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Section 12J is transforming South Africa’s investment landscape

Darryn Faulds on how South Africa’s investment landscape has been transformed through Section 12J.
Darryn-Opinion-Piece-

Section 12J is transforming South Africa’s investment landscape

Darryn Faulds, Fund Manager of Mdluli Safari Lodge & Metta Capital, unpacks a ground-breaking disruption to the traditional leisure timeshare model using Section 12J. 

South African investors have traditionally operated within a landscape of JSE Listed Shares and Fixed SA Property. This, prior to 5 years ago, has been the optimal investment decision as investors have benefitted from strong performance in both these asset classes. However, we have seen this performance come to a grinding halt in the last five years – the JSE has been close to flat and annual property growth has stagnated below inflation.

This stagnation of performance has resulted in local investors searching for alternatives, and has seen them divert their savings into offshore investment vehicles and the securing of high-income yielding funds.

One thing that has remained constant throughout this period is that all these investors have continued to pay taxes. This, together with their search for alternative yielding opportunities, has led these investors to Section 12J, whereby they can obtain a beneficial tax leveraged yield/IRR of over 15% p.a.

While Section 12J started out some 10 years ago as a tax incentive for investors, it has matured into the fastest growing alternative asset class – and investors are rightly taking notice. With over 180 VCC’s in the market as of February 2020, we are seeing a lot of innovative thinking in the industry. The impact of funding through Section 12J has had significant positive economic impact.

 

Ground-breaking disruption to the traditional leisure timeshare model:

One investment I want to showcase as an example of Section 12J’s ability to alter the South African investment landscape is Mdluli Safari Lodge Limited (“MSL”). MSL is Section 12J’s first investment within the Kruger National Park and represents a breakthrough funding structure in the development of community-backed leisure assets.

Mdluli Safari Lodge is a brand new luxury lodge, located inside the borders of the Park, that opened in January this year. The capital for the development of the lodge was raised through Section 12J. The lodge is a partnership with the local Mdluli Community – and a benchmark for community development projects in SA.

Through their unique Section 12J offer, investors have been given the opportunity to obtain all the benefits of traditional timeshare investments, without all the negatives.

Below is a comparison of MSL investment versus traditional timeshare – showing how by utilizing Section 12J, investors are not only receiving the benefit of the tax deduction, but also gaining access to a once-in-a-lifetime leisure opportunity.

 

Mdluli Safari Lodge ‘Ordinary Share’ Purchase – R500,000 Traditional Timeshare Investment – R500,000
Full Section 12J Tax Deduction, providing up to a 45% tax benefit (R225,000). No Tax Deduction Obtained
180 Free Bed Nights usable over 10 years, each night includes bed, breakfast, dinner, and a game activity.

  • Bed Nights can be utilised flexibly anytime within the year.
  • Investors are not limited to a specific unit/room.
  • The Value of the 180 bed nights alone, over 10 years, is around R729,528.
Two Set Weeks Obtained in the year indefinitely. Investors are limited to those two weeks each year and normally a specific unit/room.
No Monthly/Yearly Levies owing Yearly levies owing and payable to the manager
The Lodge returns the investors full investment amount (R500,000) in tranches from year 6-10. No Return of Capital
As a result of the Tax Deduction and the return of investment capital, investors obtain a 15% annual cash internal rate of return over the 10 years. Investors obtain no cash return and only leisure returns.

 

As you can see above, the benefits for investors in utilising a Section 12J investment to obtain leisure returns is vastly more beneficial to the traditional ‘timeshare’ leisure model that has been so popular in the past.  This project itself showcases brilliantly Section 12J’s ability to transform the investment landscape in South Africa and it perfectly fulfils the mandate behind the government’s Section 12J incentive being job creation through the financing of SMME’s.

MSL has to date raised R53 million from Section 12J investors and is looking to conclude its final limited capital raise in August 2020, whereby only 15 000 shares (R15 million) will be offered to the public. Feel free to visit https://mdlulisafarilodge.co.za/invest/ for more information on this transformative investment offer.

 

For those new to the 12J structure, here’s an explanation of its benefits:

Uncorrelation Benefits of Section 12J:
Section 12J investment strategies take place within a specific micro-environment, thus sheltering them, in large, from macro-economic factors and allowing investors to diversify their investment mix within an uncorrelated asset class.

  • 100% Tax deductible up to R2.5 million per annum: 
    • The Section 12J allowance is the largest tax deduction available to SA taxpayers and also the least restrictive, with the only condition being the shares are required to be held for a period of 5 years for the tax deduction to become permanent, as opposed to when you are of retirement age for an RA deduction, as well as that deduction limited to just under R400k per annum. 
    • Effectively means that investors only have 55% of their capital invested in a 12J at risk at any point in time.
  • Arbitrage of risk vs yield opportunity:
    • In current traditional assets classes, there are very few arbitrage opportunities available. To obtain returns of 16% or higher often carry significant risk, be it in low-cap stocks, venture capital or leveraged products carrying large downside risk.
      • Section 12J has in the past been misinterpreted by advisors and investors as high-risk venture capital. What has materialized in the asset class since 2017, has been the formulation of risk-mitigated asset underpin investment strategies, taking the form of traditional private equity, mezzanine finance and even bond type instruments.
      • Section 12J has in the past been misinterpreted by advisors and investors as high-risk venture capital. What has materialized in the asset class since 2017, has been the formulation of risk-mitigated asset underpin investment strategies, taking the form of traditional private equity, mezzanine finance and even bond type instruments.
      • Investment strategies are backed by asset underpins in the form of physical assets (vehicles, infrastructure etc), brick and mortar assets and contractual assets (Power-Purchase Agreements, Rental agreements) that underpin annual yields and realization value. 
      • Investment strategies are backed by asset underpins in the form of physical assets (vehicles, infrastructure etc), brick and mortar assets and contractual assets (Power-Purchase Agreements, Rental agreements) that underpin annual yields and realization value. 
      • Investment strategies are backed by asset underpins in the form of physical assets (vehicles, infrastructure etc), brick and mortar assets and contractual assets (Power-Purchase Agreements, Rental agreements) that underpin annual yields and realization value. 
      • These assets underpin provide predictable return profiles and clear pathways to liquidity for investors to exit after a 5-year period.

I look forward to seeing further innovation in the industry – hoping the legislation is extended beyond the upcoming Sunset Clause.

Feel free to send me an email if there’s anything further you would like to discuss.

Darryn
darryn@mdlulisafarilodge.co.za
darrynf@mettacapital.co.za

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