NexPoint Real Estate Finance, Inc.

Good day and welcome to the NextPoint Real Estate Finance Q1 2022 conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Jackie Graham. Please go ahead.

Thank you. Good day, everyone, and welcome to NextPoint Real Estate Finance's conference call to review the company results for the first quarter ended March 31st, 2022. On the call today are Brian Mitts, Executive Vice President and Chief Financial Officer Matt Guest, 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.nextpoint.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 accept as required by law and rest 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. Please go ahead, Brian.

Thank you, Jackie. Appreciate everyone joining us this morning. I'll start the call by going through our results for the first quarter. I'll cover guidance briefly and then turn it over to the rest of the team for them to give a detailed commentary on the portfolio, some of the recent activity, and some of the things that we see ahead for the remainder of the year. For the first quarter, we reported net income of $0.81 per diluted share compared to net income of $1.26 per diluted share for the first quarter of 2021. $1.23 per diluted share for the first quarter compared to 43 cents per diluted share in the same period of 2021. We report a cash level for distribution of $1.58 cents per diluted share compared to 47 cents per diluted share in the first quarter of 2021. Book value per share increased 1.3% quarter-over-quarter and 7.1% year-over-year to $21.78. For the first quarter, we paid a dividend of 50 cents per share, and the board has declared a dividend of 50 cents per share for the second quarter. When we move to guidance for the second quarter, earnings available for distribution per deleted share we're guiding to 55 cents per share at the midpoint with a range of 50 cents to 60 cents. And for cash available for distribution per diluted share, we're guiding to 64 cents per share at the midpoint with a range of 59 cents to 69 cents. So with that, let me turn it over to the team to go through the portfolio and some of the recent activities.

Thanks, Brian. The first quarter continues to show strong performance across each of our investments and asset classes. The portfolio is currently comprised of 78 individual investments with approximately $1.6 billion in total outstanding principal. The loan portfolio is 97% residential with 44% invested in senior loans, collateralized by single-family rental, and 54% invested in multifamily, primarily via agent CMBS. The remaining 3% of the loan book is life sciences and self-storage. The portfolio's average remaining term is 6.4 years, with 94% stabilized, has a weighted average loan to value of 67.7%, and an average debt service coverage ratio of 1.87 times. The portfolio is geographically diverse, with a biased course of southeast and southwest markets. Texas, Georgia, and Florida combine for approximately 49% of our exposure on a geographic basis. 100% of our investments are current, As mentioned in earnings, none of our underlying loans are currently in forbearance. Moving to the opportunities we were able to take advantage of during the quarter. During the quarter, we originated a convertible note in the amount of $38.7 million, bringing our total convertible note exposure to ground leases to approximately $60 million. Subsequent to quarter end, the sponsor repaid all but $25 million of this amount, which is converted into common equity in the company at a 12.5% discount. On January 14th, we purchased $19.6 million of preferred equity, collateralized by a single-tenant stabilized pharmaceutical manufacturing property with a current yield of 10%. On January 27th, we purchased $41.8 million of a preferred equity investment, collateralized by a stabilized multifamily property in Las Vegas, Nevada. On January 25th, three single-family rental first mortgage loans with an aggregate principal amount of $32.1 million were repaid in full, with INREC achieving an IRR of 41.5%. On February 25th, a $62 million single-family rental first mortgage loan was repaid in full, and INREC realized an IRR of 35.9%. In summary, we continue to find attractive investment opportunities throughout our target markets and asset classes, and we'll continue to evaluate these opportunities with the goal of delivering value to our shareholders. I would now like to hand the call over to Paul Richards.

