From Dull to Dazzling: NexPoint Residential Trust is Taking Multifamily by Storm

By Andie Lowenstein, Associate Editor

Hey, multifamily industry, say hello to NexPoint Residential Trust Inc., a new real estate investment trust. Its strategy is pursuing investments in Class A and B multifamily properties with a value-add component where they can invest capital to provide “lifestyle” amenities to “workforce” housing. MHN chatted with Matt McGraner, executive vice president and chief investment officer at NexPoint and managing director of real estate at Highland Capital Management, to learn the story of the growing company.

MHN: How did the company get started?

Matt McGraner, Highland Capital Management

McGraner: We got started in 2013 as a REIT underneath a closed-end fund. James Dondero, our president and founder, was searching for yield uncorrelated to the public, debt and equity markets, and he was managing a fund called NexPoint Credit Strategies Fund (NHF) and didn’t like anything he was seeing in the marketplace so he looked to real estate and really liked owning real estate directly but couldn’t do it in the closed-end fund so, to our knowledge, we were the first people to ever come up with the idea of forming a private REIT under the closed-end fund. We did that in early 2013.

We bought our first multifamily deal in October 2013 and saw a lot of opportunity in the marketplace, liked the story and the strategy of the middle-income workforce housing Class B multifamily strategy. We were growing that rapidly – we did about 40 transactions over the course of 2013 and 2014. It got to the point where it was becoming such a large part of the parent fund that we had to do something with it. We looked for a number of ways to get value for the shareholders, one of which was taking it public and listing the shares on the New York Stock Exchange. That was the original route we chose to do to get value. It was a fairly unique structure and it had never been done before.

MHN: Why did you choose to get involved with workforce housing specifically?

McGraner: We like it for a number of reasons – we like the Class B workforce housing strategy because it’s recession-proof. We really only need $750 in rent per unit to make a 6 percent yield in our markets which is really attractive. You contrast that to a Class A building in our market that earns $1,500 per unit to make a four percent yield. Particularly where the markets are today, cap rates being at historic lows for multifamily, we think when interest rates do rise cap rates will hurt the Class A building more than they’ll hurt the Class B building given that there’s such a delta between the $750 in rent we need to achieve our yields versus the nicer luxury properties and/or single-family housing. Our typical tenant is renter by necessity and has been a renter all their life so what we try to do is buy assets at great spaces, significant discount to replacement cost and go in and invest anywhere from $4,000-$10,000 per unit to improve the living spaces for the middle income renters.

For example, take a two- to three-story garden apartment complex that hasn’t been touched in the last decade or two, we’ll come in and add 2015 amenities you might see at a luxury building and put them in place at a 1985 construction building. We’ll add resort-style pools, cabanas, outdoor furniture, an outdoor kitchen, outdoor grills, update the leasing centers from the tired, old furniture and tile flooring to more of a Starbucks-style café, and put a few Apple computers in there and make it more of an interactive space. On the interiors we’ll spend anywhere from $3,000-$7,000 per unit removing carpet and installing hardwood floors, removing old blinds and put in two-inch blinds, put in California Closets, upgrading the appliance packages from a white to a black or stainless, and removing vinyl countertops and installing granite. Once we’re done with the improvements we typically see a rental increase of $90 or 25 percent more so it’s a good business on the one hand, we’re making great returns and on the other hand, we’re providing an upgraded space for the tenants.

Left: Office before
Right: Office after

MHN: Since 2013, what has been your biggest struggle?

McGraner: In early 2013, it was trying to be competitive in the marketplace and buy assets that made sense for our underwriting. The way we got around that was we started buying portfolios at wholesale discounts and we teamed up with our property manager/operating partner out of Des Moines, Iowa, BH Management Services. They’re one of the largest privately owned operators of garden-style multifamily middle-income apartments that we like to purchase and we are their largest client to date so they were a great asset in helping us overcome winning deals. Fast forward to today, even though we’re a billion dollars in assets, we’re still very small when it comes to publicly traded REIT so we didn’t do a traditional style IPO where you had bankers lead in underwriting and have research coverage day one so we’re trying to overcome the fact that we’re small and no one really knows who we are.

