JOHANNESBURG — Gidon Novick is legendary in the South African business space for being the former CEO of Discovery Vitality and founder of Kulula.com. But he’s now shifting his attention to new opportunities with a business called Lucid Ventures. In a bid to tap tax-savings opportunities presented by 12J regulation, Novick’s Lucid Ventures has launched a Hotel Fund which is helping to spur on new developments in some of South Africa’s most in-demand urban nodes. In this interview, I chatted to Novick about this fund and what the rationale behind it is. – Gareth van Zyl
This special podcast is brought to you by Lucid Ventures.
I’m Gidon Novick, and I’m the founder of Lucid Ventures.
Gidon, thanks for chatting to me today. Now, you’re the former CEO of Discovery Vitality and the founder of Kulula, and you’re now involved with something called Lucid Ventures. Can you tell us more about how you got involved with this latest venture of yours?
I left Discovery almost 3-years ago and when I did, I had a taxable income problem, if you can call it a problem. But I had quite a lot of income when I left Discovery and I heard about the Section 12J vehicle, which was a way to avoid paying tax and support new businesses in the process. It ticked two very important boxes for me. One was obviously the savings of tax, and two, getting involved in the new business world and the private equity world. So, I became very interested in it and researched it for quite some time and I ended up putting together an initial fund, which was our Lucid Growth Fund. That was a couple of years ago, and that’s how we got started. I’ll obviously tell you more about the newest fund but we’ve had one fund running now for two years and that fund has had a private equity focus and then we stumbled upon a new opportunity, which was investing in hospitality. But the model that we’ve evolved is buying into high-end residential developments, which are being built all over the country, specifically in CT where there’s a lot of activity as well as in places such as Rosebank, and Menlyn. Those are the three nodes that we’ve identified as being high growth nodes, and areas that were short of quality hotel accommodation as well as high-end residential units, and that’s been our focus.
Now, Lucid Ventures has just launched a Hotel Fund. You’ve spoken briefly about it, and it primarily focuses on properties in Cape Town, with a few more in Johannesburg and Pretoria. Can you tell us more about the rationale around that fund? Also, these are now new hotel developments that you’re getting involved with?
Just to take one step back, we focus on Section 12J, which is a government mandated incentive to stimulate economic growth and to stimulate capital investments into smaller and medium sized businesses in specific sectors. The legislation was essentially copied from the UK where they have something called Venture Capital Trust, which is similar legislation and has been very successful in the UK. The net effect is that investors in a 12J fund, like Lucid, get a 100% tax deduction in the year that they invest in the fund. Again, that was the compelling tax reason to invest in 12J but obviously, the tax is just the one side of it and the other side is finding a model that’s robust, scalable, and manages risk effectively.
12J is not all encompassing though. There are size limitation and industry limitations so one has to navigate those. The one specific inclusion in 12J is ‘hotelkeeping’ or hospitality. The opportunity that we identified was that we could we buy high-end residential units and create a hotel offering within that complex. One of the factors that drove it was that from a tourist or a corporate traveller’s perspective there’s a growing demand for accommodation which is slightly more apartment-style. In other words, accommodation where one has a bigger unit, self-catering facilities, you have a little kitchenette that you can do your own cooking if you so choose. You can do some washing if you want within the apartment. And the building itself doesn’t have extensive hotel facilities like a big dining hall with a breakfast buffet for example. It would be much more reliant on the area that it’s in. These are typically in high-demand areas where there’s transportation available, where there’s good restaurants and coffee shops close by, as well as perhaps a Virgin Active Gym. So, that’s really what we’ve identified as a big global not only a local trend. It’s also a really nice match-up with 12J, as it’s a hospitality business with a strong property underpin supporting one of South Africa’s key industries – tourism.
You mention that there’s some limits with 12J — what are some of the limits around that, especially when you’re looking at this type of sector?
The size limits are the company that you invest into, and in our case, these will be new companies. They can’t have assets worth more than R50m after you’ve invested. So, effectively it will be a limitation of a R50m investment but that would be pre-gearing. So, if one wanted to, or one was able to gear (which obviously in a property backed business is possible) one can extend that capital commitment further beyond the R50m. So, that’s one limitation. The other limitation is that a 12J fund can’t deploy more than 20% of its capital in any single venture or business, which means that you can’t really use a 12J for a bespoke single investment. That was not the intention of a 12J – it’s got to be a fund that has a portfolio of underlying businesses. In our case, it’s not a limitation because our intention is to build a portfolio across locations and across properties to give investors a good diversification.
So, if somebody had to invest in your hotel option, they would essentially invest in a spread of the hotels that you have identified?
Yes.. This is not a solution to find yourself a nice apartment in Clifton and use some kind of clever structure to do that. This is about buying into a high-end portfolio of small residential properties. They will either be a one bedroomed or a studio-type unit – typically, about 40-square metres, so this is certainly not a family home. This is a hospitality unit — it’s a unit that works well in the hospitality environment. If one day it needs to be sold, it would be sold as a studio or as a one bedroomed apartment somewhere down the line.
These properties are quite flexible then, in terms of their use?
Flexibility is key. In terms of my background, I spent most of my career in the airline industry with Kulula, and one of my learnings there is that profitability and the performance of the airline industry is almost completely dependent on capacity in the market, at any point in time. One often has very little control over that because you have competitors, and you have a macro environment that you can’t control. This is similar with hotel rooms. We would have been very reluctant to go into an investment where we’re buying into a bespoke hotel, and if the industry was not performing the way you would have liked it to, the flexibility to exit would have been very limited. This apartment-style hotel model gives us the flexibility to either exit via selling off the hotel lock, stock, and barrel. Or it would allow us to engage in a more likely scenario: selling-off units as and when we need to, in the future. Our longer-term intention is to convert the portfolio into a REIT structure which is very tax effective and gives investors the option to hold on to their shares in the portfolio.
