NexPoint Real Estate Finance, Inc. (NREF) Earnings Call Transcript & Summary

Thank you for standing by. My name is Amy, and I will be your conference operator for today. At this time, I would like to welcome you to the NexPoint Real Estate Finance Q2 2024 Earnings Conference Call. Please note that all lines have been placed on mute to prevent any background noise. It's now my pleasure to turn the call over to Kristen Thomas, Investor Relations. Please begin.

Thank you. Good day, everyone, and welcome to NexPoint Real Estate Finance conference call to review the company's results for the second quarter ended June 30, 2024. On the call today are Brian Mitts, Executive Vice President and Chief Financial Officer; Matt McGraner, Executive Vice President and Chief Investment Officer; and Paul Richards, Vice President, Originations and Investments. As a reminder, this call is being webcast through the company's website at nref.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 Li- 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 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 the forward-looking statements. The statements made during this conference call speak only as of today's date, and except as required by law, NREF 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 presentation that was filed earlier today. I would now like to turn the call over to Brian Mitts. Please go ahead, Brian.

Thank you, Kristen, and I appreciate everyone joining us today. I'm going to briefly discuss our quarterly results and then give our guidance for the next quarter before turning it over to the team for a detailed commentary on the portfolio and the macro [ rent ] environment. Q2 results are as follows. For the second quarter, we reported net income of $0.40 per diluted share compared to net income of $0.33 per diluted share for the second quarter of 2023. The increase in net income for the quarter was due to the change in net assets related to consolidated CMBS, [ VIEs ], including the sale of CMBS 8-Piece (sic) [ 8-Pieces ] for a realized gain of $6.2 million. Net interest income increased by $2.5 million to $6.7 million in the second quarter from $4.2 million in the second quarter of 2023. The increase was driven by an increase in interest income, which was driven by higher rates as well as lower interest expense from deleveraging that occurred in the first quarter this year. Earnings available for distribution was $0.68 per diluted share in Q2 compared to $0.50 per diluted share in the same period of 2023. Cash available for distribution was $0.64 per diluted share in Q2 compared to $0.53 per diluted share in the same period of 2023. The increase in earnings available for distribution was driven by the increase in net income for the quarter. We paid a regular dividend of $0.50 per share in the second quarter, and the Board has declared a dividend of $0.50 per share payable for the third quarter of 2024. Our regular dividend in the second quarter was 1.28x covered by cash flow available for distribution. Book value per share decreased 1.1% from Q1 2024 to $16.51 per diluted share with the decrease being primarily due to the decrease in fair value marks on our common stock investments. During the quarter, we funded $55.1 million on a drawable first mortgage on the Life Sciences development property in Cambridge. We originated a $150 million promissory note funding $67.5 million, which yields 16.5%, and purchased a $31.9 million CMBS [ 8-Piece ] with a bond equivalent of 9.5%. During the quarter, we sold 1.5 million shares of our Series B cumulative preferred -- or redeemable preferred for net proceeds of $32.6 million. Our portfolio is comprised of 85 investments with a total outstanding balance of $1.2 billion. Our investments are allocated across sectors as follows: 18.8% in single-family rental; 56.9% in multifamily; 22.2% in Life Sciences; 1.5% in storage; and 0.6% in marina. Our fixed income port- portfolio is allocated across investments as follows: 11.5% senior loans; 36.7% CMBS 8-Pieces; 20.7% preferred equity investments; 19.5% mezzanine loans; 4.2% I/O strips; 1.6% MBS; and 5.8% of promissory notes. The assets collateralizing our investments are allocated geographically as follows: 17% in Texas; 14% in Massachusetts; 8% in California; 7% in Florida; 6% in Georgia; 4% in Maryland; with the remainder across states with less than 4% exposure, reflecting our heavy preference for Sunbelt markets. Collateral on our portfolio is 80.3% stabilized with a 62.3% loan-to-value and weighted average DSCR of 1.52x. We have $861 million of debt outstanding. Of this, $281 million, or 32.6%, is short-term debt. Our weighted average cost of debt is 6.2% and has a weighted average maturity of 1.6 years. Our debt is collateralized by $1.1 billion of collateral with a weighted average maturity of 4.9 years, and our debt-to-equity ratio is 1.78x. Moving to guidance for the second quarter, we are guiding to earnings available for distribution and cash available for distribution as follows: earnings available for distribution of $0.50 per diluted share at the midpoint with a range of $0.45 on the low end and $0.55 of the high end; cash available for distribution of $0.45 per diluted share at the midpoint with a range of $0.40 on the low end and $0.50 on high end. So with that, I'd like to turn it over to Paul for a discussion of our portfolio.

