NexPoint Real Estate Finance, Inc.

Hello and welcome to Next Point Real Estate Finance Q2 2023 conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. And if you would like to ask a question during this time, simply press star one on your telephone keypad. I will now turn the conference over to Kristen Thomas. Please go ahead. Thank you.

Good day, everyone, and welcome to Next Point Real Estate Finances conference call to review the company's results for the second quarter ended June 30th, 2023. On the call today are Brian Mitz, Executive Vice President and Chief Financial Officer, Matt McGranner, Executive Vice President and Chief Investment 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.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 risk 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 accessed as required by law. Interim 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 Vitz. Please go ahead, Brian.

Thank you, Kristen. I appreciate everyone joining us today. I'm going to get us started by discussing our results for the second quarter, and then I'll provide guidance for the third quarter. and then turn it over to the rest of the team for their prepared comments. Q2 results are as follows. The second quarter, we reported net income of $0.36 per diluted share compared to net income of $0.26 per diluted share for the second quarter of 2022. The increase in net income is a result of improved performance of our CMBS investments in the second quarter of 23. Earnings available for distribution was 46 cents per diluted share in the second quarter compared to 49 cents per diluted share in the same period of 22. Cash available for distribution was 49 cents per diluted share in the second quarter compared to 56 cents per diluted share in the same period of 22. The decrease in earnings available for distribution and cash available for distribution from the prior year was partially driven by higher weighted average share counts, as well as a loss on the common stock component of two of our new investments. We paid a dividend of 50 cents per share in the second quarter. The Board has declared a dividend of 50 cents per share payable for the third quarter. The Board also declared a special dividend of 18.5 cents per share for the third quarter, and we intend to pay the same special dividend of 18.5 cents per share for the fourth quarter as well. Our dividend for the second quarter was 0.92 times covered by earnings available for distribution and 0.98 times covered by cash available for distribution. Put value for share decreased 1.6% quarter-over-quarter to $19.28 per diluted share, primarily due to the special dividend and mark-to-mark adjustments on our common stock investments. During the quarter, we originated three investments with $27.1 million outstanding principal with a blended all-in yield of 16.7 percent. We had one investment that partially redeemed for $6.2 million of outstanding principal, and two senior loans that fully redeemed for $11 million. Moving to guidance for the third quarter, we're guiding to earnings available for distribution and cash available for distribution as follows. Earnings available for distribution of 46 cents per diluted share at the midpoint, with a range of 41 cents on the low end and 51 cents on the high end. Cash available for distribution of 50 cents per diluted share at the midpoint with a range of 45 cents on the low end and 55 cents on the high end. The increase in cash available for distribution for the second quarter is driven primarily by the impact the new preferred equity investments made in the second quarter. Now I'd like to turn it over to Matt Goetz for his comments.

Thanks, Brian. During the quarter, the loan portfolio continued to perform strongly and is currently composed of 88 individual investments with approximately $1.7 billion in total outstanding principal. The loan portfolio is 94% residential, with 44% invested in loans collateralized by single-family rental and 50% invested in multifamily, primarily via agency CMBS. 4% of the loan book is life sciences and 1% self-storage. The portfolio's average remaining term is 5.1 years, is 92% stabilized, has a weighted average loan value of 69.2%, and an average debt service coverage ratio of 1.83 times. The portfolio is geographically diverse with a bias towards the Southeast and Southwest markets, Texas, Georgia, and Florida combined for approximately 53% of our exposure on a geographic basis. During the quarter, we originated three new investments with 26.3 million of outstanding principal with an estimated combined current yield of 16.7%. One investment partially redeemed for 6.2 million of outstanding principal and two SFR loans with a total of $10.5 million were fully paid off. The three new investments consisted of a $3.9 million preferred investment in a Life Sciences redevelopment located in the Woodlands, Texas, a suburb of Houston. The sponsor is a well-heeled repeat client with extensive experience in the Life Sciences real estate sector. The tenant has signed a long-term lease and is relocating their headquarters from Southern California to Houston upon completion of the property. The investment has a current estimated yield of 13%. We also made a $21 million preferred equity investment into a CGMP facility in Temecula, California, with another repeat sponsor. The preferred equity has a current estimated yield of 17.5%. The tenant has also signed a long-term lease agreement and is relocating 100% of their operations from Austin, Texas. The $1.2 million preferred equity investment was made in a build-to-rent portfolio in Phoenix, Arizona, with a repeat sponsor. The preferred has a current estimated return of 13.3%. The two full redemptions in the quarter consisted of $10.5 million of single-family rental loans that were purchased from Freddie Mac in 2019. The two paid-off loans achieved an average IRR of 11.1%. 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. In order to assess the impact of potential interest rate changes on our CMBS portfolio, we conducted a stress test. We aim to identify the extent to which implied yields would need to rise and portfolio marks would have to decrease to account for a $66 million decline in market value. This $66 million difference reflects the variance between our book value and the market value at the close of the previous night. Upon conducting the stress test, we observed that implied yields would need to increase by around 60% to result in a 12% decrease in the CNBS portfolio overall value. More importantly, to recognize any real impairment, there would need to be a substantial decline of over 30% in underlying multifamily and single-family property values. It is essential to note that such losses would be comparable to or even surpass the challenges faced during the Great Financial Crisis. Despite the stress test results, we maintain a strong belief in the resilience of the residential sector, especially in the current industry environment. We consider these investments in the verticals of multifamily and single-family properties to be safe, as demonstrated by their historical performance. At the end of the quarter, we maintain a cautious approach to our repo financing, with the leverage standing at approximately 63% LTV. We consistently engage in communication with our repo lending partners, discussing the market conditions and the status of our financing in the S portfolio. Regarding the ongoing performance of the SFR loan pool, I'm pleased to report that all SFR loans within the portfolio are currently performing exceptionally well. They exhibit robust debt service coverage ratios and have experienced notable net operating income growth. The demand for SFR remains strong, contributing to the positive trend. I'd also like to highlight that there were two SFR paydowns during the second quarter, generating a combined IRR of approximately 11%. To finalize and prepare remarks before we turn it over for questions, I'd like to turn it over to Matt McGrainer.

