NREF - NexPoint Real Estate Finance: Continuing With Its High Yield Low Risk Policy

2023-06-26 17:14:54 ET

Summary

• Instead of acquiring assets itself, NexPoint Real Estate Finance, Inc. buys investment securities (loans) tied to stabilized single family and multi-family properties.
• During the last three years, NexPoint generated strong interest income and cash flow in order to offer strong & steady payouts, resulting in double-digit yields.
• Investors can be assured of steady interest income, due to NexPoint’s high average coupon of 5.84 percent and a weighted average maturity of 5.4 years.
• Although, NexPoint's stock has lost 17.4 percent since the launch of its IPO back in 2020, since covid-19 market crash, NexPoint’s price has increased manyfold.

~ by Snehasish Chaudhuri, MBA (Finance).

Last time I covered NexPoint Real Estate Finance, Inc. ( NREF ) almost a year back, this mortgage real estate investment trust ("mREIT") was doing quite well. It had recorded steady price growth during the entire pandemic period, and paid steady quarterly dividends along with a high yield, for the 10 quarters it had existed by that time. That time, I expected NREF to generate strong interest income based on its portfolio of multifamily properties and SRFs. As a result of which, I assumed that this company would be able to generate sufficient earnings to continue paying such a steady dividend. One year later, I’d like to find out how much this fund has been able to fulfill my expectations, and will take a call on the same.

Since The Very Beginning, NREF Was Focused On Generating Earnings & Cash Flows

NexPoint Real Estate Finance has a market capitalization of $337 million and is trading around $15. The company went public in 2020, and from the very beginning, it has been focused on creating cash flow for its investors. The business model of NexPoint is rather interesting, but fairly simplistic. Instead of acquiring assets itself, it buys investment securities tied to them. In large part, it focuses on acquiring assets that are tied to stabilized properties. NREF deals on single-family and multi-family properties located in 50 metropolitan statistical areas. Almost three-fifth of its investments are in single-family rental assets. Again, three-fifth of its assets are classified as senior loans. This means that the company carries a fairly low amount of risk with these assets, since they have first claim on them should a default occur.

Mortgages In Multifamily Properties As Well As In SFR Are Sold To Freddie Mac

NexPoint Real Estate Finance is a mREIT that provides structured financing solutions in residential real estate, mainly in mid-sized multi-family properties and single family rentals ((SFR)). Securitized mortgages in multifamily properties as well as in SFR are sold to Freddie Mac. Freddie Mac does not lend money directly to borrowers, and by selling mortgage loans to them, lenders like NREF receive money that they can further lend out. This arrangement with Freddie Mac reduces risk to a larger extent. This mREIT generally targets lending or investing in stable properties with an objective to generate attractive, risk-adjusted returns for stockholders over the long term.

Selling Mortgage Loans To Freddie Mac Reduces Risk & Enhances Liquidity

During my last coverage, I discussed that historically, debts issued by Freddie Mac that were secured by multifamily assets or single family rentals have incurred lower losses, even during the periods of market stress. Both SFR loans and multifamily loans were subject to Freddie Mac forbearance scheme, which helped in mitigating cash flow interruptions to the bondholders. In addition, over the years, NREF was able to maintain an adequate debt service coverage ratio ((DSCR)). A year ago, the DSCR stood at 1.87. As the securitized mortgages in multifamily properties as well as SRFs were sold to Freddie Mac, it enhanced NREF's liquidity and its DSCR, as well as reduced its default risk.

So Far, NREF Had A Strong & Steady Pay-out, Well-Supported By Its Earnings

Since the company has a very small operating history, it is difficult to have a long-term view about this mREIT. However, during the last three years, the company generated strong net interest income and adequate cash flow in order to pay the kind of dividend it paid. It paid quarterly dividends for the last 14 quarters, and has been able to increase the pay-out despite the impact of covid-19 pandemic and the conflict between Russian & Ukraine. The economic uncertainties had little impact on payouts, and subsequently NREF’s yield has increased. Its yield also increased in 2023 due to a special dividend of $0.375 per share. The quarterly payout has gradually ranged from $0.22 to $0.5 at present. Moreover, there has not been a single instance of slashing dividends.

Unfortunately, NREF’s Price Performance Has Been Disappointing For Its Investors

NREF’s shares today are trading at three times operating cash flow and 30 times its quarterly dividend. But more likely than not, investors care about something else. They are interested in the amount of cash that management will pay out. Given the history of the payouts, I assume the future yields will be somewhere close to 10 percent. It generated year-end yields of 10.1 percent and 12.9 percent during 2021 and 2022, respectively. Average yield generated in 2023 is 13.8 percent. So, by investing in NREF’s stock, investors have the opportunity to capture upside value created by the firm. However, that has not been the case so far. Price dropped by 26 percent during the past 12 months, and 17.4 percent since the launch of its initial public offering back in 2020.

Since Covid-19, NREF’s Stock Has Recovered And Prices Have Increased Manyfold

Probable causes behind such negative price growth can be many ranging from lack of investors’ confidence to the uncertainty surrounding the current economic scenario. However, NREF as a company seems to be fundamentally a good one. Availability of an alternative in the form of 8.5 percent cumulative redeemable preferred stock ( NREF.PA ), could be a reason. Investors might be getting attracted to preferred stock due to its liquidation preference and the priority in dividend distribution over common shareholders.

Another probable reason for such poor price growth is the historical bottom price reached during covid-19 pandemic market crash. NREF’s stock was launched at $18.58 on February 07, 2020. But the price crashed to $6.2 on March 24, 2020. Since that covid-19 market crash, the stock has recovered and prices have increased manyfold. Today’s price is almost 2.5 times that of the historical bottom.

Investment Thesis

NexPoint Real Estate Finance, Inc.’s dividends are well supported by its earnings, and the same is expected in the coming quarters. It has a high average coupon of 5.84 percent on its entire loan portfolio, with a weighted average maturity of 5.4 years. Investors thus can be confident of steady interest income for the next few quarters. NexPoint Real Estate Finance doesn't have any solvency issue as it has been able to sufficiently cover its debt services. The average coupon size as well as the remaining maturity of the mortgage loans, also make me hopeful about the future growth prospects of this mREIT. Despite NexPoint Real Estate Finance, Inc.'s poor price growth, I would suggest income-seeking investors to hold this stock for another few quarters.

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