximately $27 million, which combined with our Stone Creek and Old Farm, is in line with where we were with the last buyer. Also in the meantime and due to a scarcity premium in the market, we recently launched the marketing of two legacy Charlotte assets, Timber Creek and Radbourne Lake. These assets have been held in the portfolio for nine years or more and are expected to provide healthy returns in excess of 25% IRRs and 4.5 to 6 times multiples on invested capital. Between these multiple sale processes, we plan on retiring the remaining $57 million of the corporate facility as planned as well as paying off the first mortgage on Hudson High House, our highest cost of debt outside of the corporate credit facility. Following these paydowns, these dispositions will generate approximately $25 million of excess additional proceeds to buy back stock or complete 1031 exchanges. We believe these dispositions are reflected in our updated guidance range and set us up extremely well to resume double-digit growth in core FFO in 2024. That's all I have for prepared remarks. I appreciate our team's work here at NexPoint BH. And I'd like to turn it over to the operator for questions.

Operator, Operator

The floor is now open for your questions. Our first question comes from Rob Stevenson from Janney Montgomery Scott. Please go ahead.

Unidentified Analyst, Analyst

Good morning, guys. It's Kyle on for Rob today. So how are you thinking about the uses of any disposition proceeds today? So I saw you reduced your acquisition guidance by $50 million. But is it going to be more to reduce debt, repurchase common stock from the value-add program going forward?

Matt McGraner, CIO

Yes. It's Matt, Kyle. We're primarily focused on retiring the $57 million of the credit facility first and foremost with the first disposition proceeds that we get in. And then the second, as I mentioned, is to retire, I think, roughly mid- to high-6s debt on Hudson House. So those two uses will be the primary first two uses of any disposition proceeds. To the extent that there's that $25 million left over after I mentioned from the Charlotte assets, depending on where our stock trades, we would probably look to buy back at these levels where we are today. And then to the extent we sell any more assets, which potentially we're thinking about maybe some Dallas assets in the latter half of the year as well, we've looked at 1031 exchanges for those in the early part of next year.

Unidentified Analyst, Analyst

Okay. Thank you for that. And then are you guys seeing any meaningful uptick in move-outs due to price increases across the portfolio?

Matt McGraner, CIO

I wouldn't say it's any more significant than normal. There are a massive amount of supply deliveries hitting in the second and third quarter and in the fourth quarter this year, after which it moderates significantly. But I'd say from our perspective, it feels fine. We're not really getting that much pushback. There is a little bit of competition from concessions from new supply in places like Phoenix. But other than that, we feel pretty good about where our residents' rent-to-income ratios are and the traffic we're seeing.

Unidentified Analyst, Analyst

Thank you. That's all for me.

Operator, Operator

Our next question comes from the line of Michael Lewis from Truist Securities. Please go ahead.

Michael Lewis, Analyst

Great. Thank you. So you guys did 8.5% same-store revenue growth in the first half of the year and your full-year guidance is 8.9%. So we've talked about this before. That still seems aggressive to me to expect a little bit of acceleration in year-over-year same-store revenue growth in the back half of the year. I'm just curious what gives you kind of confidence to guide to that to my knowledge, nobody else is.

Matt McGraner, CIO

Yes. I mean, we think that notwithstanding the fact that revenue growth was 7.9%, in the latter half of the year, particularly in the fourth quarter, we see an uptick and also a compelling comparison there. A lot of the earn-in benefit is going to hit in the second and third quarters, and then we'll have a pretty good comparison in the fourth quarter on the revenue side. So we're starting from a position of strength, I'd say, for the second half of the year. And we think that the moderation of inventories that we're seeing hit in the first, second, and third quarters will lead to more demand for our assets.

Michael Lewis, Analyst

Okay. I noticed you had 14,100 same-store units this quarter compared to 13,500 in the first quarter. I understand that other apartment REITs typically keep the same-store pool constant for the year unless there's a sale. Will there be an increase in the second half that is related to properties entering and exiting the same-store pool, which might be challenging for me to model?

Matt McGraner, CIO

Yes, the inclusion of Charlotte will likely contribute some upward tick in the same-store pool. So, yes, that's probably the difference.

Michael Lewis, Analyst

Okay. Got you. And then just lastly for me, kind of following up on the first question you were asked about the disposition proceeds. You listed off three near-term uses for those. I know this is far out in the future, and I keep kind of harping on it. I look at those 2026 hedges burning off; is there a thought to maybe start working on that now to kind of get the leverage down before you have to deal with those? None of us know what rates will be when that time comes. But maybe it can never be too early to take a look at those because it does look like it could be a significant headwind. So should we expect more dispositions to try to address that over the next couple of years?

