NXRT - NexPoint Residential Trust: Phoenix Rising

2024-01-04 17:32:37 ET

Summary

• NexPoint Residential stock has suffered due to the rising interest rate environment and its highly leveraged, floating rate debt.
• However, the company has been selling assets and reducing its debt, resulting in a significant reduction in interest rate vulnerable debt and improved balance sheet.
• NXRT trades at a significant discount to its peers and has the potential for a 30% upside if it can regain market respect.

Always trying to stay abreast of the market, in the pre-dawn hours of January 2 ^nd , Dane Bowler and I were reviewing 2023 returns data. In looking at this chart,

Source: 2MC and S&P Global

Dane observed “The multifamily sector seemed quite divergent based on location. People really don't like the sunbelt.”

Duh!

My meaningless sequitur,

“I think they don't like the sunbelt because they lost money in 2023 chasing 2022's sunbelt winners. They will now chase 2023's winners.”

Our cynical exchange is parroted every day in analyst’s offices around the world, but, today, we are really intrigued at the prospects of NexPoint Residential (NXRT).

Full Disclosure

We first became aware of NexPoint Residential shortly after it IPO’d in a spin-off offering in 2015. NXRT seemed to be growing FFO/Share but their relative obscurity left the shares languishing. That defines our modus operandi, so we loaded up on shares at an $11 average price.

As time passed, we met with management to ascertain their objectives. Early on, they declared themselves available for buyout. Nothing happened in the M&A department, and we struggled to understand what would happen with our discounted shares now trading north of $40.

NXRT had gone from discounted obscurity to now trading at or above comparative valuation of its multifamily peers. There was nothing wrong with NexPoint, but we are value investors, and we began selling our shares in pursuit of greener pastures.

We didn’t sell all our shares and instead in 2018 and 2019 gifted $1.6M of appreciated NXRT shares to 2 ^nd Market Capital Economic Opportunity Foundation (2eof). Our original $400,000 investment was converted to helping Simpson Street Free Press (SSFP) deliver rigorous academic instruction with a focus on writing for publication. SSFP students write about science, geography, books, history, and the arts. The organization’s mission is to spark student success and bridge achievement gaps.

2eof also funds Operation Fresh Start’s efforts to help disconnected youth transition to adulthood through acquiring a driver’s license, a high school diploma, and career training in conservancy, home building, food service, and healthcare. Our gift of NXRT stock has helped hundreds of young people on their life path.

At the same time, our gift of NXRT converted a significant tax liability into a meaningful tax deduction.

If ever you find yourself the holder of a significant investment gain, think about giving it away. Who might you help in that effort? And what about the tax benefits?

Today

The opportunity and returns in multifamily investment are not going away. The free money, zero interest rate environment that allowed developers to create an apartment supply surplus has vanished. Demand for affordable apartments remains. NXRT is in the affordable apartment supply business.

NexPoint Residential’s stock price has suffered profoundly in the rising interest rate environment. Not only is NXRT highly levered, but its debt is also significantly floating rate. For this calculated capital structure, NexPoint has paid dearly in the market price of its shares. Hitting a high of $95.04 in March 2022, NXRT shares plunged to low of $26.21 in September of 2023.

We need to put this transpiration of value in proper perspective. As the Fed Funds rate spiraled inexorably higher, NexPoint’s profitability was drawn into question due to their high leverage, much of it variable rate. Would they survive the rising interest expense?

At the same time, NXRT’s debt was fully hedged. Additionally, they were selling assets and de-risking their balance sheet. The first highly profitable sale completion was announced September 25 ^th and was followed by the completion of Timber Creek in Charlotte, NC in December. The Timber Creek proceeds were used to further reduce the company’s most expensive floating rate debt.

“The Company used the net proceeds from the sale to make a $17 million paydown on the Company's corporate credit facility on December 15, 2023, continuing the Company's strategic de-leveraging and balance sheet improvement initiatives. This paydown reduces the drawn balance on the facility to $24 million, a 92.8% reduction from September 30, 2022.”

A 92% reduction in interest rate vulnerable debt is a meaningful right-sizing of their capital structure. More importantly, the sales were executed at adjusted cap rates of approximately 5.0%.

This successful capital recycling gives a company breathing room and bragging rights.

"NXRT is pleased to announce another successful 2023 disposition, furthering our strategic objective to exit lower growth legacy assets in Charlotte, Dallas and Houston, and pay off our most expensive debt capital. NXRT remains committed to unlocking liquidity the Company can use to improve the balance sheet, repurchase shares and/or pay off higher property-level debt that will be accretive to future growth. We will seek to continue this approach heading into 2024," said Matt McGraner, Chief Investment Officer.

The potential share repurchase is not yet reflected in NXRT’s share price.

Dividends

In addition to not liking NXRT’s highly leveraged sunbelt exposure, investors express distaste and distrust for externally managed REITs, which NexPoint is. They generally fear that external management will not be aligned with shareholder interest.

Well, NXRT management has assuaged those fears in multiple ways. First management and insiders collectively own more than 11% of shares outstanding.

Additionally, they align with shareholders (themselves) in aggressively raising the dividend every year since their IPO.

What’s more, the growing dividend has historically been highly tax efficient, with more than 76% of the income being tax deferred thus far.

Value

At current pricing, NXRT trades at a huge discount to peers. In the optimistic era of Sunbelt apartment investment NXRT traded at a premium to peers. If NexPoint Residential can regain some market respect and trade at a sector average multiple of 16x FFO, we might see a $45 share price or 30% upside from here.

Opportunistic Entry Point

Fears of the interest rate cycle swirl around commercial real estate. NexPoint Residential approached its capital structure and debt loads with their eyes wide open and a calculated measure of risk and reason. Throughout this cycle, they have been in control and uncompromised. As the interest rate cycle reverses, they have positioned the company for sustained growth.

We are long again.

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