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NexPoint Residential: We're Off To See The Wizard

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.

Brad Thomas wrote this article and it previously appeared on Seeking Alpha on January 24, 2017.

Summary

  • “NXRT appears to be an attractively-priced REIT with substantial upside potential.” Chris DeMuth.
  • Chris DeMuth was the first to write on NXRT and it took me around one-and-a-half years to follow his lead.
  • 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.

I'll give Chris DeMuth (a.k.a. The Wizard of Oz) the credit for being the first to pounce on NexPoint Residential Trust (NYSE:++NXRT++). Back in June 2015, my fellow Seeking Alpha analyst penned an article in which he forecasted a 50% return. DeMuth ++wrote++:

NXRT appears to be an attractively-priced REIT with substantial upside potential.

Not bad for a hedge fund manager!

No sarcasm here, I was simply too busy chasing another small cap multi-family REIT by the name of Preferred Apartment Communities (NYSEMKT:++APTS++). On December 15, 2014, I wrote my first ++article++ on APTS and since that time, shares have increased by over 60%.

Both small-cap REITs have performed well and hopefully investors have dodged the other multi-family REIT that I'm not recommending now: Bluerock Residential (NYSEMKT:++BRG++). Back in February 2015 I warned:

I'm not recommending BRG until such time that the company can demonstrate an earnings track record that consists of a few quarters of successfully covering its dividend. No target price recommended.

Since my ++article++ (on Feb. 17, 2015) shares have declined by over 3%:

We did ++recommend shares++ in BRG's preferred series on October 2016; however, we are still not attracted to the common shares.

Although I don't generally follow the lead of Hedge Fund Managers (in the REIT space), I decided that it was time for me to follow DeMuth's trail in hopes of duplicating the same success that he has enjoyed to date with NXRT (nice work Chris). Maybe I'm too late to the parade (scroll down to the bottom for summary), but it doesn't hurt to add another REIT to the research lab.

++Photo Credit++

Starting From Scratch

In 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 39 multifamily properties encompassing 12,276 units of apartment space. Here's a snapshot of NXRT's portfolio that is spread across 8 states:

NXRT is focused on acquiring, asset managing, and disposing of multifamily real property located in the Southeast and Southwest United States. The company focuses on value-add properties located in attractive job growth markets. From inception through the end of Q3-16, NXRT has completed renovations on 4,118 units, achieving 10.7% rental increase, which equates to a 21% return on investment.

Job growth in NXRT's markets outpaced the national average of 1.84%, according to the Bureau of Labor Statistics September 2016 report. Average job growth, on a unit weighted basis, in NXRT was 3.08%. Orlando showed the strongest job growth on a year-over-year basis, 4.75%, while Houston had the lowest year-over-year job growth, 0.67%. When comparing the year-over-year total number of jobs added by market, NXRT owns 5 of the top 10 markets, 7 of the top 25 markets, and 10 of the top 30 markets.

Average monthly occupancy across NXRT's markets range from 91% (West Palm Beach) to 95.1% (Nashville), with a portfolio average of 93.6%.

Same-store average occupancy across NXRT's markets range from 91.7% (Houston) to 95.1% (Nashville), with a portfolio average of 93.%.

Average monthly rent across NXRT's markets range from $780 (Dallas) to $1,046 (West Palm Beach), with an average of $840.

Same-store average monthly rents across NXRT's markets range from $781 (Dallas) to $1,040 (Houston), with a portfolio average of $850.

Average monthly rents across NXRT's portfolio range from $599 (Mirama - Dallas) to $1,114 (Sabal Palm at Lake Buena Vista - Orlando), with an average of $848.

Average monthly rent across NXRT's same-store portfolio range from $599 (Mirama - Dallas) to $1,114 (Sabal Palm at Lake Buena Vista - Orlando), with an average of $850.

NXRT is a small-cap REIT and investors should consider the volatility risks. Here's a snapshot comparing NXRT to the peer group:

The Balance Sheet

NXRT has approximately $625.7M of total indebtedness (excluding deferred financing costs and mark-to market adjustments). Of the total, $60.4M (or 9.7%) was fixed rate agency financing, while the remaining $565.3M was tied to floating rate indices.

