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Listed in the New York Stock Exchange (NYSE) in February 2020, NexPoint Real Estate Finance, Inc. (NYSE:NREF) has performed quite well, when most REITs have suffered due to the pandemic. It generated significant price growth (almost 5X) since the pandemic related market crash during March 2020. However, during the past six weeks, there has been a price loss of more than 20 percent.
NexPoint Real Estate Finance paid quarterly dividends for the past 10 quarters. The dividends are growing at a steady rate, and the yield has been in between 8.5 to 10 percent. Its earnings have been sufficient to pay the kind of dividend it is paying. Thus, despite the company being in operation for a small period of time, we can expect it to continue with such high yield, provided that NREF has a steady revenue generation plan in place.
About NexPoint
NexPoint Real Estate Finance is a mortgage based real estate investment trust (mREIT) that provides structured financing solutions in residential real estate, mainly in mid-sized multi-family properties and single family rentals (SFR). It originates, structures, and invests in first mortgage loans, mezzanine loans, preferred equity, preferred stock, and commercial mortgage backed securities. The Company targets lending or investing in stabilized properties or properties with “light-transitional” business plans.
NREF is externally managed by NexPoint Real Estate Advisors VII, L.P. (NREA), an affiliate of NexPoint Advisors, L.P., an SEC-registered investment advisor with extensive real estate and fixed income experience. Highland Capital Management Fund Advisors holds more than 44 percent of common equity shares of NexPoint Real Estate Finance. Its investment objective is to generate attractive, risk-adjusted returns for stockholders over the long term. The company has a significant insider holdings of 11.3 percent.
Financial Performance in Q1, 2022
NexPoint Real Estate Finance has been able to record almost 100 percent quarter on quarter (QoQ) growth in its interest income, while interest expenses remained more-or-less at the same level. As a result of which, net interest income of Q1 2022 was almost 3x of that of Q4, 2021. This implies that the mREIT is doing well in its core business operations. However, there is hardly any change in earnings per share (EPS), and book value (BV) per share of NREF from that of last quarter. This happened primarily due to $16.5 million other income generated during Q4, 2021.
NexPoint Real Estate Finance also had a solid liquidity position by the end of Q1, 2022, as the cash balance increased. However, there was a huge drop in the mortgage loan portfolio. This raises some concern, as mortgage loans are the prime assets for a mREIT, upon which it is able to grow and generate more revenue. High inflation and interest rate hikes by the Federal Reserves may have impacted the origination of mortgage loans on the residential properties. Still, the existing assets are capable of generating substantial revenue that I believe will help sustain the current level of yield.
NERF’s Portfolio and Business Model
NexPoint Real Estate Finance has a current principal amount outstanding of $1.6 billion, the vast majority of which are securitized mortgage loans. Almost 54 percent are in multifamily properties, and 44 percent are in SFR. Multifamily property mortgages have long been the backbone of NREFs. These securitized mortgages in multifamily properties are sold to Freddie Mac. Freddie Mac does not lend money directly to borrowers, and by selling mortgage loans to them, lenders like NREF receive money that they can further lend out.
Historically, Freddie Mac debt issues secured by multifamily assets have incurred lower losses, even during the periods of market stress. Aggregate losses in Freddie Mac’s origination history have averaged 5 basis point (bps) per year dating back to 1994. Since 2009 and through February 2022, there have been only $40.6 million in losses on $485 billion of combined issuance of loans. Another positive thing about the multifamily mortgage loans is that only 0.6% of total securitized unpaid principal balance (UPB), has entered forbearance.
A forbearance plan is when the borrower’s monthly payment is reduced or suspended for an agreed upon time period, usually between one and six months. For borrowers on an active Covid-19 forbearance plan, Freddie Mac provided up to 18 months of forbearance for borrowers with a Covid-19 related hardship. These suspended payments are not forgiven, but recovered at the end of the forbearance period and can be resolved by a reinstatement, repayment plan, payment deferral, or loan modification.
Current portfolio of SFR loans is also capitalized by a secured credit facility with Freddie Mac, is matched in both duration and structure of the underlying loans, has 6.1 years of average weighted term to maturity, and a 2.5 percent interest rate spread. The SFR loans are subject to Freddie Mac forbearance program, which helps in mitigating cash flow interruptions to the bondholders.
This arrangement with Freddie Mac makes things easier for NexPoint Real Estate Finance and reduces risk to a larger extent. In addition, over the years, NREF has been able to maintain an adequate debt service coverage ratio (DSCR). At present, the DSCR stands at 1.87. The company also has a quite high average coupon of 6.28 percent on its entire loan portfolio. On an average these loans have a remaining maturity of 6.4 years, which is quite reasonable. The investors thus can be assured of strong revenue in terms of interest income for the next few years.
Investment Thesis
NexPoint Real Estate Finance recorded steady price growth during the entire pandemic period. It paid steady quarterly dividends with a high yield, for the past 10 quarters. The dividends are well supported by its earnings. In the coming years, NREF is expected to generate sufficient earnings to continue paying a steady dividend. I expect this mREIT to generate strong interest income based on its portfolio of multifamily properties and SRFs.
As the securitized mortgages in multifamily properties as well as SRFs are sold to Freddie Mac, it enhances NREF’s liquidity, as well as reduces its risk. This mREIT doesn’t have any solvency issue as it has been able to sufficiently cover its debt services. The average coupon size as well as the remaining maturity of the mortgage loans, makes me hopeful about the future growth prospects of NexPoint Real Estate Finance, Inc.
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