NexPoint Has More Room To Run

NoahBlacker

Brad Thomas wrote this article and it has appeared previously on Seeking Alpha.

Summary

  • There’s no way that NXRT can hire an internally-managed adviser, given the small-cap composition of the portfolio.
  • Earlier this week, while attending REITWeek, I attended an Investor Presentation for NXRT and I met with the CEO and other associates.
  • NXRT is no longer the screaming bargain it was over a year ago, but the company still has room to run.

A few days ago I wrote an article titled Management Matters in which I explained

while fundamentals remain one of my top research tools, I also spend time trying to understand management’s role, and whether there is an alignment of interest with the stakeholders.
The purpose for the article was to examine the externally-managed REIT model and I explained that “when you buy shares in an externally managed REIT, you are not actually hiring the management team. The Board has negotiated a contract with an outside management team to run the business, and typically, their compensation is tied directly to growing assets under management, much like the private equity model.”
I’m not totally against externally-managed REITs; in fact, I own several of them including Preferred Apartment Communities (NYSEMKT:APTS) (see my recent article), Blackstone Mortgage (NYSE:BXMT) (see my recent article), and Starwood Property Trust (NYSE:STWD) (see my recent article).
Back in January 2017 I wrote an article on NexPoint Residential (NXRT), also an externally-managed REIT. I explained in the article that NXRT is advised by NexPoint Real Estate Advisors, L.P., an affiliate of Highland Capital Management, L.P.
NXRT's advisory agreement requires that it pay the adviser an annual management fee of 1.00% of average real estate assets and an annual administrative fee of 0.20% of the average real estate assets.
There’s no way that NXRT can hire an internally-managed adviser, given the small-cap composition of the portfolio. Normally it would only be efficient for a REIT to internalize when it gets to at least $1 billion.

Earlier this week, while attending REITWeek, I attended an Investor Presentation for NXRT and I met with the CEO and other associates. I asked the CEO about internalization and he said that NXRT was unique because it (1) caps fees, (2) had no termination fee, (3) had a 60-day termination clause, and (4) there is strong insider ownership.

I asked when NXRT would internalize and he said there was really no target time or market cap size in which the company would do so. He alluded to the fact that the company was doing well and as long as shareholders were benefitting, the externally-managed model would continue.
In my article (January) I initiated a BUY rating on NXRT and I explained that “I find NXRT to be one of the safest bets with the best runway for growth… I see no reason that the company cannot continue to produce above-average results.”

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, 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 Q1-17, NXRT’s average rent increased to $857 in the same store pool from $813 or 5.3% increase.
The same store by market, Dallas was up 8.3%, Houston up 3.3%, DC metro area was up 5.5%, Atlanta was strongest at 12.6%, Nashville was 3.6%, primarily due to real estate tax adjustments. Charlotte was 5.4%, Phoenix was 9.3%, West Palm Beach was 7.1%, Orlando was 7.8%, Tampa at 9.2%.

The Balance Sheet
As you can see (below) NXRT has 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.

Given NXRT’s cost of capital and positive liquidity profile, the company continues to be opportunistic with a view towards doing more of the same.

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.

NXRT has also demonstrated strong same-store results as illustrated below (and compared with the peer group):

As illustrated below, NXRT's portfolio has grown consistently, while the company has generated steady rent growth:

For Q1-17, NXRT reported revenue of $37 million, up 10.4% over Q1-16, and NOI (or net operating income) of $19.7 million, compared to $17.7 million, which represents an increase of a 11.4%.
NXRT reported FFO of $8 million, or $0.38 per diluted share, as compared to $8.6 million or $0.41 per diluted share for Q1-16. Core FFO was $8.1 million or $0.38 per diluted share, as compared to $8.6 million or $0.41 per diluted share for the first quarter of 2016. AFFO was $9.1 million or $0.43 per diluted share, which compares to $8.9 million or $0.42 per diluted share in Q1-16.

Now let’s see how NXRT’s FFO/share growth compares with the peers:

Here’s An Externally-Managed REIT That Makes Cents
As I referenced above, I met with NXRT’s externally-managed team and I was impressed. The company did an effective job at articulating the value proposition and the company is clearly a “niche served well.”
NXRT is the only pure play Class B apartment REIT which means it really caters to affordable housing, a category that Sam Zell and others have avoided.
What intrigues me the most about NXRT is the growth potential and of course dividend growth. Let’s take a look at the dividend yield:

This may not look as exciting as APTS, but take a look at the Payout Ratio:

NXRT has plenty of dividend growth capacity and that suggests that the company is well-positioned to maintain double-digit growth. Now let’s compare the P/FFO multiple:

Yes, APTS screams cheap, but NXRT does not have the same level of complexity (diversified portfolio and preferred shares). Here’s how NXRT has performed with the peers:

The Bottom Line: 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.

To get a first look at my upcoming article, "The Evolution of My Durable Income Portfolio," click here. Disclosure: I am on the Advisory Board of NY Residential REIT, and I am also a shareholder and publisher on the Maven.
Source: FAST Graphs and NXRT Investor Deck
REITs mentioned: AIV, ESS, MAA, UDR, CPT, EQR, AVB, MORE, APTS, IRT, IRET.
*
Author Note: Brad Thomas is a Wall Street writer, and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors, if they are overlooked. Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking. If you have not followed him, please take five seconds and click his name above (top of the page).* Disclosure:** I am/we are long APTS, ARI, BRX, BXMT, CCI, CCP, CHCT, CLDT, CONE, CORR, CUBE, DLR, DOC, EXR, FPI, GMRE, GPT, HASI, HTA, IRM, JCAP, KIM, LADR, LTC, LXP, NXRT, O, OHI, PEB, PEI, PK, QTS, ROIC, SKT, SNR, SPG, STAG, STOR, STWD, TCO, VER, VTR, WPC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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