NexPoint Real Estate Finance, Inc. (NYSE:NREF) Q3 2022 Earnings Conference Call October 27, 2022 11:00 AM ET
Company Participants
Kristen Thomas – Investor Relations
Matt McGraner – Executive Vice President and CIO
Brian Mitts – Executive Vice President and CFO
Matt Goetz – Senior Vice President, Investments and Asset Management
Paul Richards – Vice President, Originations and Investments
Conference Call Participants
Stephen Laws – Raymond James
Steve DeLaney – JMP Securities
Jade Rahmani – KBW
Operator
Please standby. Good day, everyone. And welcome to the NexPoint Real Estate Finance Q3 2022 Conference Call. Today’s call is being recorded.
And now, at this time, I’d like to turn the call over to Kristen Thomas. Please go ahead.
Kristen Thomas
Thank you. Good day, everyone. And welcome to NexPoint Real Estate Finance conference call to review the company’s results for the third quarter ended September 30, 2022. On the call today are Matt McGraner, Executive Vice President and Chief Investment Officer; Brian Mitts, Executive Vice President and Chief Financial Officer; Matt Goetz, Senior Vice President, Investments and Asset Management; 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 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 law — 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 on — of these non-GAAP financial measures, see the company’s presentation that was filed earlier today.
I would now like to turn over to Matt McGraner. Please go ahead, Matt.
Brian Mitts
Actually, it will be, Brian. Thanks, Kristen, and I appreciate everyone joining today. I am going to kick things off going through our Q3 and year-to-date results and then I will touch on guidance for the fourth quarter and then turn it over to the team for some detailed commentary.
Q3 results are as follows; third quarter, we reported net loss of $0.54 per diluted share, compared to net income of $1.17 per diluted share for the third quarter of 2021. The decrease in net income as a result of lower prepayments in Q3 and mark-to-market adjustments on the CMBS portfolio.
Interest income increased 14% over Q3 2021, driven by a 76-basis-point increase in average yield on investments. Interest expense increased 37%, driven by $102 million of additional borrowings and a 98-basis-point increase in average rate.
Earnings available for distribution was $0.48 per diluted share in Q3, compared to $0.51 per diluted share in the same period of 2021.
Cash available for distribution was $0.50 per diluted share in Q3, compared to $0.62 per diluted share in the same period of 2021. The decrease in earnings available for distribution and cash available for distribution was the result of lower prepayments in Q3.
We paid a dividend of $0.50 per share in the third quarter and the Board has declared a dividend of $0.50 per share for the fourth quarter. Our dividend in the third quarter was 0.96 times covered by earnings available for distribution and 1 time covered by cash available for distribution.
Book value per share decreased 4.2% quarter-over-quarter to $20.68 per diluted share, partially as a result of the mark-to-market adjustments in the CMBS portfolio.
During the quarter, we originated or purchased nine investments with $113 million of outstanding principal with a combined current yield of 8.3%. Four investments were redeemed or sold with $27.5 million of outstanding principal for a total net loss of $731,000.
Year-to-date results are as follows; for the nine months ended September 30, 2022, we reported net income attributable to common shareholders of $0.71 per diluted share, compared to net income of $3.02 per diluted share for the same period of 2021. This decrease is largely driven by mark-to-market adjustments in our CMBS portfolios.
Earnings available for distribution was $2.25 per diluted share year-to-date, compared to $1.35 per share — per diluted share in the same period of 2021, an increase of 67.5%.
Cash available for distribution was $2.69 per diluted share year-to-date, compared to $1.57 per diluted share in the same period of 2021, an increase of 72.1%. Higher year-over-year earnings available for distribution and cash available for distribution for the year were driven by higher prepayments and requisite prepayment penalties in the first and second quarters.
Our dividend for the year was 1.5 times covered by earnings available from distribution and 1.8 times covered by cash available for distribution.
Now let’s move to guidance for the fourth quarter. For fourth quarter, we are guiding to earnings available for distribution and cash available for distribution as follows; earnings available for distribution of $0.53 per diluted share at the midpoint, with a range of $0.48 on the low end and $0.58 on the high end.
