Hello and welcome to NexPoint Real Estate Finance Q2 2023 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I will now turn the conference over to Kristen Thomas. Please go ahead..

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 30th, 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, Investment 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 invest.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 read 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..

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 on 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 distribution from the second quarter is driven primarily by the impact of a new preferred equity investments made in the second quarter. I’d now 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 of total outstanding principal.

The loan portfolio is 94% residential with 44% invested in loans collateralized by single-family rental and 50% investment in multifamily, primarily via agency CMBS. The 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 as a weighted average loan-to-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 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 two 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 and suburb of Houston.

The sponsor is a well-heeled repeat client with extensive experience in the life sciences real estate chapter. The tenant has also 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 has a current estimated yield of 17.5%, the tenant has also signed a long-term lease agreement as relocating a 100% of their operations from Houston, Texas.

A $1.2 million preferred equity investment was made in build-the-rent portfolio in Phoenix, Arizona with a repeat sponsor. Their preferred has a current estimate of 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 need to identify the extent of which implied yields were need to rise and portfolio marks would have to decrease to account for $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 a stress test, we observed that implied yields were 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 need to be a substantial decline of over 30% in underlying multifamily and single family property values, it is essential to note that such loses will be comparable to or [technical difficulty] surpass the challenges faced during the great financial crisis.

Despite the stress test results, we maintained a strong belief in the resilience of the residential sector, especially in the current industry environment, we consider these investments in the vertical of the multifamily and single family properties to be safe 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 53% LTV. We consistently engaging communication with our REPO lending partners, discussing the marketing conditions and the status of refinanced 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 operating income growth. The demand for SFR remains strong, contributing to the positive strength.

I’d also like to highlight that there were two SFR pay downs during the second quarter, generating a combined IRR of approximate 11%. To finalize the prepared remarks before we turn it over for questions, I’d like to turn it over to Matt 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 lists.

On the origination front, transaction volumes were still relatively muted, but we are seeing some seller capitulation in the 5 to 5.25 cap rate range for multifamily to storage assets. We expect cash and refis provide a stable pipeline of originations, particularly for our multifamily – for our private preferred business to multifamily operators.

As a reminder, we generally generate low double-digit yields here laid out 60% to 75% of the capital stack with the ability to take over the asset and been of a default. We expect this attractive business that would be quite active as many multifamily bridge loans maturing over the next two years will need cap financing to meet agency refi tests.

Beyond multifamily, we’re seeing more structured financing opportunities across the board as equity investors would rather seek preferred or mezz to shore up capital stacks than comp capital. Particularly as the investment community searches for a stable risk-free rate.

To close, we’re 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. [Operator Instructions] 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 the losses on two common stock investments early in the call.

Can you just provide a little more details on those investments?.

Yeah. So two of our preferred investments have a common stock components to them. And I think it was about does increase one of those and we accounted those as we mentioned investments that we don’t have that controlling interests are partnering those deals as their FIFO and there are some startup costs associated with those investments.

So although first expenses were allocated to our common stock position essentially marking it down to the zero in this first quarter, but we expected a and have a mark-to-market gain when we exit these investments..

Yeah. Crispin, it was a development deal. So it’s not a true loss per se, it’s just as they mentioned, these expenses are accruing because of the development stuff and just the way their accounting works..

Okay. Okay, that makes sense. And then, just in the release you called out a life sciences is kind of seeing kind of a big sector for you guys right now or I kind of – and I’ve heard this kind of a new deal in the quarter.

But can you just speak to just kind of some of the key drivers there on calling out life sciences rather than other sectors that 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 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 life sciences as a pharmaceutical, manufacturing and other and good manufacturing practices.

As we stated in prior calls, we like this sector for a lot of reasons, the restoring wave from offshore supply chains constraints and then the sector is particularly non-bank at the moment, so it’s hard for most banks, generally hard for most banks to make loans anyway right now.

But particularly for assets that they view or more industrial in nature, but we view as completely mission critical to the tenant base.

And we see this as a giant you know wave over the next kind of 5 to 10 years and even just like to get it front it, we’re catching as many of these opportunities as we can again because it’s really played by debt funds in other commercial mortgage REITs that banks can understand the underwriting the FF&E and the basis. So that’s why we like it.

