Harvey Could Be a Catalyst for Nexpoint

Harvey Could Be A Catalyst For NexPoint

In January, I decided to initiate research coverage on NexPoint Resident (NXRT) and I concluded that the “balance sheet is getting stronger and the recycling efforts should allow the company to generate stronger returns.

The favorable markets (southeast and southwest) also provide NXRT with a steady pool for fishing out new product and the resurgence in manufacturing should serve as a catalyst for Class B apartment landlords. Although we're not going "all in" for any small-cap REIT, I find NXRT to be one of the safest bets with the best runway for growth.”

Then in June I wrote a follow up article and explained,

“NXRT is no longer the screaming bargain it was over a year ago, but the company still has room to run. The management team, although externally-advised, provided me with comfort and based on my analysis and research I am initiating a position within my Small Cap REIT portfolio.”

Last week we saw devastating news in Houston as Hurricane Harvey reaped havoc on America’s 4th largest city (after NYC, LA, and Chicago). According to REIT analyst, Matt Werner (with Chilton ,explained.

“It will likely overtake Chicago soon given the trajectories of the cities.Houston was a leader in job growth among the top 20 MSAs for several years coming out of the recession, as it was one of the first to regain it’s peak employment post-2009.

However, the oil downturn starting in late 2015 made it the worst job producer over the past 18 months. Importantly, as oil has stabilized, Houston is showing greenshoots in the form of accelerating job growth, while many other cities are decelerating.”

Werner adds that “the catastrophe from Harvey will produce a ripple throughout the Houston economy. I would expect occupancy to rise among self-storage, apartment, and hotel properties.

Pre-Harvey, all three of these property types were overbuilt, so this will help current owners, assuming the property is not damaged or destroyed.”

NexPoint has outsized exposure in Houston, representing ~10% of NOI:

Prior to Harvey, NexPoint was planning to rehab all three of its Houston properties. I’m not sure what damage these properties suffered, I did not see any press releases issued by the company (I will reach out on Tuesday):

It’s likely that the Houston properties will see robust rent growth as a result of Harvey….Let’s take a deeper dive….

NexPoint: The Sunbelt REIT

On March 31, 2015, NexPoint Credit Strategies Fund (NYSE:NHF) spun off NXRT to create a pure play multi-family REIT. In Q3-15, NHF acquired its first apartment community (in Dallas) and NXRT has since grown to 36 multifamily properties encompassing 12,027 units of apartment space. Here's a snapshot of NXRT's portfolio that is spread across 8 states and 10 different markets:

NXRT is the only pure-play, publicly-traded REIT on the NYSE, focused on value-add multifamily real property. The company is focused on acquiring, owning and operating well-located middle-income multifamily properties with "value-add" potential in large cities, primarily in the Southeastern and Southwestern United States.

NXRT targets markets that it believes have the following characteristics: (1) attractive job growth and household formation fundamentals, (2) high costs of homeownership or class A multifamily rental, and (3) elevated or increasing construction or replacement costs for multifamily real property.

Job growth in eight NXRT markets outpaced the national average of 1.74%, according to the Bureau of Labor Statistics March 2017 employment report. Average job growth, on a unit-weighted basis, in NXRT’s markets was 3.24%.

Atlanta showed the strongest job growth on a year-over-year basis, 3.93%, while Houston had the lowest year-over-year job growth (pre Harvey), 1.03%. When comparing the year-over-year total number of jobs added by market, NXRT owns in 4 of the top 10 markets, 7 of the top 15 markets, and all 10 NXRT markets ranked within the top 25.

Although Houston has had a tough go recently, that economy still managed to produce modest positive growth, adding 30,900 jobs year-over-year.

Average monthly rent across NXRT’s markets for the first quarter 2017 ranges from $766 (Phoenix) to $1,139 (Houston), with an average of $883. Average monthly occupancy across NXRT’s markets for the first quarter 2017 ranges from 92.1% (Houston) to 96.6% (West Palm Beach), with a portfolio average of 94.6%.

In Q2-17 NexPoint’s same-store rents increased 5.2%, same-store occupancy was down slightly by 40 bps from Q2-16 to 93.3%, same-store revenue increased to $29 million from $27.2 million in the same quarter last, 6.6% increase, same-store expenses increased to $13.7 million from $12.8 million in the same quarter last year, that's a 7.1% increase driven primarily by higher real estate taxes, same-store NOI increased to $15.3 million versus $14.4 million in the same quarter last year, which is a 6.2% increase.

The Balance Sheet

As you can see (below) NXRT has had higher leverage than the peers and the company has made great strides in increasing its fixed rate debt. The swaps allow NXRT to fix a majority of debt to mitigate the risks associated with floating rate debt (without incurring substantial prepayment penalties). Also, NXRT does not have any preferred exposure and maintains a flexible balance sheet.

In connection with de-risking the balance sheet, NXRT has been fixing the rate for 4.5 years and pushing out the maturity while maintaining the prepayment flexibility. The company did lever up slightly in Q2-17 partly from the cash portion of the buyout from BH.

The buyout of BHs minority stake was for $51.7 million. BH is the property manager, who's been NexPoint’sjoint partner from the beginning. BH’s minority interest closed on June 30 (the last date of the month) and it was funded by $49.65 million in cash with 2 million of OP units, which can be converted in the NXRTs common stock at the midpoint of NAV for the second quarter.

NexPoint has taken proactive steps to reduce interest expense, while fixing the rate without incurring harmful decisions or prepayment penalties. Year-to-date NexPoint has sold over $112 million worth of assets for an average IRR of 39.7% in a quarter times multiple on invested capital.

The Growth Platform

NXRT does not have much of a track record, but the company's limited history provides a glimpse of the future prospects. Here's a snapshot of the company's growth since the NHF spin.

In Q217 NexPoint’s total revenues were $35.2 million, as compared to $33.7 million for Q2-16. Net income was $9.9 million versus $16.6 million in the same quarter last year. FFO was $1.7 million or $0.08 per share versus $7.2 million or $0.34 per share in Q2 2016.

Core FFO was $6 million or $0.28 per share versus 7.9% or $0.37 per share in the prior quarter last year. AFFO was $7.4 million or $0.34 per share versus Q2-16 was $8.3 million or $0.39 per share. NOI for the second quarter 2017 is $18.1 million versus $17.4 million in the second quarter of 2016.

NexPoint guided Core FFO per share diluted basis $1.35 on the low end, $1.45 in the high and the mid point of $1.40, AFFO per share on a diluted basis, $1.60 on the low end, the $1.70 on the high-end for the midpoint of $1.65.

The company also updated acquisitions from a low end of $140 million, which includes some of the acquisitions to-date to the high-end of $200 million to account for potential acquisitions.

As illustrated below, NexPoint has grown its dividend by ~6% in 2017:

Now take a look at this FFO/share forecaster (source: FAST Graph):

Houston Could Be A Boom For NexPoint

The forecaster chart below does not include the potential rental growth for NexPoint in Houston; however, it’s likely that this small cap REIT will generate favorable growth in 2018 and 2019. Let’s take a closer look at NexPoint’s dividend yield:

Now let’s take a look at the P/FFO multiple:

NexPoint’s payout ratio is sound (~65%) and the shares are now trading at a more attractive level (as compared to my last article). I believe that the company is positioned to generate outsized returns from its planned sale of the Atlanta portfolio. I am also bullish as it related to NxPoint’s inside ownership:

I am maintaining a BUY and increasing exposure in my Small Cap REIT Portfolio. Keep in mind, the company is externally-managed but I consider NexPoint a good entry price at this time: