NXRT - NexPoint Residential Trust Inc

[RedDaruma]

I saw a couple of thread about Scion's 13F but seems nobody posted the idea on this name yet. It's been a few weeks since I bought it but hopefully this can help the people interested. I spoke to several buys-side people and they quickly mentioned about 1) we are in the late inning of the apartment development cycle and 2) high debt level. On the former, most of the headlines we see are mainly talking about the national average and, if you dissect between property types, there seems to be a huge S/D imbalance on NXRT's main target Class B. On the second point, they are simply taking a step to reduce it. More details on the attach file.

NXRT_Final.docx

[winjitsu]

Excellent write-up. I've spent some time on NXRT but I couldn't pull the trigger just because REITs aren't in my circle of competence.

 

Just curious, do you think this is a compounding investment (i.e. earnings continue to grow based on re-investment), or just under-appreciated and will revert to market multiples? For operating businesses, I understand how strong competitive advantages/moat can lead to sustained high margin and growing operating cash flow. But reinvestment for NXRT, revolves around acquiring new properties, and in RE, management could deal with some very irrational bidders going forward in the future (they don't have any advantage in the bidding process). 

 

Side note, in your analysis you said:

 

Another recent private transaction also suggests NXRT’s assets are underappreciated in public market. In Oct ‘15, Starwood Capital Group and Milestone Apartments Real Estate Investment Trust agreed to buy Landmark Apartment Trust Inc., an owner of multifamily Class B properties in the southern U.S., in a deal valued at $1.9B ($8.17/sh). The deal includes 78 apartment communities with in 8 states (Dallas, Atlanta, and Nashville) and sold for ~$80K/unit. Applying this per unit value to NXRT’s 13,155 units and use ’15 NOI of $60.4M, the implied est. NAV/share would be $22.54. This value is ~80% higher than the current share price.

 

Isn't the proper way to do this valuation is find the cap rate of acquired properties and then apply that to rate to NXRT's portfolio? I wonder if just using a $/unit measurement, you're simplifying a little too much. Again, I know nothing about RE/REITs, so genuinely curious  :)

[shhughes1116]

I have a small position in NXRT.  Took a fairly long look at their financials, presentations, and SEC filings and decided to establish a tracking position (<2.5% of portfolio value).  I'd like to think REITs are in my circle of competence...I am a small-time slumlord and invest in property via REITs. 

 

I realize everyone has their own investment style, so take all of what I say with a grain of salt. 

 

Comparing company-wide transaction multiples is a waste of time for REITs, if you ask me.  Even with Class A or Class B, there is a fairly significant diversity of properties (location, property quality, location, property occupancy, location, property amenities, location, and location).  If you are going to invest in REITs, you better be willing to look under the hood...in other words, you better be willing to look at the underlying properties on a property-by-property basis.  Before I invest a substantial sum of money in a particular REIT, I want to know what they paid for the property, what the assessed values are, what the comparable sales values are, what the comparable rents are, whether or not they are charging below-market rents (my preference is to see below-market rents when I invest money...), the demographics of the location (I prefer Southeast and Southwest urban areas over Northeast and Rustbelt urban areas), and try to gauge cash flow per property.  In the case of NXRT, where part of the hypothesis is based on rehabbing properties to improve property value and increase rents, you need to be tracking these changes over time also.

 

The availability of Zillow and Redfin and Apartments.com makes all of this much easier now than 10 years ago...

 

Those numbers will give you an idea of management quality:

1) Are they overpaying for Class B properties?

2) Are their rehab expenditures resulting in increased property values (per real estate assessment) and increased rents?

 

Those numbers will also give you an idea of the durability of their market position.  If they are charging below market rents, then I see two benefits:

1. Ability to raise rents in a middling/strong market;

2. Ability to absorb market weakness without needing to lower rents much. 

 

In general, I think their process is spot-on for generating value in real estate -  (1) Find neglected, reasonably-valued properties in growing areas, preferably with below-market rents; (2) Rehab the properties and raise the rents, generating increased cash flow. (3) Reinvest cash flow in additional properties; (4) Rinse and repeat.   

 

After I do my property-by-property analysis, I will make my decision to either increase my investment (2.5% -> 10% of portfolio value), or dispose of my stake. 

 

 

[Guest MarkS]

Nice post, shhughes.  It's helpful to see how people think about their investments.

Thanks

Mark

[RedDaruma]

Excellent write-up. I've spent some time on NXRT but I couldn't pull the trigger just because REITs aren't in my circle of competence.

 

Just curious, do you think this is a compounding investment (i.e. earnings continue to grow based on re-investment), or just under-appreciated and will revert to market multiples? For operating businesses, I understand how strong competitive advantages/moat can lead to sustained high margin and growing operating cash flow. But reinvestment for NXRT, revolves around acquiring new properties, and in RE, management could deal with some very irrational bidders going forward in the future (they don't have any advantage in the bidding process). 

 

Side note, in your analysis you said:

 

Another recent private transaction also suggests NXRT’s assets are underappreciated in public market. In Oct ‘15, Starwood Capital Group and Milestone Apartments Real Estate Investment Trust agreed to buy Landmark Apartment Trust Inc., an owner of multifamily Class B properties in the southern U.S., in a deal valued at $1.9B ($8.17/sh). The deal includes 78 apartment communities with in 8 states (Dallas, Atlanta, and Nashville) and sold for ~$80K/unit. Applying this per unit value to NXRT’s 13,155 units and use ’15 NOI of $60.4M, the implied est. NAV/share would be $22.54. This value is ~80% higher than the current share price.

 

Isn't the proper way to do this valuation is find the cap rate of acquired properties and then apply that to rate to NXRT's portfolio? I wonder if just using a $/unit measurement, you're simplifying a little too much. Again, I know nothing about RE/REITs, so genuinely curious  :)

 

winjitsu - I think this is an undervalued asset play, rather than a compounding investment. I couldn't find any moat around NXRT's business; if S/D situation deteriorates, there is nothing prevent others from entering Class B market. I just think NXRT is undervalue and buying it is one way to enter the market for others chasing yields. I mentioned about a $/unit measurement just to show the example and I agree with shhughes1116 on his view all properties are different. I didn't make the comparison for each of property but again as shhughes1116 pointed out, I also found Zillow, Redfin, Apartments.com were useful. I hope this helps.

[dorsiacapital]

I have a small position in NXRT.  Took a fairly long look at their financials, presentations, and SEC filings and decided to establish a tracking position (<2.5% of portfolio value).  I'd like to think REITs are in my circle of competence...I am a small-time slumlord and invest in property via REITs. 

 

I realize everyone has their own investment style, so take all of what I say with a grain of salt. 

 

Comparing company-wide transaction multiples is a waste of time for REITs, if you ask me.  Even with Class A or Class B, there is a fairly significant diversity of properties (location, property quality, location, property occupancy, location, property amenities, location, and location).  If you are going to invest in REITs, you better be willing to look under the hood...in other words, you better be willing to look at the underlying properties on a property-by-property basis.  Before I invest a substantial sum of money in a particular REIT, I want to know what they paid for the property, what the assessed values are, what the comparable sales values are, what the comparable rents are, whether or not they are charging below-market rents (my preference is to see below-market rents when I invest money...), the demographics of the location (I prefer Southeast and Southwest urban areas over Northeast and Rustbelt urban areas), and try to gauge cash flow per property.  In the case of NXRT, where part of the hypothesis is based on rehabbing properties to improve property value and increase rents, you need to be tracking these changes over time also.

 

The availability of Zillow and Redfin and Apartments.com makes all of this much easier now than 10 years ago...

 

Those numbers will give you an idea of management quality:

1) Are they overpaying for Class B properties?

2) Are their rehab expenditures resulting in increased property values (per real estate assessment) and increased rents?

 

Those numbers will also give you an idea of the durability of their market position.  If they are charging below market rents, then I see two benefits:

1. Ability to raise rents in a middling/strong market;

2. Ability to absorb market weakness without needing to lower rents much. 

 

In general, I think their process is spot-on for generating value in real estate -  (1) Find neglected, reasonably-valued properties in growing areas, preferably with below-market rents; (2) Rehab the properties and raise the rents, generating increased cash flow. (3) Reinvest cash flow in additional properties; (4) Rinse and repeat.   

 

After I do my property-by-property analysis, I will make my decision to either increase my investment (2.5% -> 10% of portfolio value), or dispose of my stake.

 

Very nice post. Would love if you post your property by property analysis once completed.

[shhughes1116]

Sure, I can do that. 

[AJB96]

I've also been spending time researching NexPoint. What has me interested is the stock's discount to the underlying value of the properties based on private market multiples and comparable transactions such as Landmark and NXRT's own property sales. NXRT also trades at a discount to peers based on cap rates and P/FFO. On top of it there is a substantial opportunity to add significant value from the planned renovations which so far has achieved a 21.5% ROI. Interestingly, the management team has been (nearly unanimously) buying stock over the past year.

 

My notes are attached.

 

Alex

NexPoint_Summary.pdf

[bonkers]

I will share my views on 1) cap rates, 2) leverage, and 3) insider buying.

 

1. My main concern with this investment is related to currently low cap rates, and piling oversupply in other markets, which will probably have ripple effects. It appears that historically cap rates have not closely followed interest rates. I think that the 8 % cap rates of 1993-2002 were both related to disgust from previous collapse, and more focus on tech investments (vs. “old economy” real estate). Now we have the polar opposite in New York with cap rates below 4 %. So assuming that they will not mean revert at all in coming years is quite bold.

