Belpointe PREP: Significant Discount To NAV Should Gradually Narrow Ahead (OZ)

Belpointe PREP, LLC (NYSE:OZ) continues to trade at a significant discount to its intrinsic value, a profile that is justified to some extent by the lack of cash flow generation, a situation that is expected to change in the coming months when the company completes an important redevelopment project.

As I’ve covered in previous articles, Belpointe’s valuation is at a discount to its net asset value (NAV), making it a speculative buy within the REIT sector. Since my last article on Belpointe, its unit price has traded sideways even though it has been somewhat volatile, but it’s down by less than 4% and has underperformed the market during the same period.

This shows that investors need to be patient as Belpointe is still in an early growth phase and execution risk of its business plan should not be overlooked, which largely explains with the trust trades at a significant discount to NAV.

As I’ve not covered Belpointe for some months, I think it’s now a good time to revisit its investment case and see if Belpointe still offers value for long-term investors or not.

Business Profile And Financial Overview

Belpointe was founded in 2020, being therefore a very recent trust, and currently has a market value of about $219 million. It operates as a limited liability company (LLC), and aims to operate in a manner that qualifies it as a partnership for U.S. federal income tax purposes.

From an operating standpoint, its goal is to develop and buy commercial real estate (CRE) in qualified opportunity zones, being this the main distinctive feature of its business profile compared to other REITs. To be considered a qualified opportunity fund, it must hold 90% of its assets within qualified opportunity zones, something it has achieved since its inception about four years ago.

By having this special tax treatment, Belpointe allows some of its investors to be eligible for favorable capital tax gain tax treatment in their investments, being one of the most attractive features of its investment case for unitholders.

The company is externally managed, by Belpointe PREP Manager, which means its external manager is responsible for daily operations and therefore Belpointe does not have any employees and doesn’t have any intention of having employees in the foreseeable future. Its manager does have investment and asset management professionals, who manage Belpointe’s assets and liabilities on its behalf, leading to lower costs than having a dedicated team managing its investments and financial resources.

Belpointe’s investments consist of properties located in qualified opportunity zones, which are economically distressed communities, enjoying preferential tax treatments as an incentive for investments in these areas. These qualified opportunity zones were created in 2017, as a way to encourage new investments in low income urban and rural communities across the country, existing nowadays about 8,700 qualified opportunity zones across the U.S.

The unit’s main goal is to have a diversified investment portfolio that generates recurring cash flows over the long term, expecting to return attractive and recurring distributions to unitholders over the long term. However, as Belpointe is still in an early growth phase and is not generating enough cash flow, it has not returned capital to unitholders yet, and this may take some time to change.

Its current investment portfolio is spread across several assets in Florida, Connecticut, and Tennessee, being a mix of undeveloped land, office, retail stores, and industrial buildings. Most of its assets are owned for redevelopment, aiming to build new apartment buildings or residential communities, as Belpointe considers that is strong demand for these types of units in its targeted locations.

At the end of last March, its total assets amounted to nearly $451 million, of which about $337 million was real estate under construction, $39 million was land, and only $18 million were buildings. This means the vast majority of its assets aren’t productive yet, thus its earnings and cash flow generation is still quite limited. It also held about $29 million in cash at the end of Q1 2024, which should be enough to finance its investments in the short term.

Most of its assets were financed by equity raised, while its liabilities at the end of Q1 amounted to only $129 million, a profile that is likely to change in the coming years as Belpointe wants to increase debt leverage, to have more funds available for investments.

Nevertheless, it aims to use leverage in a sustainable way, which should not put its business model in jeopardy, having a debt target ratio between 50% and 70% of its assets over the long term, mainly in the form of mortgage loans.

Considering that its assets are mostly still in the development phase, it’s not surprising to see that Belpointe’s revenue was only $0.4 million in Q1 2024, while its total expenses amounted to $4.4 million, leading to a net loss of close to $4 million in the quarter. Cash expenditures related to construction amounted to nearly $38 million in the past quarter, which was financed by its own cash resources and proceeds from construction and mezzanine loans ($67 million in total), leading to an increase in its cash position of about $19 million in Q1.

Regarding its net asset value, it amounted to nearly $362 million at the end of last March, or $99.59 per unit, which is significantly above its market value and unit price. Indeed, Belpointe is currently trading at only 0.6x NAV, a similar valuation compared to when I last analyzed it. While this discount is justified to some extent by the unit’s lack of revenues and cash flow generation, there is plenty of upside potential over the next few years if Belpointe executes its redevelopment projects and starts to generate meaningful cash flows.

While the current macroeconomic outlook is uncertain and there is some political risk considering the Presidential election next November, Belpointe focuses on a niche segment of the real estate sector and long-term demand for its properties should remain positive over the medium to long term. Moreover, there are now stronger prospects of rate cuts ahead, which should help to boost its property valuations, being positive for its balance sheet and to maintain moderate leverage levels over the coming years.

Investors should note that Belpointe has a significant pipeline of investments, totaling about $1.3 billion, of which one of the largest ones is expected to be completed by the end of 2024. This will be an important outcome for Belpointe, as it will become an important asset for the unit to start generating significant revenues and cash flows, enabling it to further invest in business growth over the next few years both through organic sources and a higher ability to raise debt through banking partners.

Conclusion

Belpointe PREP continues to invest in business growth, but it’s not expected to generate meaningful cash flows over the next couple of quarters. Therefore, I don’t expect its unit price to change much over the short term, but the long-term potential remains good and the discount to NAV can potentially reduce gradually over the coming years as Belpointe executes on its growth strategy.