Thanks, Matt. During the first quarter, the company was yet again active in the primary bond market. Though there were not any CMBS bond acquisitions made during the first quarter, the company participated in two Freddie Mac bond auctions. one of which was a small balance loan VPs in Freddie Mac's Fresby program, and the other, which was a floating rate K deal. Both options demonstrated extremely strong demand and ultimately priced well inside previous market clearing levels. Just this morning, we closed on a seasoned Freddie Mac small balance loan VPs. The VPs was purchased for approximately $39 million, which we will prudently lever via attractively priced rebuild financing. The bond carried a current coupon of approximately 4.25% and was purchased at a discount. We expect to generate an all-in unlevered yield of roughly 8% and a levered yield in the low to mid-teens. The weighted average life of the bond, assuming a 15% CPR, is roughly six and a half years. As discussed in the previous quarter's commentary, the market continues to experience inflation headwinds, along with the Fed signaling multiple half-point rate hikes. Though, as previously mentioned, there has been insatiable demand for freighted XDP bonds, and we continue to see price tightening. We continue to be sensibly levered on our repo at roughly 57% LTV at quarter end. Lastly, I wanted to briefly touch on the continued performance of the SFR loan pool and the Q1 2022 loan paydowns. All SFR loans are currently performing and demonstrating strong metrics in terms of rent growth and occupancies as the demand for single-family rentals continues to shine brightly. The portfolio has had a few SFR loan paydowns in the first quarter, which generated a combined IRR north of 40%. compared to the original underwriting of 9%. Due to the early pre-payment penalties, the investments were able to generate additional net proceeds than the original underwriting, which was roughly one-third of the original investment's time horizon. To finalize our prepared remarks, before we turn it over for questions, I'd like to turn it over to Matt McGrainer. Thanks, Paul.

Again, we continue to be pleased with the underlying credit performance of NREF's portfolio, generating book value growth for the eighth consecutive quarter while providing durable cash flows for our shareholders. The recent market volatility has started to bear fruit for NREF's investing pipeline, creating second chance and gas financing opportunities in our core property types, especially in the multifamily sector. And finally, we continue to cultivate programmatic, special situation, and preferred opportunities with SFR, storage, and multifamily sponsors with an underwriting pipeline today north of $400 million. I just want to thank the team for continued execution, and now I would like to turn the call over to the operator for questions.

Thank you. Ladies and gentlemen, to ask a question, please signal by pressing star 1 on your telephone. Please ensure that the mute function on your telephone is switched off to allow your signal to reach our equipment. Again, to ask a question today, please signal by pressing star 1 on your telephone.

We will pause for just a moment to allow everyone an opportunity to signal for questions. Our first question today comes from Steven Laws from Raymond James.

Please go ahead.

All right, good morning. You know, as we look at the portfolio mix, you know, the multifamily SFR mix has sort of flipped over the last year. As you look at your investment pipeline and where you're seeing the most attractive risk-adjusted returns, you know, where do you see that mix going, say, over the next 12 months?

Hey, Steve.

It's Matt McGregor. Yeah, I think we continue just to have more financing opportunities within the multifamily sectors. It's just a larger market, more institutional, more transaction volume. Obviously, the Freddie Mac pipeline is going to stay there. And as I mentioned kind of briefly in the prepared remarks, as long as the agencies kind of, you know, keep spreads wider than banks and other life codes. We're seeing these gap financing opportunities in the multifamily sector kind of accelerate. So our historical private preferred pipeline is about $100 million a year. That could be $200 million this year as just lower LTVs that are generated by the agency's create that 65 to 85% of the stack type of financing. So I would expect us to spend a lot of time in that market, and that's just a function of the recent volatility.

Thanks, Matt. And on the common stock investment, kind of what's the outlook there? And, you know, if you fully redeploy that into investments today, if you were to kind of look at it that way, what type of impact would that have on adding interest income or CAD to the current portfolio returns?

Yeah, so the ground lease investment, I think, is what you're referring to, right?

Yes.

Yeah, so we decided to convert We could have the whole thing repaid, but we like leaving some out there, just have some connectivity with the sponsor, number one. And then number two, and probably more importantly, we think it's a two-act over three years. So hopefully investors realize that we're not just a dividend payer. We do have special situation investments like this one that create the book value growth. and more total return potential than the normal mortgage rate. So, you know, we like that risk-adjusted, you know, profile of creating, you know, roughly another, you know, $1, $1.50 a share for shareholders.