Thank you, Paul. Underlying NOIs embedded in our stabilized SFR, multi, life science, and storage collateral continue to outperform other property types, providing a resilient base of earnings for distribution and stable yields to our investors. We continue to believe NREF has the highest quality collateral in the commercial mortgage REIT sector, evidenced by strong coverage ratios, stabilized values, and no investments on reserve or watch lists. On the origination front, transaction volumes are still relatively muted, but we are seeing some seller capitulation in the five, five and a quarter cap rate range for multifamily and storage assets. We expect cash-in refis to provide a stable pipeline of originations, particularly for our private preferred business to multifamily operators. As a reminder, we generally generate low double-digit yields here, layered at 60% to 75% of the capital stack, with the ability to take over the asset and the event of a default. We expect this attractive business to be quite active as many multifamily bridge loans maturing over the next two years will need gap financing to meet agency refi tests. Beyond multifamily, we are seeing more structured financing opportunities across the board as equity investors would rather seek preferred or MES to shore up capital stacks than call capital, particularly as the investment community searches for a stable risk-free rate. To close, we are excited about these opportunities in the coming quarters and pleased with the company's continued stability. And as always, I'd like to thank the team for their hard work. And now we'd like to turn the call over to the operator for questions.

Thank you. If you have a question, please press star 1 on your telephone keypad. To withdraw your question, simply press star 1 again. Your first question comes from the line of Crispin Love with Piper Sandler. Please go ahead.

Thanks. Good morning. If I heard right, you mentioned losses on two common stock investments early in the call. Can you just provide a little more detail on those investments?

Yeah. So two of our preferred investments have a common stock component to them. And I think it was about $500,000 for each one of those. And we account for those as equity-messed investments because we don't have a controlling interest. Our A partner in those deals has the control. And there are some startup costs associated with those investments. So all the first expenses are allocated to our common stock position, essentially marking it down to zero in this first quarter. But we expect to recoup that and have a market-to-market gain when we exit these investments.

Yeah, Chris, it was a development deal, so it's not a true loss per se. It's just, as Dave mentioned, just expenses that are accruing because of the development and just the way the accounting works.

Okay, that makes sense. And then just in the release, you called out life sciences as kind of being kind of a big sector for you guys right now, and I heard there's kind of a new deal in the quarter, but can you just speak to kind of some of the key drivers there on – calling out life sciences rather than other sectors? Does it have to do with less demand for multifamily right now, just given the rate environment, or just kind of other reasons why you view life sciences to be more attractive right now?

Yeah, sure. It's Matt McGrainer. I think it's... Well, I guess, first of all, the multifamily, I think we're going to see more opportunities just by virtue of the sheer size of that market over the next 24 months. But in particular, we like life sciences, and more specifically, the CGMP side of life sciences, so the pharmaceutical manufacturing and other good manufacturing practices. As we've stated in prior calls, we like this sector for a lot of reasons, the reshoring Um, from, you know, from offshore supply chains, uh, constraints. Um, and then the sectors, particularly non bank at the moment. So it's hard for for most banks. Um, well, it's generally hard for most banks to make loans anyway right now, but, um, uh, particularly for for assets that, um. they view are more industrial in nature, but we view as completely mission critical to the tenant base. We see this as a giant wave over the next five to 10 years and would just like to get in front of it. We're catching as many of these opportunities as we can, again, because it's really played by debt funds and other commercial mortgage REITs, because banks can't understand underwriting the FF&E and the basis. That's why we like it. We have great relationships within the sector and just want to grow it more, but I'd say life sciences and multi will be our two, probably two strongest areas of growth over the next couple years.

Great. That makes sense. I appreciate you taking my questions. That's all for me. Thanks a lot.

Your next question comes from the line of Steven Laws with Raymond James. Please go ahead.

Hi, good morning. Good morning. I wanted to follow up, I guess, on Kristen's question, kind of touched on life sciences, but, you know, two investments there. But I noticed one has a pretty short remaining term, the one in Temecula. So can you talk to that? And, you know, is that something we may see is more, you know, short duration investments like that?

