CPD: The next big ESG three – the emerging responsible investing sectors that balance altruism with financial reward

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Investors can gain exposure to emerging asset classes that tick all the ESG investing boxes.

With ethical or socially responsible investing becoming enshrined in the thinking of institutional funds and retail investors alike, demand for assets that fit that bill will only grow.

By the same token, investors need to maintain appropriate diversity in their portfolios and ensure that their investing strategies are tax effective.

Through the fractional platform model, which is gaining ground in Australia, investors can gain exposure to emerging asset classes that tick all the ESG (environment, social and governance) investing boxes while offering above-market returns.

In this article we explore three of them:

  1. Affordable housing
  2. Carbon offset credits
  3. The rapidly growing market for Islamic finance in Australia.

1. Affordable housing

Affordable rental housing is provided by registered community housing providers (CHP) to tenants on low to moderate incomes. These providers might own some of the dwellings and also manage properties for investors, institutions and government bodies.

Many providers specialise in providing accommodation to particular client groups, which may include disability and youth housing or aged tenants.

As an investment sector this has caught the eye of the large industry super funds, with Australian Super, Cbus and Aware Super all earmarking considerable funds.

Formerly State Super, Aware Super is leading the sector with a $400 million commitment, including a 102-unit ‘build-to-rent’ affordable development in Miranda in southern Sydney (half of which is dedicated to affordable housing).

In a new measure that acknowledges the importance of fostering affordable housing investment, the Australian Taxation Office allows a 60 per cent capital gains tax concession on the sale of such an asset. This compares with the standard 50 per cent discount on properties held for more than 12 months, and the same for equities.

As its name implies, affordable housing provides accommodation to needy tenants at below-market rates. For investors, it’s a case of navigating considerable paperwork, but the rewards can be well worthwhile at a financial level and in terms of the emotional satisfaction of contributing to a socially beneficial initiative.

For the investor to be eligible for the concession, the housing provider will issue them with an annual affordable housing certificate. This shows the number of days the investment property was used to provide affordable housing during the income year.

The paperwork also serves as a declaration the property met the conditions of eligibility for the CGT discount. According to the ATO, the provider must issue this certificate on or before 31 July immediately following the relevant income year. In the case of non-direct investments, the provider will issue the certificate to the relevant trust, managed investment trust or partnership.

The ATO stresses the importance of keeping a good record of affordable housing certificates, as they record the total number of days the dwelling was used to provide affordable housing after 1 January 2018.

Each entity that holds an ownership interest in the dwelling also receives a certificate from the provider showing that the dwelling was used to provide affordable housing.

To be classed as affordable housing, the property must be “real” and not a caravan, mobile home or houseboat (or indeed a tent). The dwelling cannot be commercial premises and – crucially – the tenancy must be overseen exclusively by a registered community housing provider. Other conditions are that the property must be “genuinely made available” to rent (as with any other investment property).

The dwelling – and it can be new or existing – must be offered at below market rents to “eligible tenants on low to moderate incomes”. This is based on a household income and household consumption test.

The affordable housing must be offered for a minimum of three years (1095 days), but this period does not have to be continuous.

There are no specific postcodes or geographic areas that define where affordable housing must be.

To be eligible for the CGT concession on sale, the owner must be an Australian individual resident. Alternatively, the capital gain can be distributed via a managed investment trust (MIT) or an “interposed partnership” (not including public unit trusts or super funds). But only the individual investor can claim the discount.

CHPs are strictly regulated by state-based community housing registrars and have specific reporting obligations.

A new affordable housing rental and shared equity model

DomaCom, Australia’s only ASIC registered fractional platform operating in this space has partnered with community housing providers to deliver affordable housing to essential workers (nurses, firefighters, teachers and police officers).

With a rental and shared equity model affordable housing is one step further in helping people achieve equity ownership in residential property by involving developers on the equity side who give the platform a rebate ranging from 10% – 20% which is split between investors and tenants. This is in addition to the tenants receiving a discount of 25 per cent of the market rent.

After due diligence, DomaCom creates a syndicate campaign for each property, with investors contributing 40-50 per cent of the purchase price.

A loan is established through the National Housing Finance and Investment Corporation to fund the remaining amount of the purchase price at 2.5%.

Investors in this asset class receive an immediate uplift in the value of their investment from the cash rebate.

A unique aspect is that tenants are gifted one per cent of equity each year until they reach 5 per cent. As well as empowering the tenant to property ownership, this mechanism acts as a leasing incentive to retain the tenant.

Through a minimum investment of $1,000, investors share the benefits of rental income and capital growth and are compensated for the reduced rental yield by the discounted government loan of 2.5 per cent (based on a maximum loan to valuation ratio of 40 per cent).

