NXRT - NexPoint Residential: Property Level Strength Is Offset By Rising Interest Burden

2023-07-31 13:55:46 ET

Summary

• Owner and operator of "value-add" multifamily properties, NexPoint Residential, reported Q2 results that were met with disappointment.
• Though the REIT reported strong performance at the property level, earnings growth was hamstrung by a higher interest burden.
• The higher interest expense combined with a pull-back in expectations for same-property growth led to negative revisions in full-year guidance.
• Though shares continue to trade at a discount to their estimated net asset value, I continue to view shares as a "hold."

NexPoint Residential ( NXRT ) outshines their peers in same-property net operating income ("NOI") growth, led by the sizzling Florida market. But their significantly higher debt burden is weighing on their earnings potential. Though shares trade at a discount to their estimated net asset value ("NAV"), I view the stock as reasonably valued at current pricing levels.

NexPoint Residential's Q2 Results

NXRT reported total overall Q2 revenue growth of 5.8%, in line with expectations. In the same-store population, rental income was up 7.6% and operating expenses were up 7.7%. Despite the greater expense growth, same-store NOI was up 7.6% YOY.

Same-store occupancy ticked down 60 basis points ("bps") as average rent per unit grew 7.9%. The occupancy figures varied by region. In Phoenix and Las Vegas, for example, occupancy was up 290bps and 140bps, respectively.

But in markets such as Atlanta and Nashville, NXRT lost 340bps and 270bps in occupancy. This came as effective rents increased by 7.1% and 9.8% in the two markets. This compares to a lower degree of rental growth of 5.4% in Phoenix and an even lower 0.7% growth in Las Vegas.

Despite the upper-single-digit growth in NOI, core FFO was essentially flat from last year, mostly due to higher interest expense.

The higher interest expense also led to negative revisions in the full-year outlook. Looking ahead , NXRT sees full-year interest at a midpoint of +$67.7M. This is up +$3.5M from the prior midpoint. Combined with a pullback in expectations for growth in the same-store population, core FFO is now seen at a midpoint of $2.98/share. This is down from the prior midpoint of $3.06/share.

Shares have been on a downtrend since the release and are now down about 8% over the past month. This brings their losses YTD and over the past year to 3% and 37%, respectively.

Key Takeaways Of NXRT's Q2 Results

Same-Store NOI Strength

NXRT has historically outperformed their peer set in same-store NOI growth. Forward guidance is a continued reflection of this. For the full year, NXRT is expecting 10% same-store growth. This compares to others, such as Independence Realty ( IRT ), who recently guided for 6.5% growth.

One significant factor is NXRT's large presence in Florida. In Q2, NXRT counted approximately 14K units in their same-store population, over a quarter of which were in Florida.

It's important because monthly rent runs $300 over the portfolio average. YOY, rents were up just under 12%. And total rental revenues were up a corresponding 12.3%. At its current weighting, the gains out of Florida contributed nearly 400bps to NXRT's total quarterly rental growth.

IRT didn't have quite as much uplift in their markets. On their side, their greater exposure is in the Atlanta and Dallas markets. There, rents were up 7.3% and 8.5%, respectively. But total revenues were up just 2.8% and 6.9% due to occupancy loss. In the two respective markets, IRT lost 250 and 100bps of occupancy.

For their part, NXRT grew rents by 7.1% in Atlanta but reported a 0.1% decline in total rental income due to 340bps of occupancy loss. Dallas was better, with rent and rental income growth of 6.8% and 5.6%, respectively. There too, however, occupancy was down 120bps.

In most markets, rate growth was offset by occupancy loss, with the exception of Florida. NXRT did lose 410bps of combined occupancy in their Orlando and Tampa markets. But in South Florida, their largest market in the region, they gained 80bps.

Looking ahead, NXRT could be at risk if the market in Florida cools. On their Q2 conference call, EVP, Matt McGraner, did note that there was a large quantity of supply hitting the market. Since NXRT's same-store outperformance is primarily based on revenue growth as opposed to expense control, the company could be at a disadvantage if they experience a pullback in the rate of growth in Florida.

Underwhelming FFO Performance

Despite the strong performance at the property level, NXRT is not delivering on growth in FFO. True, FFO was up about 12%. But last year, the company booked casualty losses. Adjusted for this, core FFO was down a penny/share from last year.

The weakness is driven not necessarily by properly level expenses but by interest expenses. Through the first six months of the year, interest was up +$8.2M YOY. This diluted FFO by $0.32/share.

The interest burden is on a total debt load, which I view as overleveraged. In Q2, NXRT generated annualized EBITDA of approximately +$135M. Net debt, on the other hand, was +$1.7M or over 12.5x EBITDA.

McGraner provided updates on their disposition plans for the year, and if they complete them as expected, the net debt multiple is expected to drop into the high-single-digit. Lower overall debt is good. But it's still too high. IRT, in comparison, is operating in the low 7x range.

Attractive Returns On Renovations

NXRT's value-add program continues to deliver attractive returns on investment ("ROI"). In the first half of 2023, NXRT completed renovations on 1.357K units, with 667 completed in Q2. On those renovations, the company realized an ROI of 21%. This compares favorably to IRT, which completed renovations on 625 units with an ROI of 17%.

For NXRT, the renovations are creating a monthly rent premium of $224. And looking ahead, there should be tailwinds on their future jobs due to the more favorable pricing environment.

Is NXRT Stock A Buy, Sell, Or Hold?

According to company filings, shares in NXRT are estimated to be valued at approximately $68/share. This is based on a mid-5% cap rate, with strong NOI contributions out of Florida. At this valuation, shares would have an upside potential of 65% and would trade at a forward FFO multiple of 22.8x. This estimate would also be used to justify any future share repurchases.

In my view, I don't see the upside coming to fruition. The current NOI estimate reflects double-digit growth in several of their markets. With new supply hitting the market, I expect rental growth to slow more than expected in the coming months. The NAV estimate also factors in dispositions which have not yet been completed. Given current market uncertainties, I would rather wait to see the results of any sales that complete.

At about 13.8x forward FFO, I view NXRT as fairly valued at current pricing. Sure, same-property NOI growth is impressive, but this is offset by their high debt burden, which is diluting their earnings potential. Sales are expected to reduce total leverage, but completion remains uncertain at this point. For investors seeking positioning, I believe it is best to leave NXRT on hold.

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