From May 13, 2016 through August 12, 2016, NXRT entered into 4 interest rate swap contracts with a combined total nominal value of $400M, all of which became effective in Q3-16. NXRT has an adjusted weighted average interest rate of 2.96% on total indebtedness (as of Q3-16).

As you can see (above) APTS has higher leverage than NXRT 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 more flexible balance sheet than APTS and BRG.

Here's a snapshot of the balance sheet compared with the peer group:

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:

More recently, NXRT acquired 2 properties in Houston for around $108M, or $17K per unit. Here's a snapshot of Old Farm Apartments:

Here's a snapshot of Stone Creek Apartments:

Both properties were acquired at a substantial discount as NXRT continues to maintain its business plan of investing capital into properties as a value-add strategy. NXRT cites these properties were acquired at a 5.74% cap rate (year 1) vs. a dividend yield of 3.94%. NXRT plans to dispose of 6 properties and monetize attractive gains:

At Q3-16, NXRT reported net income of $8.8 million, or earnings of $0.33 per common share, which included $9.6 million of gain on sales of 4 properties, Colonial Forest, Park at Blanding, Willowdale Crossings and Jade Park, and depreciation and amortization of $8.7 million, compared to net income of $16.6 million, or earnings of $0.69 per common share, for Q2-16, which included $16.4 million of gain on sales of three properties, Meridian, Park at Regency, and Mandarin Reserve, and depreciation and amortization of $8.1 million.

FFO, net of four dispositions made during the quarter, totaled $6.9 million, or $0.32 per common share, compared to $7.2 million, or $0.34 per common share, for Q2-16. NXRT paid a Q3-16 dividend of $0.206 per share and on November 7, 2016, the company's board of directors approved a quarterly dividend of $0.220 per share, a $0.014 per share, or 6.8% increase, over the prior quarter's dividend.

We're Off To See The Wizard

As I alluded above, Chris DeMuth was the first to write on NXRT and it took me around 1½ years to follow his lead. Now that Chris and others have been chasing the same gem, the question remains:

Is There Any Shine Left For NexPoint?

To begin, let's take a look at the current dividend yield compared to the peer group:

Before you scream, take a look at the payout ratio (compared with the direct peers):

Note: I left BRG out of that chart because it's a "sucker yield" (not covering the dividend at all - not even close).

NXRT has plenty of dividend capacity, so I'm not too bothered with the 3.8% yield.

Now let's examine the P/FFO multiple (compared with the closest peers):

As I anticipated, NXRT is no bargain (Chris beat me to the bargain table); however, take a closer look at the 2017 FFO growth forecast (using FAST Graph tools):

As referenced in a ++previous article++, Investors Real Estate Trust (NASDAQ:++IRET++) recently cut its dividend in anticipation of the recycling underway. So it's understandable that shares are cheap. APTS has more leverage and it has become a more complex operation (drifting away from the pure play apartment platform). Independence Realty Trust's (NYSEMKT:++IRT++) payout ratio is unsafe.

Now let's examine the growth forecast for 2018. Obviously this is a more subjective exercise, but it doesn't hurt to have another set of (analyst) eyes:

To Sum It All Up: NXRT is externally advised by NexPoint Real Estate Advisors, L.P. an affiliate of Highland Capital Management, L.P. I get it, the company is small, but management should become to start moving towards an internalized platform. 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.

However, NXRT insiders control over 18% of the shares.

My conclusion is that NXRT has performed as expected and I see no reason that the company cannot continue to produce above-average results. 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 (a.k.a. - The Trump Factor) 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.

My Target Price (waiting on a pullback) is $21.00.

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Source: FAST Graphs, and NXRT Filings.

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).

Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.

Disclosure: I am/we are long O, DLR, VTR, HTA , STAG, GPT, ROIC, HCN, OHI, LXP, KIM, WPC, DOC, EXR, MYCC, TCO, SKT, UBA, STWD, CONE, BRX, CLDT, HST, APTS, FPI, CORR, NHI, CCP, CTRE, WPG, KRG, SNR, LADR, PEB, BXMT, IRM, CIO, LTC, DEA, NSA, HASI, VER, SRG, SPG.

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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