And we have the great relationships within the sector and just want to grow it more, but I’d say for life sciences and multi will be our two – probably two strongest areas of growth over the next couple of years..

Great. That makes sense. Appreciate you taking my questions. That’s all from me..

Thanks a lot..

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

Hi, good morning..

Good morning..

I wanted to follow-up I guess on Crispin’s question kind of touched on life sciences. But you know two investments there, but I know it’s one has a pretty short remaining term, the one in the Temecula.

So can you talk to that and you know is that something we might see as more you know like short duration investments like that?.

Yeah, 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 the short term investments. Yes, it’s – I would assume probably 2024 type out there..

Okay, so I don’t need to look at that paying off this quarter?.

I don’t think so..

Okay. Maybe you know Matt McGraner, maybe a bigger picture you know can you talk a little bit about you know what’s your saying in multi across affordable in the 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 pretty well volumes going in that that’s where we are year-to-date on those limits.

But can you talk bigger picture about what you’re seeing and kind of workforce in affordable multifamily?.

Yeah. Of course, I’d love to. I think generally multifamily you know in the Class B range has held up pretty well. We’re approaching a time with some tough comps you know 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 your – you are seeing new lease trade outs here 1%, 2%, 3% that’s what we experienced we saw that in May we experienced the same thing. Renewals are a little bit stronger in the kind of 4%, 5% range and then occupancies are generally stable.

You know I think that on the transaction side, you’re starting to see a little bit more deals you know purchases and sales, I expect a hiccup in the transaction volume you know in the – really after Labor Day after summer kind of winds down.

Here the 5% cap rate range still feels like the right answer given that you know if you’re underwriting or if you can – if your comps 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 that’s here today.

But generally speaking, I think the multifamily sector is healthy. There won’t be some challenges with some of these CRE, CLOs that you’re seeing articles written about. That is the real thing and there will have to be some capital called or some cap financing to shore up those deals.

But I don’t think you know I think there’ll be able to work through you know multifamily especially in the B sector is a great business, you know we’re not – everything that Fed is done and everything with the banking crisis just going to make affordable housing all the more important..

Great. Appreciate the comments this morning. Thank you..

Thanks, Stephen..

[Operator Instructions] Your next question comes from the line of Jade Rahmani 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 DSC takeout, it’s really about the debt service coverage and LTV, I think you need something like below a 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 would pick interest and you know given the NXRT platform as well as the strong relationship with Freddie Mac I would think providing that gap pillar capital could be a big opportunities.

Are you starting to see an increase in deal flow there?.

Yeah, we are, Jade. That’s a great point and when I touched on briefly in the prepared remarks and this is the business that we started really in concert with Fannie and Freddie back in 2013-2014.

So, here we’re able to work with them and to comprise it had a document that would allow for our ability as a flex sponsor to take over the asset there has been a bit of default.

Agree with you that there the bridge loans that were kind of two years or two plus one that we’re 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 were in this business a lot than little over $500 million of it from just a not a gross investment dollar but a net investment dollar amount. So, 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 of financing that you’re going to plan?.

Yeah I think it’s going to be both you know I think with the cost of debt where it is and then you know if we are indeed higher for longer the cap financing from [inaudible] sponsors is going to be a thing. We’re already seeing it and even with great new construction deal and great sponsors, those opportunities for mezz 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 are some reasonable range that you would expect naturally to occur?.

Yeah I think you know given how the history of this – of the K program and I think 30 basis points of [cumulative] [ph] defaults not losses over the history of the program you know they’ve done a good job with the special servicers and particularly the DCH is like ourselves in these deals to work through in reaching outcome to the extent there is a problem that’s you know acceptable to everyone.

The news about these defaults are you know highly diversified and you know most of the loans that we own and – or the look through loans the biggest loans are in parts of the country where we operate at Texas and Florida and Georgia. So we think there will 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 work through by virtue the K program than in the private conduit market. Now, 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 customer be in a part of business..

Thanks for taking the questions..

Thanks, Jade..

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

We appreciate everyone’s time. We’ll get back in touch next quarter. Thank you..

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