Thanks, Brian. The second quarter results exhibited strong performance across each of our investment sectors. Our approach continues to center on areas where our expertise in owning and operating commercial real estate provides a distinct advantage. This dual role as both owner and lender allows us to effectively leverage information to assess and identify value across the entire capital stack, aiming to deliver outside risk-adjusted returns. Our investment strategy continues to focus on credit investments and assets that are stable or nearly stabilized, prioritizing careful underwriting, minimal leverage and a moderate debt basis. We also emphasize lending to reputable sponsors to consistently provide dependable value to our shareholders. In the second quarter, despite improving yet still less-than-ideal conditions in the commercial real estate market, we were able to deploy capital in accretive investments as well as take advantage of strong bids in the secondary bond market and recycle more seasoned bonds into other opportunities. Our loan portfolio continues to remain stable, comprising of 85 individual assets with approximately $1.2 billion in total outstanding principal. The portfolio is geographically diverse with a preference towards Sunbelt markets. From the beginning of the first quarter through today, the company has been very active in underwriting and deploying capital. During the quarter, we completed the purchase of a new-issue 5-year fixed Freddie Mac B-Piece investment with attractive metrics. The securitization has high 50% LTV, 1.3x plus DSCR and a diverse geographical footprint with great sponsorships. The [ 8-Piece ] will yield an all-in unlevered fixed rate of 9.5% and with utilizing reasonable leverage, we expect to generate a mid-teen levered return on a strong collateral pool. The company also funded an additional $55 million of Life Science senior loan which bears interest rate of SOFR plus 900. On the disposition loan [ repayment ] side, as mentioned, we sold a bond, which generated a very healthy gain, which was redeployed into newly originated and accretive deals. At the end of the quarter, we remain committed to maintaining a cautious approach to repo financing with the leverage standing in the 60% loan-to-value range and delevering our repo lines by approximately $60 million and further decreasing our overall debt-to-book value ratio to 1.78x from over 2.0x from the prior quarter. We consistently engage in communications with our repo lending partners, discussing the market conditions and the status of our financing CMBS portfolio. In summary, we are consistently identifying appealing investment opportunities across our target markets and asset classes. We are committed to meticulously evaluating these opportunities to enhance shareholder value. We have a strong confidence in the resilience of the residential sector, particularly given the current interest rate climate. Our investments in the multifamily and single-family verticals are considered secure, as evidenced by the historical performance and current rent-versus-ownership dynamic, providing a long-term sector tailwind. Additionally, we continue to be very enthusiastic about our investment pipeline in the Life Science CDMO sector. To finalize our prepared remarks before we turn it over for questions, I'd like to turn it over to Matt McGraner.

Appreciate it, Paul. As he just mentioned, Q2 was an active investment quarter in which we originated $200 million worth of deals across multifamily and Life Science verticals. The $150 million bridge loan originated during the quarter is emblematic of great opportunities in the market to earn outsized risk-adjusted returns. We are seeing wonderful opportunities to make senior loan -- secured loans on new construction, redevelopment and increasingly last-mile TI funding in the Life Sciences sector at great [ bases ]. These loans are underwriting to mid-50% LTVs with all-in mid-double-digit returns. The other material investments made during the quarter were in the Freddie Mac K program where multifamily credit quality and underwriting performance continues to outperform expectations even in the face of record supply. Same-store NOI growth continues to improve in the residential sector broadly with demand being quite exceptional during the first half of the year. Since supply is expected to peak in the second half of the year, I'd like to share a couple of stats from our research tracking starts and deliveries. Annual starts in the multifamily sector are now at their lowest level in 10 years, approximately 280,000 units per year. The year-over-year drawdown in starts from 2023 is approximately 40%. 2Q '24 quarterly starts came in at just 38,000 units nationally, which would represent an annual run rate of 150,000 new units, or 50% of the trailing 10-year average. Trailing 12-month starts are way down from the peak across all major metros, including Sunbelt markets, down anywhere from 40% to 60% versus 2020's peak. Finally, RealPage forecasts a return to normal 2% to 4% annual organic rent growth in 2025. Meanwhile, we remain pleased with our solid Q2 results, especially on a relative basis. Our portfolio continues to perform exceptionally well and despite the short-term supply challenge -- challenges in multifamily, [ underlying ] performance in multi, SFR, storage and Life Sciences remain stable. To close, we're excited about these opportunities in the coming quarters and pleased with the company's continued stability and the opportunity to go on offense in this environment. As always, I want to thank the team for their hard work. And now we'd like to turn the call over to the operator for questions.

