Owning residential rental properties has been a pretty good business of late, with real estate investment trusts (REITs) able to push through huge rent increases. A revival in demand following a weak spell during the 2020 pandemic is a big part of the story, but for some names there's more you need to understand. NexPoint Residential (NXRT -1.25%) is a perfect case in point. Here are the big trends that you need to know if you are going to dig into this apartment REIT.
How good it is
In the first quarter of 2022, apartment REIT NexPoint Residential was able to increase rents by 15.4%. Although occupancy was down around 90 basis points year over year, it was still robust at 94.2% and roughly flat with the year-end 2021 figure. The business is on solid ground.
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Part of the reason why rents are rising so fast is that the apartment sector is recovering from the 2020 pandemic hit, which, broadly speaking, led to rent decreases and weak occupancy metrics. Apartments generally have one- or two-year leases, so they get hit pretty quickly when things start to sour. The normal approach is to cut rent rates and offer concessions (like free rent) in order to keep units occupied. That can lead to a quick hit to results, but the flip side of the coin is that rebounding apartment markets tend to show up quickly in financial results, too. That's what's on display today.
Although the coronavirus pandemic was (and still is) an unusual, unexpected, and extreme event, the ups and downs here, while exaggerated a bit this time around, are really just normal for the industry. So NexPoint Residential's strong results shouldn't be too shocking. And yet there's more here than meets the eye.
Working from the walls in
One of the interesting things of note from NexPoint Residental's quarterly earnings release is that it completed 531 full and partial upgrades. That means it either redid an entire apartment or fixed up a section of an apartment with things like kitchen or technology revamps. It was able to charge an extra $138 per unit, on average, for the 489 of those upgraded apartments that it leased out in the quarter. The rest will probably do about as well, if not better. Note that construction is ongoing, so the difference between the upgraded and leased-out units shouldn't be seen as an indication of any trends; it's more likely just timing.
This is not a new effort for NexPoint Residential. The REIT has completed 6,398 full and partial upgrades, 4,510 kitchen and laundry appliance upgrades, and 9,624 technology upgrades. Each one of these investments allows it to up the rents it charges, with more material improvements (full and partial upgrades) resulting in an average hike of $139 and smaller tech improvements leading to an average $43 rent increase. The return on investment here is notable, with average returns of 21.8% for the full and partial upgrades, 70.8% for kitchen and laundry upgrades, and 33.5% for technology improvements.
Unlike the rebound from the pandemic, the upgrades are not a short-term event. This is an ongoing approach that allows NexPoint Residential to increase its revenues over time. NexPoint Residential's portfolio has over 14,500 units in it, so there's plenty of room for the REIT to keep putting capital to work as it looks to continue driving internal growth.
And since improvements will wear out over time and technology advances, there's no reason to think that NexPoint Residential won't be able to swing back around to the beginning again with a new round of improvements once it has worked through its portfolio. Acquisitions would also help to keep the upgrade hopper full, as well.
Not unique, but very interesting
To be fair, most REIT apartment landlords try to make sure they own desirable properties. Some do this by building or buying relatively new properties; others take on older assets and put some cash in to modernize the units. The latter is a big piece of what NexPoint Residential does, and the financial outlays are far more modest than what it would cost to build or buy an entire apartment complex.
If you are looking at apartment REITs, you'll want to take this difference into consideration. NexPoint Residential's roughly 2% dividend yield is a bit miserly, but if it can keep improving its rent rates via internal investment, the premium relative to some its larger peers might be worth considering for long-term investors.