Just talking about exiting or selling-off units what kind of return on investment can investors expect out of a fund like this?
When we were more focused on the private equity side that question is almost like, how long is a piece of string? It’s a very difficult thing to pin down but with the Lucid Hotel Fund it’s much easier to predict what those likely returns are. There are essentially three components to the return. The one is the tax saving that you’re getting and one can look at the compounded effect of the tax saving. In terms of the tax saving alone, if you had to take a 5-year period (because 5-years is the minimum term that an investor is committed to) into a 12J fund, there’s about 8.5% that accrues to an investor just by virtue of that upfront tax incentive. So, you have a very good standing start in a 12J investment.
— Gidon Novick (@gidonnovick) October 28, 2017
The other two components would obviously be the annual profitability that would come through from the hotel operation. We’ve modelled in our base-case a 6% return. Then the third component, which is probably the most subjective, is the capital appreciation. Now, we’ve got a basis model of 6% capital growth. If you look at Cape Town properties in the areas that we’re investing in over the last 5-10 years, you’ve seen over 20% capital growth. But as you well know, the past is not necessarily a predictor of the future and I certainly wouldn’t stick my neck out and say that you’re going to get 20% capital growth going forward. But a very important component of the model is that we’re investing in the best areas and we are certainly investing with an eye to grow the capital base of these investments over time.
The biggest insulation we think we have is to go into the most desirable areas and typically areas where the commercial activity (and I’ll use Rosebank as an example) is running way ahead of the residential accommodation in the area. With Rosebank, one just has to walk up and down the streets and you see the massive capacity coming to the fore on the commercial side and there’s no doubt that the residential side is lagging. On top of that, you have a local government strategy and a policy of densifying areas like Rosebank and the CBD of Cape Town, and Menlyn in Pretoria. So, you have very strong local government support to densify and build high-rise buildings to support the residential demand that’s coming through.
Talking about these top addresses that you’re focused on. I’m just looking at some of the addresses here so, it involves the likes of 16 on Bree, the Harbour Place in Cape Town, the Regency in Menlyn, and Rosebank Central in Rosebank. Can you maybe run through some of these addresses for us?
Sure. One of the projects which is worth talking about (because it exists and we’ve invested in it already and it’s quite a good indicated model) is in the centre of Cape Town where there was a building called Safmarine House. If you drive through CT you’ll notice it. It’s got a kind of triangular summit at the top, but it was an old office building. A group of developers led by Signatura, which is one of the top developers in Cape Town redeveloped that building into two components. The first half of the building is a Radisson Blu Hotel. It’s a hotel run by Radisson – a beautiful location right in the trendy part of Cape Town. The second 10-floors of the building was specifically built as apartment-style units but those units effectively form part of the hotel. They are sectionalised and were sold-off as individual units. So, we’ve been buying up units in that Radisson over the last year, into our existing fund. That works beautifully because you have a very high quality, global brand running a world-class hotel in the right part of town and, obviously, attracting tourists from all over the world, as well as corporates that are coming to Cape Town for a conference at the Convention Centre, etc. That’s quite a sweet spot for us in terms of having a hospitality business that is the right area, it has a great brand associated with it and it has the potential to grow the capital value over-time.
In Rosebank as well, you spoke a little bit earlier about how Rosebank and the commercial development is almost running ahead of the residential development.
There are a number of new hotels and residential blocks going up in Rosebank. We have a site just off Oxford Road, very close to the Gautrain that we can develop into an apartment hotel. It would fit very well within the theme that we’re building, which is a hospitality business within a high-end residential complex in the right area.
Menlyn is another interesting node as well. In fact, I was there recently and it’s quite astounding the level of development there. It looks like it’s becoming the Sandton of Pretoria.
Yes, it is. It is astounding what’s going on there. The Menlyn Maine Centre is a huge catalyst in terms of building an ultra-modern, ultra-consumer friendly precinct. And on the back of that, we see an opportunity to get into the hospitality environment in Menlyn. But again, within our very specific model (which is within residential units running a hospitality operation), we’ve focused on The Regency, which is a 300-unit development. It will be coming onstream in a few months’ time and a large part of the Regency will be run as a hospitality operation.
These are quite long-term developments in many ways, so are you feeling bullish about the tourism sector and I guess, the business tourism sector in SA because I imagine that a lot of business tourists would be using these types of facilities as well?
South Africa has one of the best tourist products in the world and currently attracts only 2 million tourists annually, a drop in the ocean relative to the 1,2 billion global tourist industry. The growth of tourism is critical to our economy and creating the jobs we so desperately need.Graham Wood is one of our principals and a doyen of the tourism industry. He ran Southern Sun hotels for many years. He’s been instrumental in really directing our efforts to the right hotel operator, and making sure that we attract the most appropriate operator for the properties that we’re getting involved in.
Anybody who wants to find out more about your Hotel Fund – should they contact you guys through the website or who can they get in touch with?
Yes, absolutely. The Lucid Venture’s website has all the information on the hotels and we’ve got our team ready to respond literally immediately because the deadline is a couple of weeks away, in terms of 12J – it’s the end of tax year. Our Hotel Fund closes on February 20 so, we’re in for a very busy couple of weeks.
Gidon, thanks very much for telling us more about this very interesting fund.
This special podcast is brought to you by Lucid Ventures.