 

To me it seems that especially office and commercial real estate is general is very close to peak, and about to crash again, as they have always done. Observing the supply of class A high-end residential, I would also anticipate lower occupancy, prices, and some bad debts with builders. Considering this, the key question to me is how much fallout will class B residential suffer? Is it a separate market and local enough to remain intact?

 

Unfortunately, historically and on aggregate cap rates of various classes have moved pretty much in tandem: If cap rates for class A go up, so will for class B. For NXRT this would mean going from 6 % to 7-8 %, and once the turn comes, this can happen in only 2-3 years.

 

I think occupancy might remain high and cash flow good, but the NAV would go down. Current private market valuations do not help if the entire pricing moves. They might still be able to add some value by renovations (if they are still able to get higher-rent tenants), but value loss would take that ROI from 20 % to 0 % for a while. This would probably still be a fairly nice “worst case” if the discount to NAV would close, but if it doesn’t, the price of (also) this REIT might go down, not up.

 

2. The high leverage is due to historical reasons, but the management is planning to reduce it. How will this happen? The cash flow comes too slowly, and with REIT there is pressure to pay it out as dividends. So they will have to divest units, which will lead to lower diversification (more risk), probably higher geographical concentration (selling non-core), and of course lower cash flow. In order to get from 66 % down to 40 % debt to gross assets, I estimate that they have to divest 23-54 % of their RE assets (!)

 

3. What comes to insider buying, to me it seems that the big old cheese Dondero owned 3.3 M shares at spin-off from historical base, and has during last 12 mo. added +0.15 M more. This is almost the entire “insider stake”, but 45 M USD is small compared to his net worth of maybe a billion or more. His young lieutenants running the show own roughly 100-200 kUSD each, some of also this from bonuses, and only little bought with real money. So I wouldn’t call that “loading up”. If I’d invest in this, even my minimum investment would be bigger than what the CXOs own.

 

So, using mgmt guidance for 2016, de-levering to 40 % net leverage, and using current market CF-multiples I get a valuation range for NXRT 12-20 USD per share, where the highest sensitivity is to at what cap rates can they divest the assets to de-lever.

 

And all this is assuming their interest costs will not rise!

[RedDaruma]

Hi Alex. I'm curious. What is your PT?

[AJB96]

Congrats to those who invested in this name. I just sold my stake in NexPoint. The stock is up 50% since I purchased shares in March. I think an argument could be made for the stock to be worth $20-$25 but I chose to put my money into some other names that are much cheaper.

 

Alex

[shhughes1116]

Care to share the names that you moved into with your NXRT money?

[RedDaruma]

Alex - Thank you. Your discipline is well aligned with Klarman!

[hooplaer23]

Even after the significant increase in the share price, the company is still trading at an implied cap rate that is wide of what similar properties are trading for in private transactions.  As direct evidence of this, the company recently sold two properties in Jacksonville at a 6% cap rate.  Management has also taken a number of positive actions over the last several weeks including announcing a $30 million buyback authorization and swapping $200 million of the company’s debt from floating rate into fixed.  Even without more cap rate compression, the company should still be able to generate solid NOI growth as it continues to renovate and release units, given that only 25% of the company’s units has been renovated thus far. 

[frommi]

There is a new presentation with updated guidance+nav calculation. http://www.nexpointliving.com/Cache/1500087592.PDF?O=PDF&T=&Y=&D=&FID=1500087592&iid=4561930

Based on that NAV is currently ~22$. But their Q1 NOI is already running above the guidance and when i just assume 5% additional growth this year NAV can be 26-28$/share in under a year. Really impressive what high single digit rent growth together with high leverage can achieve. (Of course only as long as the cycle lasts, has someone a crystal ball for that?)

[hooplaer23]

It is worth noting that the Q1 NOI number includes the NOI from the two Jacksonville properties and the one Austin property that were recently sold.  With gross proceeds from the sale of $64.5 and a 6% cap rate, that suggests annual NOI of just under 4 million from those three assets.  Management has indicated that a portion of the proceeds will be used to repay the $29 million bridge loan maturing in August, and the company may also have been buying back shares.  I think both are good uses of the cash, but in the short term the NOI from those three assets might not be "replaced" with new assets. 

[frommi]

Thx for the reminder, but these actions actually improve nav/share even more because the dispositions are at the top end of caprates and the stock still trades below nav. They have compounded value/share at ~25% and thats pretty impressive. I don't have a lot of stocks in my watchlist that compound value as fast as this.

[AJB96]

Care to share the names that you moved into with your NXRT money?

 

I put a portion of the money in Seritage Growth Properties and Nexen Tire preferred in South Korea. I plan to start a thread on Nexen at some point. There is a third company I bought shares in but it's very illiquid and I'm still trying to buy more - so I'll keep that one a secret.