Q2 2023 Nexpoint Real Estate Finance Inc Earnings Call
Participants
Brian Dale Mitts; CFO, Executive VP of Finance, Secretary, Treasurer & Director; NexPoint Real Estate Finance, Inc.
David Ernest Willmore; VP of Finance; NexPoint Residential Trust, Inc.
Kristen Thomas; Director of IR; NexPoint Real Estate Finance, Inc.
Matthew Ryan McGraner; Executive VP & CIO; NexPoint Real Estate Finance, Inc.
Matthew X. Goetz; SVP of Investments & Asset Management; NexPoint Real Estate Finance, Inc.
Paul Richards; VP of Asset Management; NexPoint Hospitality Trust Inc.
Crispin Elliot Love; Director & Senior Research Analyst; Piper Sandler & Co., Research Division
Jade Joseph Rahmani; MD; Keefe, Bruyette, & Woods, Inc., Research Division
Stephen Albert Laws; Research Analyst; Raymond James & Associates, Inc., Research Division
Presentation
Operator
Hello, and welcome to NexPoint Real Estate Finance Q2 2023 Conference Call. (Operator Instructions) I will now turn the conference over to Kristen Thomas. Please go ahead.
Kristen Thomas
Thank you. Good day, everyone, and welcome to NexPoint Real Estate Finance's conference call to review the company's results for the second quarter ended June 30, 2023. On the call today are Brian Mitts, Executive Vice President and Chief Financial Officer; Matt McGraner, 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.nexpoint.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 except as required by law, NREF 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 Mitts. Please go ahead, Brian.
Brian Dale Mitts
Thank you, Kristen. 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. For the second quarter, we reported net income of $0.36 per diluted share compared to net income of $0.26 per diluted share in 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 $0.46 per diluted share in the second quarter compared to $0.49 per diluted share in the same period in '22. Cash available for distribution was $0.49 per diluted share in the second quarter compared to $0.56 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 2 of our new investments. We paid a dividend of $0.50 per share in the second quarter, and the Board has declared a dividend of $0.50 per share payable for the third quarter. The Board also declared a special dividend of $0.185 per share for the third quarter and we intend to pay the same special dividend of $0.185 per share for the fourth quarter as well.
Our dividend for the second quarter was 0.92x covered by earnings available for distribution and 0.98x covered by cash available for distribution. Book value per share decreased 1.6% quarter-over-quarter to $19.28 per diluted share, primarily due to the special dividend and mark-to-market adjustments on our common stock investments.
During the quarter, we originated 3 investments with $27.1 million of outstanding principal with a blended all-in yield of 16.7%. We had one investment to partially redeem for $6.2 million of outstanding principal and 2 senior loans are 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 $0.46 per diluted share at the midpoint with a range of $0.41 on the low end and $0.51 in the high end. Cash available for distribution of $0.50 per diluted share at the midpoint with a range of $0.45 on the low end and $0.55 on the high end. The increase in cash available for distribution for the second quarter was driven primarily by the impact of the new preferred equity investments made in the second quarter.
Now I'd like to turn it over to Matt Goetz for his comments.
Matthew X. Goetz
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 of 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 to value of 69.2% and an average debt service coverage ratio of 1.83x. The portfolio is geographically diverse with the 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 3 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 2 SFR loans with a total of $10.5 million were fully paid off. The 3 new investments consisted of a $3.9 million preferred investment in the 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 (inaudible) 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. A $1.2 million preferred equity investment was made in the build-to-rent portfolio in Phoenix, Arizona with a repeat sponsor, preferred has a current estimated return of 13.3%. The 2 full redemptions in the quarter consisted of $10.5 million of single-family rental loans that were purchased from Freddie Mac in 2019.
The 2 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.
Paul Richards
Thanks, Matt. In order to assess the impact of potential interest rate changes upon 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 CMBS portfolio overall value.
More importantly, to recognize any real impairment, there needs to be a substantial decline of over 30% in underlying multifamily and single-family property values. It is essential to note that such losses will be comparable to or surpass the challenges faced during the great financing presses. Despite the stress test results, we maintained a strong belief in the resilience of the residential sector, especially in the current interest rate environment. We consider these investments in the verticals of multifamily and single-family properties to be saved as demonstrated by the historical performance.
At the end of the quarter, we maintained a cautious approach to our repo financing with a 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 finance CMBS 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 -- our net operating income growth. The demand for SFR remained strong, contributing to the positive trend. I'd also like to highlight that there were 2 SFR paydowns during the second quarter, generating a combined IRR of approximately 11%. To finalize the prepared remarks before we turn it over for questions, I'd like to turn it over to Matt McGraner.
Matthew Ryan McGraner
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 list.
On the origination front, transaction volumes are still relatively muted, but we are seeing some seller capitulation in the 5% to 5.25% cap rate range for multifamily and storage assets. We expect cash and refinance 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 in the event of a default.
We expect this attractive business to be quite active as many multifamily bridge loans maturing over the next 2 years, we'll need GAAP 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 mezz to shore up capital stacks and 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 I'd like to turn the call over to the operator for questions.
Question and Answer Session
Operator
(Operator Instructions) Your first question comes from the line of Crispin Love with Piper Sandler.
Crispin Elliot Love
If I heard right, you mentioned losses on 2 common stock investments early in the call. Can you just provide a little more detail on those investments?