Thank you. The floor is now open for questions. [Operator Instructions] We'll pause for just a moment to compile the Q&A roster. The first question comes from the line of Stephen Laws with Raymond James.

Nice quarter. I appreciate the comments and the guidance, as always. I wanted to touch base, just how you think about the capital raising, what the perpetual Series B is as well as the funding of the Life Sciences investment. Do those 2 things sort of match up as the drawdown matches the capital raising? And then, outside of that, where do you stand on redeploying the capital that was supporting the large repayment that occurred in Q1?

I'll start. It's Matt. On the capital raising front, with the Series B, it's actually matching up pretty well. We're raising roughly $15 million or so approximately a month, and that fairly matches draws of about $15 million to $20 million a month. So from a timing perspective, it's actually working out really well and one reason why we think the -- why we are forecasting guidance covering our dividend going into the second half of the year and feel good about that. And then in terms of redeploying the payback from the loan payoffs, we've largely delevered by that, and then we're reviewing several capital markets options on how best to relever the balance sheet and match those -- and match new investments with those opportunities. But for now, the Series B is kind of making it easier and consistent for us to redeploy the capital and match-fund the Cambridge loan.

Great. And as a follow-up, I wanted to talk about the kind of -- I hate to say transition, but a little bit of a shift in the portfolio and probably the right time in the cycle to do it. I imagine it's a little less stabilized, a little lower DSCR, but it's also seen the LTV drop a good bit. So it seems like you're looking at maybe taking advantage of financing market efficiencies and some people that have left the sector. But can you talk about kind of where you're seeing the most attractive risk-adjusted returns and kind of what's driving that focus as you put new money to work today?

Yes, I think you're alluding to our activity increasing in Life Sciences sector. And from our vantage point, it is just that. It's a retrenchment of a number of different types of lenders into the space at a time when you're really seeing not a hockey stick but a resurgence of growth. [AREs this ] quarter -- in the second quarter, they had re-leasing of over 1 million square feet, 300,000 square feet in new development. We're seeing some of the same things across our investments in Life Sciences without really any lender support. And so you have projects that were started in 2021, '22 that raised a ton of capital. We can come in and prime that capital that's been raised and fund the last da- the last dollars to finish out some of these TIs and other warm-shell components and be in a basis of $700, $800 a square foot on projects that are finished that are worth $1,500 to $1,600 a square foot, all-in with rates that are probably mispriced in a normalized environment. Meanwhile, on the multifamily side, you have a ton of liquidity coming into that space, and spreads have dramatically come in. We just announced yesterday or 2 days ago, with NXRT, a $1.5 billion refinancing at a borrower spread of 109 basis points over SOFR. So that should give you some indication -- oh, as well as the Blackstone AIRC, [ the ] CMBS deal that's about to go off, or just did. It was upsized by almost a third, from $2.1 billion, I think, to $2.9 billion. So the market is really there for certain property types right now, and we want to take advantage of where it's not and have enough conviction and belief and see it on the ground that liquidity will return probably in '25 and certainly '26. And we can make investments today that will bear fruit over the long term for our shareholders.

Your next question comes from Jade Rahmani with KBW.

What are you seeing in terms of multifamily deal flow? Are you seeing any pickup from the agencies? And what do you think is driving their behavior this year?

I missed the second part of the question, Jade. Can you repeat that for me?

Please. And what do you think is driving their behavior this year? They seem somewhat conservative on multifamily lending.

I think, from our perspective, it's just the deal flow. I guess the first part of your question answers the second part of the question. The deal flow is still very, very muted. Negative leverage persists. Cap rates for good-quality product that agencies would typically finance are still 5% -- or we've been on a deal in South Florida that was 4.5% cap rate -- or ended up going off at a 4.5% cap rate. So leverage is still negative in most cases, which is having some impact to deal flow. That being said, you did see the KKR-Lennar deal go off, and obviously the $20 billion worth of private equity multifamily transactions in the first quarter. So large deals are getting done. I would say, individual, smaller deals are still down. I think I think the last stat I saw was it's 40%, again, year-over-year down in transaction volume. So I think it's, from an agency standpoint, not that they're being overly conservative. And Paul, I'll kick this to you after this for your comments. But it's just there's just not a lot of product. When we went to them with our pool of multifamily loans, the $1.5 billion, they were pretty excited about the opportunities. They haven't seen the bulk, if you will. Paul, I don't know if you have anything to add to that.