Cash available for distribution of $0.52 per diluted share at the midpoint, with a range of $0.47 on the low end and $0.57 in the high end. The increase in cash available for distribution and earnings available for distribution from the third quarter is driven primarily by new investments in the portfolio.
So, with that, let me turn it over to team for the detailed commentary.
Matt Goetz
Thanks, Brian. The third quarter continued to show strong performance across each of our investments and asset classes. As of today, the portfolio is currently comprised of 83 individual investments, with approximately $1.7 billion of total outstanding principal.
The loan portfolio is 96% residential, with 42% invested in senior loans collateralized by single-family rental and 54% invested in multifamily, primarily via Agency CMBS. The remaining 4% of the loan book is life sciences and self-storage.
The portfolio’s average remaining term is 5.6 years is 93% stabilized has a weighted average loan-to-value of 68.1% and an average debt service coverage ratio of 1.76 times. The portfolio is geographically diverse with the bias towards the Southeast and Southwest. Texas, Georgia and Florida, combined for approximately 49% of our exposure on a geographic basis. All of our investments are current.
Moving to the opportunities we were able to take advantage of during this quarter and shortly thereafter. Through today, we were able to close 11 new investments totaling $132 million, with a weighted average unlevered yield of 9 point — 9% and an average levered yield of 11.2%.
$9 million of mezzanine investments were made, collateralized by a stabilized self-storage property located near Miami, Florida, with an unlevered yield of 11%. $21.5 million in three separate preferred equity investments collateralized by stabilized multifamily properties located in Plano and Fort Worth, Texas and Parkland, Washington at a weighted average estimated yield of 13.3%.
A $15 million preferred equity investment also closed collateralized by stabilized life sciences CDMO property outside of Minneapolis, Minnesota yield of 10%. The tenant is well-capitalized group and signed a long-term lease at the property.
$1.5 million of MSCR notes with an estimated leverage yield of 13.8% closed and $85.1 million of CMBS, including the Freddie Mac B-Piece with an average unlevered yield of 7.6% and levered yield of 12.9% closed shortly after the quarter.
In summary, we continue to find attractive investments throughout our target markets and asset classes and we will continue to evaluate these opportunities with the goal of delivering value to our shareholders.
I’d now like to hand the call over to Paul Richards.
Paul Richards
Thanks, Matt. During the third quarter, the company was active in the primary bond market and was awarded a $70.5 million Freddie Mac floating rate B-Piece, an attractive yield at SOFR + 525 and a levered yields in the low to mid-teens, which has prudently levered via attractive price repo financing. The bond bodes a great geographical presence, prudent underlying loan leverage and as always, excellent sponsorship.
We struck the entire CMBS portfolio by shocking cap rates and NOI growth to determine how far our cap rates to theoretically widen and interest rates could rise until the bond performance will deteriorate. The results were somewhat as expected. The vast majority of the portfolio has shown strong NOI growth over the past few years and refi risk is minimal even at these stressed rates.
We continue to be sensibly leveraged on the repo at roughly 60% LTV at quarter end and have constant dialogue with our great repo lending partners on the state of the market and the repo CMBS portfolio.
Lastly, touching on the continued performance of the SFR loan pool in the Q3 2022 loan pay down. All SFR loans are currently performing and demonstrated strong metrics in terms of rent growth in occupancies as the demand for single-family rental growth is still red-hot.
The portfolio has one SFR loan payoff in the third quarter, which generated an IRR of 22% as compared to the original underwritten IRR of only 9%. Due to the early prepayment penalty, the investment was able to generate outsized net proceeds than the original underwriting ended roughly one-third of the original investment time horizon.
To finalize our prepared remarks before we turn it over to questions, I’d like to turn it over to Matt McGraner.
Matt McGraner
Thank you, Paul. As the team has mentioned, NREF’s credit investments and primarily stabilize shorter term lease duration assets with lower CapEx that had and should continue to maintain dynamic pricing power in today’s inflationary environment.
Underlying NOI embedded in our stabilized SFR multi- and storage-collateral continue to outperform other property types, providing a resilient base of earnings for distribution and stable yields to our investors. Though moderately decelerating from historical peaks earlier this year, same-store NOI growth in multifamily SFR and storage are still pushing high single to low double digits.