Great. Thanks for the color there. And you mentioned dividend. I do want to ask about that lastly. You know, strong coverage, you know, outlook, you know, in the supplement looks like continued strong coverage. Can you talk about how you think about setting the dividend and thoughts about potentially increasing it given the strong coverage you have in place?

Yeah. Hey, Steve. It's Brian. I think overall we want to make sure that we can continue to cover it with go-forward earnings. And obviously it's difficult when you're getting prepayments and things to really estimate that out into the future. So As we increase earnings, we want to be cautious about increasing the dividend and try to peg it at a coverage to our earnings available from distribution because we think that's a better longer-term view than just cash available for distribution. I think once we get a couple quarters under our belt for the current portfolio and better understand where the prepayments are going to go, particularly in that SFR pool where I think just the run-up in values of SFR properties puts the borrowers in a position where they're at a pretty low LTV with our loans. They can refinance those pretty easily and not very expensive either and go up to a large LTV. So it makes sense for them to pay those huge prepayment penalties in some cases, but That just creates a little bit of uncertainty in the portfolios. We just want to be careful before we raise the dividend. But we'll look at it as a coverage on earnings available for distribution as our sort of benchmark.

Great. Appreciate the comments, Brian.

Thank you. As a reminder, ladies and gentlemen, to ask a question today.

Please signal by pressing star 1 on your telephone keypad.

We'll now take a question from Jade Romani from KBW. Please go ahead. Thank you very much.

As it relates to the multifamily outlook, how are you thinking about it in terms of valuation of the asset class from the impact of rising rates and also a potential slowdown in rent growth? For some color, I think the shelter index is about one-third of what the Fed looks at in terms of inflation. And given the timeline to turnover assets, and I believe multifamily turnover ratios are still running low, that suggests inflation will have a lagging effect on inflation. And so if the Fed really wants to get inflation under control, they have to slow down not just the home purchase market, but also the rental market. So question is, what are you thinking and projecting for the outlook for rent growth in multifamily, as well as single family for rent? And what impact do you think housing, sorry, rising rates will have on cap rates?

Yeah, hey, Jay, Matt McGregor. Lots of impact there. I think we reported an NXRQ hearing two days ago, had our strongest same-story LI growth. that we've had in a couple of years. Blended lease growth, both renewals and new leases north of 20%. Same thing has occurred in April. Mid-America just did basically the same thing this morning or yesterday after it closed. And most of the operators in sort of the, I guess even on the gateway markets have all kind of increased guidance in terms of just seeing top line and GPR growth within their rent rolls. This year, I think we'll see continued strength in underlying leases, especially and particularly in the agency, the middle market, the agency cohort. I think the cap rates in the transaction volumes, at least for now, have kind of to take a brief pause, but there's still a ton of equity out there chasing deals. And while there might be less sort of in the buyer pool, so to speak, the well-heeled and the institutional capital is still chasing multifamily because there's underlying growth and stability in the rents and a perfect, not a perfect, but you know, close to as perfect as you can get for an inflation hedge. More institutional capital has been allocated toward the residential sector for these reasons as an inflation hedge, so I don't see that evading. Cap rates right now have remained steady. There is a negative debt constant, at least on the agency side, cap rates are tighter than spreads. That dynamic gives us some concern, if any, that cap rates would increase, but they haven't yet. As I'm sure you're aware, in the last few weeks, the agencies have continued to tighten spreads. I'd say that we're still positive, obviously, on a relative basis to multifamily more so than probably any other property type in this current environment, especially when it's in the middle market segment, which is largely where most of our activity is. In terms of SFR, I'll let Brian or Paul comment.

