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What You Need To Know Before Investing In NexPoint Residential Trust, Inc. (NYSE:NXRT)

Simply Wall St

NexPoint Residential Trust, Inc. is a US$848m small-cap, real estate investment trust (REIT) based in Dallas, United States. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how NXRT’s business operates and also how we should analyse its stock. I’ll take you through some of the key metrics you should use in order to properly assess NXRT.

View our latest analysis for NexPoint Residential Trust

REIT investors should be familiar with the term Fund from Operations (FFO) – a REIT’s main source of cash flow from its day-to-day business activities. FFO is a higher quality measure of earnings because it takes out the impact of non-recurring sales and non-cash items such as depreciation. These items can distort the bottom line and not necessarily reflective of NXRT’s daily operations. For NXRT, its FFO of US$42m makes up 53% of its gross profit, which means over a third of its earnings are high-quality and recurring.

NYSE:NXRT Historical Debt, March 15th 2019

Robust financial health can be measured using a common metric in the REIT investing world, FFO-to-debt. The calculation roughly estimates how long it will take for NXRT to repay debt on its balance sheet, which gives us insight into how much risk is associated with having that level of debt on its books. With a ratio of 5.0%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take NXRT 20.08 years to pay off using just operating income, which is a long time, and risk increases with time. But realistically, companies have many levers to pull in order to pay back their debt, beyond operating income alone.

I also look at NXRT’s interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it’s better to use FFO divided by net interest. With an interest coverage ratio of 1.46x, NXRT is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.

In terms of valuing NXRT, FFO can also be used as a form of relative valuation. Instead of the P/E ratio, P/FFO is used instead, which is very common for REIT stocks. NXRT’s price-to-FFO is 20.07x, compared to the long-term industry average of 16.5x, meaning that it is overvalued.

Next Steps:

In this article, I’ve taken a look at Funds from Operations using various metrics, but it is certainly not sufficient to derive an investment decision based on this value alone. NexPoint Residential Trust can bring about diversification for your portfolio, but before you decide to invest, take a look at the other aspects you must consider before investing:

  1. Future Outlook: What are well-informed industry analysts predicting for NXRT’s future growth? Take a look at our free research report of analyst consensus for NXRT’s outlook.
  2. Valuation: What is NXRT worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether NXRT is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.