The rental and shared equity model is a leveraged growth investment rather than an income investment, as rental income services the debt component.

Technically speaking, the fund is an investment vehicle managed by DomaCom. As an ASIC-registered managed investment scheme, the fund issues units in the sub-fund that holds the property.

2. Offsetting CO2 emissions with carbon credits

The push to “decarbonise” economies is fast gaining momentum, with most governments setting some form of carbon emissions target.

More than 170 companies to date have pledged to become carbon-neutral by 2050, while 77 countries (including the UK) have set similar goals. Closer to home, the South Australian government has committed to 100 per cent renewable power by 2030.

Globally, renewable projects are being spurred by a combination of powerful factors, including the stricter emissions target, population growth and supply constraints. In Australia, some of the constraints are caused by the retirement of coal-fired plants, such as Victoria’s Hazelwood and NSW’s Liddell.

Battery storage offers not just the underlying ability to smooth out variable renewable generation, but commercial opportunities such as arbitraging low and high demand periods.

Ideally there would be a seamless transition between coal and gas fired power and renewable energy (with battery backup).

But battery technology is still evolving, as are other storage methods such as hydrogen derived from green energy.

While individuals can take direct action such as taking public transport and avoiding unnecessary flights – which is not so difficult during the global pandemic – carbon emissions are going to be an unavoidable aspect of economic activity for some years to come.

Alternatively, carbon credits allow companies and individuals to offset their unavoidable emissions from certified projects than can verify their impact.

These credits are generated from certified activities that support community development, protect ecosystems or install efficient technology to reduce or remove emissions from the atmosphere.

Investing in renewables

There are increasing opportunities via the fractional model for investors to participate in renewable investments that produce income far in excess of current and likely future interest rates. Most projects offer medium to long term power purchase agreements, with additional revenue from large renewable generation certificates. Investors can expect to receive monthly distributions, equating to a yield of 4 to 8 per cent.

3. Islamic finance

Observant Muslims are constrained from accessing traditional lending and deposit products because of restrictions imposed under Shariah Law.

Notably, these include the levying of interest.

Globally Islamic finance is said to be growing at 15-25 per cent a year and now accounts for more than $US2 trillion of assets.

Australia’s 2016 Census shows there were about 600,000 resident Muslims in the country, representing growth of 27 percent (130,000) on the 2011 survey. This is now getting close to 1 million.

Given that, Australia also hosts one of the fastest growing Islamic finance sectors. Estimates put the value of the local sector close to $200 billion and that’s with only 5 per cent of the local Muslim community accessing the market.

Essentially, Islamic finance allows observant Muslims to undertake investments such as buying a house without falling foul of their beliefs.

A core tenet of Islamic financing is that interest is usury (riba) which favours the lender over the borrower. The principles also prohibit investing in forbidden (haram) activities such as producing pork or alcohol.

The rules also prohibit any form of speculation or gambling, which means that ownership of goods cannot depend on an uncertain event in the future.

The contract must also pertain to a real underlying transaction and not entail excessive risk or uncertainty, which rules out derivatives contracts as well as short selling, bonds and options. Parties to a contract must bear the profits and the losses equally.

Islamic banking solutions include profit and loss sharing partnerships (mudarabah), where one partner provides the capital to another partner responsible for investing and managing the capital.

Another iteration is a profit and loss sharing joint venture (musharakah) by which all partners contribute capital and share the profit and losses on a pro rata basis.

In the case of a property purchase, the bank and the investor jointly purchase the asset and the investor builds up equity in exchange for payments.

Other alternatives are leasing arrangements by which the lessor (the owner) leases the property in exchange for rental and purchase payments.

On the investment side share ownership is allowed, as is private equity activity. While conventional bonds are prohibited, Shariah-compliant bonds mean the paper represents an ownership in the asset rather than a debt obligation.

The constraints of Shariah Law also mean that Muslim workers are constrained from superannuation choices, because most funds invest in debt instruments and possibly other proscribed industries.

Acceptable alternatives include the Sharia-complaint super provider Crescent Wealth, which “actively avoids investments in industries such as gambling, alcohol, tobacco, weaponry, and interest-earning organisations.”

The Muslim community in Australia currently ranks home ownership at close to half the rest of Australia so there is significant opportunity in funding residential property for this community, with a very reasonable return to investors including rental income and capital growth.

DomaCom offers investors a fractional exposure for Muslims and non-Muslims sympathetic to the principles of Islamic financing via a relationship it has forged with Crescent Finance, which is part of the Crescent Group.

It offers an Income Fund that predicts a minimum yield of 3% and targets 4.5% and a Growth Fund that expects a minimum capital gain of 3% and targets between 6-7%. Both funds can be accessed via the DomaCom platform.

 

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