Matt McGraner, CIO

Yes, that's a good point. Once again, the situation is quite uncertain, as is the decision-making process of our policymakers. As I mentioned, we plan to use the proceeds from Charlotte to pay off one of our first mortgages on one of our assets, which will free that asset from any encumbrances. Furthermore, we have plans to potentially sell three additional assets in Dallas either in the second half of this year or early next year, aiming to generate approximately $180 million. If we proceed with that, as I indicated during the prepared remarks, 2024 is poised to be a very strong year for core FFO growth and would help lower our net debt to EBITDA into the high single digits from its current level. This will be a priority for us. We believe we can both reduce our debt while boosting earnings. Additionally, we will look to minimize our leverage while also, as much as possible, taking advantage of extending our out year swaps.

Michael Lewis, Analyst

Great. Thank you.

Operator, Operator

Our final question comes from the line of Buck Horne from Raymond James. Please go ahead.

Buck Horne, Analyst

Hey. Good morning, guys. You mentioned as part of the revenue guidance reduction, things like bad debt expense as well as the occupancy pressure. I was wondering if you could just add a little color in terms of what you're seeing regarding bad debt trends and how you expect the back half of the year to play out?

Matt McGraner, CIO

Due to the change in rental income, we are facing around $1 million in bad debt, a couple of million in reduction of gross potential rent from moderating market rents, and an additional $1.5 million in vacancy loss, mostly related to bad debt. This situation is primarily driven by a couple of markets, particularly Las Vegas and Atlanta. Atlanta recently reopened their courts, which resulted in a spike in skips and evictions in the second quarter. This development caught us somewhat off guard. However, we will work on moving those tenants out and re-leasing the properties. These two markets are the main drivers of the current situation.

Buck Horne, Analyst

Okay. That makes a little bit of sense, given the court systems there. And just in terms of the occupancy pressure that you may be feeling from new supply. I guess part of the thesis here was that your average price points were so far below kind of the incoming level of new supply, so it's a little surprising to hear you guys comment that there are new assets that are offering concessions that are pulling away some demand from you guys. Can you characterize that a little bit further, or how are you seeing the new supply in your markets compete against your properties specifically?

Matt McGraner, CIO

Yeah. I mean it's not across the board, right? Some average effective rents are $1,100, $1,200 with headroom of $400, $500. I was more isolating it to the couple of markets where we're seeing massive deliveries right now in some markets that compete. We're at an average effective rent, for example, at one of our nicer B-plus assets in Phoenix at $1,400, $1,500 in rent, and you have a new lease-up deal that should have a $2,300, $2,400 effective rent but they're giving away 8 to 12 months free, which will push that down to $1,800 effective, $1,800, $1,900 effective, which will put a little bit of pressure on a specific time on that asset. That's the example I'm seeing. Otherwise, we feel pretty good about our price point relative to the market and our continued thesis. But I didn't mean to suggest that this was like a big tide of concern for our company in particular. I would expect that the other peers in the group with new assets would feel more than we are.

Buck Horne, Analyst

Okay. That's helpful. And one last question regarding expenses. What are your expectations for property taxes, especially with the insurance renewal scheduled for April 1? Congratulations on securing that. I'm also curious about the initial assessments you're seeing for 2023 taxes, particularly in the Texas markets and counties. Additionally, how do you foresee the rest of the year shaping up regarding those assessments?

Brian Mitts, CFO

Yes. So we lowered our expectations for taxes. I think we were in the low teens to start the year with some conservatism in budgeting. Given what we know today, that number at the midpoint is 10%. So we're seeing about 300 basis points. We saw some settlements. We had long-standing litigation for Houston assets from '21 and '22. We recognized a little over $700,000 on those litigations. So that's a little bit of a pickup there. In terms of what we're seeing for the Texas market specifically, we're into the appraisal review boards for the protest there. It's a fight like it is every year. I think that we started the year with a pretty conservative budget expectation, and we're going to continue to fight that. I don't know that we will have everything settled by the end of the year. But I think it is shaping up to be a little bit more favorable for us. Obviously, we've seen cap rates expand from where they were. So the argument that values as of January 1, 2023, are down year-over-year is pretty compelling, and we're trying to use that with our consultants to really realize that release.

Buck Horne, Analyst

Okay. All right. Appreciate the color. Thanks for the time guys.

Operator, Operator

I would now like to turn the call over to the management team for closing remarks.

Brian Mitts, CFO

I don't think we have any additional remarks. I appreciate everyone's time, and we'll be in touch and talk to you next quarter. Thank you.

Operator, Operator

Thank you, ladies and gentlemen. This does conclude today's call. Thank you for your participation. You may now disconnect.