Something intriguing lurks beneath the surface of NexPoint Residential Trust's (NXRT) recent Q1 2024 earnings call transcript, a hidden gem that seems to have slipped past the discerning eyes of Wall Street analysts. While the focus understandably remains on navigating the choppy waters of record-high apartment supply, NXRT appears to be strategically positioning itself for a potential surge in internal growth, a silent wave poised to break once the supply storm subsides.

The key lies in the company's calculated pullback on full interior unit renovations. In Q1 2024, NXRT completed just 59 full and partial upgrades, a stark contrast to the 1,300 units forecasted for 2023. This deliberate slowdown, according to Bonner McDermett, VP of Asset and Investment Management, is a direct response to the competitive pressures of new supply, where offering $200-$250 rent premiums in a market flooded with units commanding $400-$500 more proves challenging.

While a defensive move in the short term, this strategy could be masking a powerful catalyst for future growth. As Matt McGraner, EVP and CIO, aptly describes it, they are stockpiling a "Gen 2" of roughly 5,000 to 5,500 units ready for a full interior value-add program. This reservoir represents a potent 1.5 to 2 years of internal growth potential, a stockpile they are strategically holding back until the supply picture improves, likely in Q4 2024 and beyond.

Potential Rent Increase from "Gen 2" Renovations

The numbers paint a compelling picture. Assuming an average rent premium of $250 per unit for the remaining "Gen 2" units, NXRT could potentially unlock an additional $1.25 million to $1.375 million in monthly rental income, translating to a potential annual increase of $15 million to $16.5 million. This internal growth engine, combined with the anticipated waning of new supply in NXRT's submarkets, could translate into a substantial acceleration in same-store NOI growth, exceeding historical rates of 6% to 8% and potentially reaching double digits.

Projected Decline in New Apartment Supply

Consider the supply projections. In 2024, NXRT submarkets are expecting 25,100 new units, a number more than halved to 10,832 in 2025. By 2026, this figure plummets to a mere 1,000 units. This dramatic drop in new supply creates an opportune window for NXRT to unleash its internal growth potential, capitalizing on a market with significantly reduced competition and pent-up demand.

This strategy of deferred gratification could be a masterstroke, particularly as NXRT's existing swap agreements expire in 2025 and 2026, coinciding with the anticipated surge in internal growth. This confluence of events, coupled with potentially lower interest rates and improved equity cost of capital, could significantly boost NXRT's FFO and valuation, propelling it well beyond current projections.

Adding to the intrigue, consider a fun fact: NexPoint, the sponsor behind NXRT, is known for its contrarian investment approach, often identifying value where others see uncertainty. This strategic pause on full renovations, waiting for the optimal time to capitalize on its internal growth potential, fits squarely into their established investment philosophy.

While the current market dynamics warrant a cautious approach, NXRT's calculated pullback on renovations could be a brilliant gambit, a strategic maneuver to unleash a wave of internal growth once the supply storm subsides. This hidden potential, overlooked by most, could be the catalyst that propels NXRT to new heights in the coming years.

"Fun Fact: NXRT's strategic approach to renovations is akin to a surfer waiting for the perfect wave. By holding back on full upgrades until market conditions are more favorable, they are positioning themselves to ride a wave of internal growth when the supply tide recedes. This patient approach could pay off handsomely, potentially leading to higher rents, increased NOI, and a stronger valuation for the company."