That being said, we’ve reached out to a number of investors and done hundreds of calls, hundreds of meetings with investors and tried to tell a story. Everyone that listens to this story is interested, we’re doing the same thing the larger private equity firms are doing in the private markets, we’re just taking it to the public markets and we’re really the only pure play value-add operator that’s traded in the public markets in the U.S. So, getting the story out has been hard to do without having an investment bank research analyst in our corner. We are optimistic that we’ll get research coverage in the next month or two so that’ll help. Getting our name out there and making sure people know who we are has been the biggest challenge and the only thing we can do is continue executing on the strategy and driving performance and at some point hopefully people take notice.

MHN: What’s in the pipeline for NexPoint?

McGraner: We’re excited to be fully public for a year and have a track record of four full consecutive quarters of earnings and leases. That’ll be in March we’ll look forward to that. At the same time, we become shelf eligible, which means we can have a registration statement that’s filed on the shelf with the SEC, so that we can raise capital in a pretty quick manner. You have to be a year public to do that so that’s a big milestone it helps a company like ours grow. We’ve looked at a few deals and we just purchased a couple in Phoenix last week that we’re really excited about and that’s a new market for us.

We’re looking forward to seeing a full turn of the fruits of our labor and the cap X, both in terms of across the portfolio the numbers and the results of having 41 upgraded deals with brand new leasing centers, pools and turned units. That’ll be cool once we get the full portfolio running and seeing how that fresh product out there is received by people of all ages, especially the millennial age group.

Left: Pool before
Right: Pool after

MHN: Where do you see the future of workforce housing going based on your experience so far?

McGraner: I think the workforce Class B strategy has become more in vogue, we’re seeing a lot of new entrants into the market. I’m still optimistic that there’s room to grow rents and provide these affordable spaces without pricing ourselves out of the market and having our tenants move on to something that might be a newer asset like 2005 or 2010 build. That’ll always be on our minds and challenging but as long as Fannie and Freddie are in the market, which we don’t see that GSE disappearing anytime soon, and as long as you can still buy apartments that have been well-maintained and occupied for 20 plus years at decent yields at 5.5 to 6.5 percent yields I think it’s still going to be a very liquid, highly transactional, very exciting space to be.

You couple that with technology and the building products of today that are being implemented into these older properties, you’re taking the obsolescence out of these deals and taking a product that’s pretty sleepy and we all think of as maybe our first apartment or something we might not otherwise want to live in and you’re walking into a unit of a 1985 construction deal and having a very modern white cabinetry with brush nickel finishes, stainless steel, granite countertops and hardwood floors. I think that as long as people continue to put money in the deals and upgrade the spaces, you’re changing neighborhoods; you’re pouring capital into pockets of cities that might otherwise not have seen it so it’s really changing and upgrading the face of the neighborhood too.

MHN: What else should our readers know?

McGraner: We’re new but we’re not new to investing. Highland’s been around since 1993. We’re a solid pedigree in investing, especially in conjunction with our partner BH. We have 22 billion assets across the firm so we have the capabilities to grow the company and perform.

We’re really the only workforce housing pure play multifamily REIT in the space. Most other multifamily REITS are focusing on the same thing – upgrading their portfolios, buying newer deals, buying lower yielding assets on the coastal markets – so we’ve always been contrarian in zigging while others are zagging. If you want a 3-percent yield and you want a Class A luxury multifamily REIT on the coast there’s 10 or 12 to choose from, but if you want something different, a little higher yield with a recession-proof strategy, I think it’s important to take a look at our company.

We own 15 percent of the stock of the company and I know we’re small but I’m still not sure any other REIT owns as much of their company as we do so it’s aligning ourselves with our shareholders. It’s a big positive and we’re continuously supporting the stock and the story and we’ll continue to do so because we believe in it.