For that one specifically, Stephen, it will be extended. It was just kind of the nature of the facility itself. So, we'll most likely extend that out a year or so or a short term. But, yeah, I would assume it's probably a 2024 type payoff there.

Okay. So, I don't need to look at that paying off this quarter? I don't think so. Okay. Great. Maybe, you know, Matt McGrainer, maybe bigger picture, you know, can you talk a little bit about you know, what you're seeing in multi across affordable and workforce housing, you know, with what cap rates have done. Can you talk about the Freddie program and performance there? And, you know, I know we're, you know, pretty low volumes going into that, looking where we are year to date on those limits. But, you know, can you talk bigger picture about what you're seeing in kind of workforce and affordable multifamily?

Yeah, of course. I'd love to. I think generally multifamily in the Class B range has held up pretty well. We're approaching a time with some tough comps. A year ago in that sector, most operators were able to drive double-digit increases in rents. Today, you'll see some earn-in benefit from 2022 strong rents, but you are seeing new lease trade-outs. 1%, 2%, 3%. That's what we experienced. I saw that MAIA experienced the same thing. Renewals are a little bit stronger in the 4% or 5% range, and then occupancies are generally stable. I think that on the transaction side, you are starting to see a little bit more deals, purchases and sales. I expect a pickup. and the transaction volume, and really after Labor Day, after summer kind of winds down, the 5% cap rate range still feels like the right answer, given that if you're underwriting, or if your cost of debt is generally around 5% and you can underwrite a little bit of growth, you have some positive leverage. So I do think that's kind of the new normal, at least as it sits here today. But generally speaking, I think the multifamily sector's healthy. There will be some challenges with some of these CRE CLOs that you're seeing articles written about. That is a real thing, and there will have to be some capital called or some gap financing to shore up those deals. But I don't think, you know, I think they'll be able to be worked through, you know, multifamily, especially in the B sector is a great business and, you know, they're not Everything that the Fed has done and everything with the banking crisis is just going to make affordable housing all the more important.

Great. Appreciate the comments this morning. Thank you. Thanks, Stephen.

Once again, if you have a question, it is star one. Your next question comes from the line of Jade Ramani of KBW. Please go ahead.

Thanks very much. Are you starting to see... A pickup in deal flow on some of these multifamily bridge loans where, you know, to get a GSE takeout, it's really about the debt service coverage and LTV. I think you need something like below 60% LTV to have a 1.2 times debt service coverage. So I think mortgage REITs that have that exposure are going to be offering preferred equity In some cases, mezzanine with pick interest. And given the NXRT platform, as well as the strong relationship with Freddie Mac, I would think providing that gap filler capital could be a big opportunity. Are you starting to see an increase in deal flow there?

Yeah, we are, Jay. That's a great point and one I touched on briefly in the prepared remarks. And this is a business that we started really in concert with Fannie and Freddie back in 2013, 2014. So we were able to work with them to comprise a set of documents that would allow for our ability as a select sponsor to take over the asset if there is an event of default. Agree with you that the bridge loans that were kind of two years or two plus one that were originated in 21 and 22, that wave will come. They're not going to be able to meet the agency tests, and there will be that opportunity. And we'd love to offer it. Like I said, we're in this business a lot, done a little over $500 million of it. from just not a gross investment dollar, but a net investment dollar amount. So I'm really excited about this opportunity for sure.

And do you think those rescue opportunities are going to be the primary source of deals or you'll see, you know, de novo acquisition deals with regular way financing that you're going to plan?

Yeah, I think it's going to be both, you know, I think with the, with the cost of, with the cost of debt where it is, and if we are indeed higher for longer, the gap financing from well-heeled sponsors is going to be a thing. You're already seeing it, and even with great new construction deals and great sponsors, those opportunities for MEDS are appearing. But yeah, I think I do see this as our probably the biggest piece of the pie over the next – certainly over the next 12 months.

And on the Freddie Mac CMBS pools, as loans come up for maturity and need to refinance, is it your expectation that there won't be meaningful defaults, or do you think there's some reasonable range that you would expect naturally to occur?

Yeah, I think, you know, given how – the history of the K program and I think 30 basis points of cumulative defaults, not losses, over the history of the program. They've done a good job with the special servicers and particularly the DCHs like ourselves in these deals to work through and reach an outcome to the extent there is a problem that's acceptable to everyone. Good news about these pools are they're highly diversified and most of the loans that we own or the look-through loans or the biggest loans are in parts of the country where we operate, like Texas and Florida and Georgia. We think there'll be some pain. I wouldn't expect it to be anywhere near the CRECLO, but I think any Any sort of issues will be more easily worked through by virtue of the K program than in the private conduit market. If you have issues in the Fannie and Freddie program as a sponsor, then you're kicked out, and you certainly don't want that if you want to be in the apartment business.

Thanks for taking the questions.

Thanks, Jay.

There are no further questions at this time. I will turn the call back to the management team for closing remarks.

Yeah, I appreciate everyone's time. We'll be back in touch next quarter. Thank you.

This concludes today's conference call. Thank you for joining. You may now disconnect your line.