On the origination front, the team continues to put capital to work in our core property types at accretive yields and in addition we believe this market is right for us to generate more of our special situation, tactical type of investments for well-yield sponsors to take advantage of the lack of liquidity in the private markets, especially as it relates to multifamily portfolio transactions and single-family rental, particularly in the build to rent space.
We are also pleased with the lack of transitional assets or business plans within our portfolio. Indeed we are not — we are thankfully not speaking to you today discussing transitional business plans on office or other longer term duration assets.
And finally, it’s an exciting time for our business and that our portfolio enjoys a stable and transparent earnings stream for the next five-plus years, from which we can utilize our deep relationships, and frankly, our own investment platforms across multi SFR storage and life sciences to continue to generate outside risk adjusted returns to our investors.
I thought I have for prepared remarks. Now we would like to turn the call over to the Operator to answer any of your questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] And we will first hear from Stephen Laws of Raymond James.
Stephen Laws
Hi. Good morning.
Matt McGraner
Hi, Steve.
Brian Mitts
Good morning.
Stephen Laws
Good morning. I guess maybe Matt McGraner, maybe start with a bigger picture question, with mortgage rates going to 7%, where they are. Can you talk about what impact you expect that to have on your SFR and multifamily kind of as this rolls through, do you expect higher renewal rates, how do you expect to look at occupancy or expect increases there? Maybe talk about the buying a home becoming less affordable and how that benefits your SFR multifamily investments?
Matt McGraner
Yeah. I think it’s — you are alluding to it, but you are exactly right, everything that is doing right now is making home affordability any easier across the multifamily loan growth and then our equity portfolio.
We are seeing retention rates — retention rates go from 40% to 50%, excuse me, 45% to 50% climbing to 55%, 56% in sort of the affordability workforce space, which is largely what our CMBS portfolio makes up as well.
Same thing on the SFR piece, our platform there, volume growth and our other platforms continue to see really high retention, especially again in that affordable space. And I would expect with the lack of construction financing out there, the supply is going to even decrease for developers.
New starts have fallen off of a cliff in the second half of the year and we think multifamily supply peaks in late 2023, and 2024 to 2025 will probably be pretty good years for both equity investors in this space and on the credit side.
Stephen Laws
Great. Thanks, Matt. When we think about new investments, when you look at things on a relative attractiveness, money going to work in mezz, I appreciate, Matt, guess highlighting the new investments, some new private equity investments, preferred equity investments to I think. But can you talk about how those stack up from a return standpoint versus considering stock repurchases, just given the weakness here ahead of the quarter and where book value came in north of 20%?
Matt McGraner
Yeah. I think the idea is probably to balance it in a barbell strategy and do both. Thankfully, as you might recall in Q2, we had $150 million of pipeline for the rest of the year, roughly $115 million of that has been soaked up.
And so we are pretty pleased with the growth profile over the next 12 months from external investments. So, to the extent that we stay at 75% of book value, that might be our first use of free cash flow on the margin, but otherwise, I think, it would be a barbell.
Stephen Laws
Great. And my last question for now. On the two common stock investments, can you give us an update on those and how you are thinking about investment time line and returns or considerations of reallocating anything into cash flowing debt investments?
Matt McGraner
Yeah. I will start with the storage piece and I will kick it to Paul to talk about the ground lease investments. So on the storage side, we are seeing within our own portfolio, pretty dramatic same-store NOI growth, eclipsing 25%-plus and then in 2022, 2023 we think could be low-teens as well, rents in kind of in the same realm.
We just closed on the senior side of the portfolio at SASB right after Labor Day with JPMorgan at accretive levels. So we were sorting out the capital stack. That was the first piece. The second piece is ongoing with Extra Space discussions in terms of delevering their preferred.
And I would expect that we would have a resolution there by year end at an accretive level for the common equity. So pretty pleased with how the portfolio is performing and also pleased with the cap stack maneuvering that we have been able to achieve so far this year in this environment. Paul, will talk on the ground.
Paul Richards
Yeah. Definitely, Matt. On our ground lease investment, right now they are rolling on all cylinders right now. They have dry powder that are deploying at 4.5%-plus cap rates on stabilized ground leases. So it’s stabilized assets.