Yes. I think, in the past, we saw a lot of 10-year fixed 7-year floats. But we've been seeing new origination has been more on the 5-year fixed as we close on 2 from this year alone, so shorter term. But treasury rates today, they're 5 years down to [ 3.85% ]. And if that's fixed, I think you might see some more deal flow as treasure -- treasuries continue to rally. But as of right now, it seems like it's [ fine ], but still a little -- as Matt pointed out, a little tight in the agency space for deal flow.

Is the NXRT refinancing at that 100 to 110 basis points spread?

It's 109 basis points over SOFR.

And so, in your mind, when you look at the weighted average cost of capital and maybe some expectation of rate moderation, what do you think the -- how do you look at the all-in cost of capital of that debt deal?

Well, that deal is sort of different because we have $1.25 billion of swaps at an average blend of 1.36%. So borrowing cost is just an additional 109 basis points over that, but the swaps are burning off in '26. So for that company, it's amazingly accretive in keeping the flexibility on a floating rate to buy and refinance and have 0 defeasance or yield maintenance [ to lease-up ]. That's a one-off situation. But it does, I think, illustrate the agencies, Freddie in particular, rolling up their sleeves, digging in and trying to come up with a bespoke solution to one of their select sponsors.

And more broadly, when you look at a multifamily acquisition maybe for NXRT, you mentioned some bidding on something that sold at a 4.5%. Let's say you were bidding maybe at a 5%-ish. How are you looking at levered returns in that kind of situation?

Yes. I mean I think it's all -- it depends on who you are. In our case, we're a public company that has an implied cap rate sitting out there at 6.25%, and the transaction market is still tight at -- the private transaction market is still tight at 5% or lower cap rates. So we have the opportunity to sell assets there and buy back stock, and that's what we continue to do. But in terms of underwriting new levered returns, the way that we look at it historically is try to go in at a plus or minus 5% cap rate and move that cap rate to a 6.5%, 7% over the course of 3 or 4 years by adding value and renovating units and then deciding whether to sell or refinance.

Okay. And then, lastly, on the book value per share, do you have a post-quarter or intra-quarter update? How do you think it compares with quarter-end book value?

Are you talking about from 6-30 to today or---

Yes. Yes, just the mark-to-market impact of where book value might be, if there's been an improvement based on spreads?

Yes, that's a great question. We are seeing more of a reflation this past month on mark-to-market just from treasury rates alone on our mark-to-market book of CMBS. So yes, you are seeing an uptick in those values. So I would say that we have clawed back some percentage points this past month just on the mark-to-market of the CMBS [indiscernible].

It's a good question, Jade. And in addition, I wanted to mention that part of the book value decline was from our storage portfolio that I think is -- we're doing a pretty big refinancing there on some of the debt that we'll expect to accrete to value for the storage portfolio in a SASB later on in the year, probably in the third quarter, if not the -- in the third quarter -- late third quarter, early Q4. And that portfolio, I'm pleased to report, is, for the first time in history, given it was all development back in '17, '18, '19, it's now 90% stabilized, 90% leased and occupied and is performing well. So we expect some reflation in that mark as well.

Just on the preferred issuance, I know that you're now excluding potential dilution from the share count. And just to reduce any confusion, how do you think of that? Do you believe that those shares would eventually be settled in cash, and so it makes sense to exclude the dilution?

Yes, that's another good question. So there's a couple of factors of how we came to that methodology. First and foremost, there's a 2-year lockout for the company to even redeem shares. The second point is there is a mechanism where only 20% of the actual outstanding [ prep ] can be redeemed per year. So there's a cap on it. So there wouldn't be any event where the full prep would be fully redeemed at any one point in time. There's also large penalties for investors to redeem. That stair-steps down over time. But currently, there's, I believe, an 11% penalty for investors to redeem at this point in time. And the last point, I think that you guys have seen NXRT. NREF, in all our vehicles, our plan is never to dilute the company when we're trading below book value. It's just not helpful. And so we would look to settle in cash in the future. So that's why we came to the conclusion of using this specific share count versus a fully diluted with the Series B shares included.

[Operator Instructions] At this time, there are no further questions. I would like to turn the call back over to the management team for closing remarks.

All right.

Sorry, Matt, go ahead. No, go ahead. I appreciate it. Thanks. Thanks for everyone's time. We'll talk to you next quarter.

That concludes the call for today. Thank you so much. You may now disconnect.