Yeah, I'll start. It's Brian. It's a lot of the same dynamics, I think, with multi- Overall, I think we look at the portfolio itself and the underlying assets, and again, the LTV in those deals is fairly low. It's hard for us to report on that because we don't get updated numbers specifically across the entire portfolio frequently, but being in the business and owning over 22,000 homes ourselves across the country, And the different vehicles, we do understand that market. And so we feel pretty optimistic about it. But as we mentioned earlier, it is a less institutionalized sector. It is harder to find opportunities. And there's a big disparity between a handful of really large players and then everyone else who's pretty small and not necessarily the types of partners that we want to lend to from this vehicle. So I think as far as the sector goes, We like SFR. It's got a lot of strong fundamentals and tailwinds, but it's hard to put money to work there. Obviously, we don't control the velocity of prepayments in the current environment. Paul, if you want to.

Yeah, I agree with everything Brian just said. The only thing I would add on would be the difference between homeownership versus renting in the SFR space. We've seen mortgage rates go up past 5% and if you're looking at what homeownership costs versus renting, You know, it's 40% more in HPA versus renting. It's only been about 10, 15% in growth rates. So it's still cheaper to rent on the SFR side. And, you know, I think if you look at our rental to incomes, it's still 20, 25%. So there's still room to run, you know, in that regard. So I think it's still attractively priced from a rental standpoint.

I think lastly, Jay, I don't know how the Fed is going to get it under control by raising rates. You know, we've had this debate internally and, I mean, The Fed increases will just continue to make homeownership less affordable and available to the masses. So I think that the rental space, the middle market rental space that we operate in, where the majority of our investments are, will continue to benefit from that.

Yeah, thanks. I don't know how they will either. They may need to cause unemployment to rise, and that means probably a recession, but there's a labor shortage, so hard to see how all of this plays out. Let's see. On the single-family rental repayments, any partial paydowns received from Progress Residential? And with CLO spreads widening and the all-in cost to issue a CLO, up, does that decrease any likelihood of repayment from Progress Residential?

Hey, Gabe. It's Paul.

On the Progress Residential or the Resi loan, yeah, no prepayments on that. It's still a long-dated bond or a long-dated loan, so the prepayments still call it 20% or so. Yeah, I don't see that prepaying anytime soon, given the size. So, Brian, do you have anything else on that?

No, I don't think that's accurate.

Thank you. In terms of the GFC multifamily outlook, do you think that they have recently picked up volumes or they're still struggling to gain market share? I saw recently that there are some stories about them loosening underwriting, not just what yeah tightening spreads as you mentioned but also their look back that service coverage ratios you know a lot of deals haven't penciled for them because they're looking at old rents instead of where things are today uh do you have a sense of whether their deal flow has picked up yeah i mean you're exactly right anecdotally they're um they had a pretty terrible march in terms of production um you know april doesn't seem like they're um

they're really gaining any more market share. There's less transaction volume in April anyway, in March. So they're definitely behind their pace. We had Freddie Mac in here, I think, two and a half weeks ago. And they were, I guess, trying to internally work through how they can be competitive and make sure that they can still provide liquidity to the market because right now they're about a month behind their last year's run rate.

Can you give a mark-to-market book value? Is book value down based on where rates have moved thus far in 2Q?

From the CMBS side, the B pieces actually did tighten.

Given the fact that the options price tuner base points tighter than the original market clearing levels or the previous market clearing levels, those tightened. The I.O. strips, which of course are more interest rate sensitive, those did have, one, they're advertising, and two, interest rates rising did cause a little bit of mark-to-mark loss on the I.O. strips. But all in all, I believe it was a pretty tight quarter in terms of the CMBS book.

Okay, but so post-quarter end, in the second quarter so far, is book value relatively flat, would you say, or is it up or down? Any comment you could provide or not, really?

Yeah, relatively flat as of this month.

Okay. Thanks very much, and I appreciate the color. Thanks, Jay.

Thank you. As a final reminder, ladies and gentlemen, if you wish to ask a question at this time, please signal by pressing star 1 on your telephone keypad.

It appears we have no further questions at this time. Yeah, great. Appreciate everyone's time.

Thank you for participating. We will talk next quarter. Thank you.

Thank you. This would conclude today's conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.