So they have a very good runway into — that we look to this year and next year to take advantage of what’s going on in the marketplace, which is a lack of liquidity on the credit side. So they are will fill that gap with Visa with the types of investments.
So I think that they really have to stride at the right time, and with this dry powder, it’s going to be good in the next 12 months to 18 months. So I think in terms of exit, call it, three year, four years, maybe two years, four years, but I think there’s also a market possibly for an exit too, since we have such a small piece of the equity as well. So it’s — I think we are — I think it’s a great time to be in this investment.
Matt McGraner
Yeah. Particularly just to add to that, Stephen. There — these are both kind of bite size check sizes and really great portfolios to the extent that we found the special sit or other use of proceeds that we thought was more accretive. We have a number of external parties, quite frankly, internal parties to monetize these two assets, so pretty good optionality.
Stephen Laws
Great. Really appreciate the color on both of those investments. Thank you.
Matt McGraner
Thanks, Steve.
Operator
Next we will hear from Steve DeLaney of JP — JMP Securities.
Steve DeLaney
It was nice to be on with you on the call and also to be active from a research perspective. I was wondering you guys have had a great track record with the Freddie K-Series. We have been reading lately just trying to keep up with all the problems in the CLO market that Freddie is starting to crank up this Q-Series again with multifamily bridge loans. Just wondered if you are looking at that? I know you are — you prefer stabilized rather than transitional properties, but as this develops and expands, could you see yourself getting involved in the Q-Series, as well as with the K that you have done so well with?
Matt McGraner
Yeah. Thanks, Steve. This is Matt McGraner and great pleasure to talk to you and appreciate the coverage. We have had a long history, as you noted, with Freddie and have iterated with them all in a number of entrepreneurial and creative things that they try to do. We will continue to do that with the Q-Series. I think it’s in the early stages.
So to the extent that we think it’s an attractive investment for this portfolio, we will look at it. But on the other things that we are doing with them, we will — we — I think largely still prefer this a large property types the K-Series.
Steve DeLaney
Got it. And with the K-Series, obviously, those are fixed rate term loans, mostly 10 years, I guess, in this move up in coupons. I suspect when we see reports from Walker & Dunlop, Arbor Realty, et cetera, that we are going to see a dramatic slowdown. So is it your expectation when you are sort of looking at the portfolio out into 2023, anyway that there’s going to be a big drop in issuance?
Matt McGraner
Yeah. I think that largely the K-Series that we have done have been floating. So we are actually benefiting from the SOFR…
Steve DeLaney
Yeah. Okay.
Matt McGraner
Yeah. A lot of it is from this project. You are right, you hit on the team that’s going on right now. So to the extent that there’s refi activity or purchase activity, most sponsors are floating today…
Steve DeLaney
Yeah.
Matt McGraner
….given that they don’t want to put on fixed rate debt at 5.5% to 6% levels and that’s pretty material negative leverage if you believe cap rates are still sub-5%, 4.5% to 5%, which we do. So most of the product, I think, over the next six months to nine months will be skewed on the floating side, would be my guess.
Steve DeLaney
Yeah. Makes sense. And it depends on your view on the Fed, but our thinking here is that, we are going to get a pivot sometime in the second half of 2023 and we will just then see how far we move back down the hill, so to speak.
Matt McGraner
Yeah. [Inaudible]
Steve DeLaney
Yeah. Just one last quick one. We are not — it’s — we have got a major disruption as we have been talking about. We don’t know how long it will last, hopefully not. But let’s just say the — this mess continues well through 2023, do you think you could see some situations where there will be needs for rescue financing by borrowers or even seeing banks capitulate and be selling some loans at an attractive discount? I know we are not there now. But is that something you would be prepared to take advantage of if this thing gets really bad?
Matt McGraner
Yeah. So we — if you go back to COVID, there was a great opportunity that lasted about three weeks to buy assets dislocated…
Steve DeLaney
Yes.
Matt McGraner
….securities and we did as much as we possibly could, but there was just so much capital on the sidelines that soaked up pretty…
Steve DeLaney
Yeah.
Matt McGraner
…pretty quickly. I do think an interesting research project for someone would be to go pull gateway office assets that are 40 years old or longer that are held by either CMBS or banks at the basis of whatever the per square foot basis of the loan is that, I think, probably, are in trouble or will be in trouble. That could be an interesting set of weakness. But I don’t think you will see us dip into that space, but I do think that’s probably where the size of the trust probably first illuminate.