David Ernest Willmore
Yes. So 2 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 capture those equity investments since we don't have controlling interest. Our partner in those deals had the control and there are some start-up costs associated with those investments. So all the first expenses were allocated to our common stock position, essentially marking it down to 0 in this first quarter, but we expect to recoup that and have a mark-to-market gain when we exit these investments.
Paul Richards
Yes, Crispin, it was a development deal. So it's not a true loss per se. It's just, as David mentioned, these expenses are occurring because of the development and just the way the accounting works.
Crispin Elliot Love
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 or kind of -- 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?
Matthew Ryan McGraner
Yes. Sure. It's Matt McGraner. 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 sciences, the pharmaceutical, manufacturing and other good manufacturing practices. .
As we stated in prior calls, we like this sector for a lot of reasons, the reshoring wave from offshore supply chain constraints. And then the sector is particularly nonbanked at the moment. So it's hard for most banks. Well, it's generally hard for most banks to make loans anyway right now, but particularly for assets that 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 kind of 5 to 10 years, and we 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 that banks can't understand underwriting the FF&E in the basis. So 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 2 -- probably 2 strongest areas of growth over the next couple of years.
Crispin Elliot Love
Great. That makes sense. I appreciate you taking my questions. That's all from me.
Operator
Your next question comes from the line of Stephen Laws with Raymond James.
Stephen Albert Laws
I wanted to follow up, I guess, on Crispin's question, kind of it touched on life sciences, but -- 2 investments there. But I noticed one has a pretty short remaining term, the one in the Temecula. So can you talk to that? And is that something we may see is more short duration investments like that?
Paul Richards
For that one specifically, Stephen, it will be extended. It was just kind of the nature of the facility itself. So it will most likely extend that out a year or so or short term, but yes, it's -- I would assume it's probably a 2024 type payoff there.
Stephen Albert Laws
Okay. So I don't need to look at that paying off this quarter?
Paul Richards
I don't think so.
Stephen Albert Laws
Okay. Matt or Graner, maybe bigger picture. Can you talk a little bit about what you're seeing in multi across affordable and workforce housing? With what cap rates have done? Can you talk about the Freddie program and performance there? And I know we're -- pretty low volumes coming in that looking where we are year-to-date on those limits. But can you talk bigger picture about what you're seeing in kind of workforce in affordable multifamily?
Matthew Ryan McGraner
Yes. Of course, 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 earning benefit from 2022 strong rents, but you are seeing new lease trade-outs 1%, 2%, 3%, that's what we experienced. I saw that MAA experienced the same thing. Renewals are a little bit stronger in the kind of 4%, 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 in the transaction volume 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 you can -- if your cost of debt is generally around 5%, 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 is healthy. There will be some challenges with some of the CRE sellers, you're seeing articles written about, that is a real thing and there will have to be some capital call, there is some gap financing to shore up those deals. But I don't think -- I think they'll be able to be worked through multifamily especially, and the B sector is a great business. And 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.
Operator
(Operator Instructions) Your next question comes from the line of Jade Rahmani of KBW.
Jade Joseph Rahmani
Are you starting to see a pickup in deal flow on some of these multifamily bridge loans where to get a GSE take out, it's really about the debt service coverage and LTV. I think you need something like below 60% LTV to have a 1.2x debt service coverage. So I think mortgage REITs that have that exposure are going to be offering preferred equity, in some cases, mezzanine with thick 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?
Matthew Ryan McGraner
Yes, we are, Jade. It's a great point and what 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 a default. I agree with you that the bridge loans that were kind of 2 years or 2 plus 1 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 -- like I said, we're in this business a lot, done little over $500 million of it from just not a gross investment dollar, but a net investment dollar amount. So really excited about this opportunity for sure.
Jade Joseph Rahmani
And do you think those rescue opportunities are going to be the primary source of deals? Or you'll see the Novo acquisition deals with regular way financing that you're going to play in?
Matthew Ryan McGraner
Yes, I think it's going to be both. I think with the cost of debt where it is and if we are indeed higher for longer, the GAAP financing from well-heeled sponsors is going to be a thing. You're already seeing it in -- even with great new construction deals and great sponsors, those opportunities for mezz are appearing. But yes, I think -- I do see this as our -- probably the biggest piece of the pie over the next -- certainly over the next 12 months.
Jade Joseph Rahmani
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?
Matthew Ryan McGraner
Yes. I think given how the history of this -- 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 (inaudible) are highly diversified and most of the loans that we own are -- look through loans are the biggest loans are in parts of the country where we operate, like Texas and Florida and Georgia. So we think there'll be some pain. I wouldn't expect it to be anywhere near the CRE CLO. But I think any sort of issues will be more easily worked through by virtue of the K-program than in the private conduit market. Now if you have these issues in the Fannie and Freddie program as a sponsor, then you're kicked out, and you certainly don't want that to be part of the business.
Operator
As there are no further questions at this time, I will turn the call back to the management team for closing remarks.
Brian Dale Mitts
Yes, I appreciate everyone's time. We'll be back in touch next quarter. Thank you.
Operator
This concludes today's conference call. Thank you for joining. You may now disconnect your lines.
Brian Dale Mitts
We'll be back in touch next quarter. Thank you.