Steve DeLaney
Yeah. That’s where we are seeing all the 4 and 5 rated loans with the commercial mortgage REITs, that’s for sure is the office space.
Matt McGraner
Yeah.
Steve DeLaney
Awesome. Thank you so much for the comments this morning.
Matt McGraner
Thanks, Steve.
Operator
Next we hear from Jade Rahmani of KBW.
Jade Rahmani
Thanks very much. Do you have any view on home prices and where you think they will go in 2023? What would your guess or estimate be for magnitude of home price decline?
Brian Mitts
Yeah. Hey, Jade. It’s Brian Mitts. From an SLR perspective, I think, you got to distinguish it from housing itself. Obviously, housing prices, I think, are going to decline or decelerate and increase if not decline.
But I think from the SFR perspective, we are seeing really strong rent growth and high occupancies. I think Invitation has reported already, but as Matt mentioned, within our private portfolio, which is quite large.
We haven’t seen a deceleration of rents. We have seen good NOI growth. So I think that we are not going to see the same type of decline in asset values in that context. So I think SFR has still got great fundamentals.
I think if you look across our loan portfolio at the underlying assets, that’s very similar. So we may see a little retracement just depending on kind of where cap rates go and where they are at is kind of anyone’s guess at this point.
Just the transaction volume is pretty thin across really all sectors. But it certainly hasn’t moved in tandem with interest rates and I think that you are not going to see the same type of value degradation in SFR on housing in general.
Jade Rahmani
Okay. They did report Invitation Homes and their stock is down 8.5% today, just…
Brian Mitts
Yeah. Well, they…
Jade Rahmani
… definitely weakness in their results.
Brian Mitts
Yeah. Their expenses, I think, were quite high and surprised to the downside on a core FFO or FFO decrease in our guidance. But I think the public markets and private markets were up so far, I think, are very disconnected as well.
Jade Rahmani
Okay. Where do you think multifamily either prices in absolute nominal terms or cap rates to go also, similar prices?
Matt McGraner
Hey, Jade. Yeah. It’s Matt McGraner. I think, so we are marketing ourselves on the equity side portfolio, Sunbelt portfolio today and bids are coming in and spot cap rates around 4.5% levels. There’s a couple of data points out in the market on larger portfolios, $500 million plus that are non-Sunbelt or partially Sunbelt that are eclipsing 5% today.
So kind of taking those two data points from what we see and there’s not a lot of transaction activity as you know. But if you got to sell, it’s probably a 4.5% to 5% cap rate today and then the bid sheets aren’t as deep as they were certainly in the first half of the year.
Jade Rahmani
Okay. And so to finance that you would be in the 6s on a cost of debt or high 5s?
Matt McGraner
It depends if you go fixed or floating. If you go floating, you are probably 200 over the SOFR rate, so yeah, on a floating basis. And then on a fixed rate basis, the spreads to the 10-year largely been 150 to 175 is what we are seeing. Commission business on the Agency side, they will tight spreads probably 20 basis points to 30 basis points on both floating and fixed.
Jade Rahmani
20 basis points to 30 basis points?
Matt McGraner
Yeah.
Jade Rahmani
Okay. And so what do you think the IRR is on those kinds of deals?
Matt McGraner
On a leverage basis, high — probably high-single digits on a five-year hold if you have growth. If not, it’s certainly less than that. There’s too much negative leverage right now in the multifamily space.
So something’s got to give on an unlevered basis which could — where we think you will probably see most of the activity in the latter half of the year or in the first half of the year. All these core funds that are buying core plus products and I think that they are underwriting to an unlevered probably 6% or 7% return over a 10-year hold.
Brian Mitts
Operator, are there any other questions?
Operator
There are no further questions at this time. I will turn the call back over to our presenters for any additional or closing comments.
Matt McGraner
Yeah. I appreciate everyone’s participation today and I look forward to speaking to you next quarter. If you have any other questions, feel free to reach out to the team here and we will be happy to answer them. Thank you.
Operator
That does conclude today’s conference. Thank you all for your participation. You may now disconnect.
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