Islamic Finance and Real Estate Business
There have been a number of activities involving real estate investments structured with Islamic finance in the Gulf States. In 2006, Al Roustamani Enterprise set up a US$2.3 billion Shariah compliant real estate development fund to invest in a global chain of Shariah compliant hotels. Also in the same year Nakheel Group, real estate developers in Dubai launched a US$2.5 billion Sukuk bond for the financing of real estate developments. In August 2006, Qatar real estate investment company issued a Sukuk worth US$270 million, the deal was structured by Standard Chartered Bank (2006); a diminishing musharakah. Structure was used to finance the transaction and it was the first corporate Sukuk to emerge from Qatar.
Outside of the GCC there have been activities in financing real estate investments with Islamic financing and Shariah compliant real estate activities. The world’s first listed Islamic REIT (real estate investment trust) and Asia’s first healthcare REIT was Al aqar KPJ REIT listed on the Malaysian stock exchange in August 2006 with an asset size of US$260 million, subsequently Al-Hadharah Bousted REIT consisting of oil palm plantation as assets was listed in January 2007. The largest Shariah compliant REIT by asset size, Sabana REITs is in Singapore.
Presently, there is no formal guideline for operating an Islamic real estate company, however from a Shariah law perspective, a company operating under Shariah law is prohibited from investing in conventional financial institutions, alcohol, pork products, pornography, gambling, cinema, arms and munitions – as they are classified as non-permissible investments. In addition, an Islamic real estate company must adhere to certain financial screening conditions. Real estate development and investment must be financed using Islamic financing, if available.
The differences between the two types of real estate investments i.e. Shariah compliant real estate investments and conventional real estate investments lie in two forms of compliance: first is the qualitative screening in terms of the property type eligibility for investments and second, a quantitative screening based on the accounting ratios including leverage and cash ratios expected of a Shariah compliant real estate company. The non-permissible rule applies to real estate developers and investment companies’ alike; specifically Islamic real estate companies when making investment decisions apply Shariah laws. Ratings intelligence, a consulting company, provides a framework for Shariah compliance in real estate companies to the current Shariah compliant S&P Citigroup global property index with the advice of Shariah scholars.
Any property type Leverage compliance Debt to market value of equity must be less or equal to 33%. Cash compliance Account receivables to market value of equity must be less than 45%. In some cases, non-permissible activities are permitted, only if it does not exceed a 5% and in some instances 20% threshold of revenue.
Islamic real estate companies are prohibited from leasing space to supermarket or shops which exceed 5 percent threshold revenue from non-permissible activities. Real estate companies that invest in hotels are not Shariah compliant, unless the hotel derives its revenue from 5 percent threshold from non-permissible activities or less. Hotel often sell alcohol beverages, while some have casinos where gambling takes place, these are all non-permissible forms of investment according to Shariah law. However, in the Middle East there has been an increase in Shariah compliant hotels which operate in accordance with Shariah laws, these hotels are alcohol-free and serve halal food.
Hence real estate companies which invest in commercial and office space in which more than 5 percent of their revenue is from conventional financial services as well as advertising and media are regarded as non-compliant. Shariah S&P Citigroup property global index specify a benchmark ratio for Shariah real estate companies, this financial ratios was also used by the Dow Jones Shariah index to construct a Shariah index. The debt to market value of equity (12 month average) must be less than or equal to 33 percent.
Account receivables to market value of equity (12 month average) must be less than or equal to 45 percent or (Cash þ interest bearing securities) to market value of equity (12 month average) must be less than or equal to 33 percent. In some cases, non-permissible activities are permitted, only if it does not exceed a 5 percent threshold. In other words, revenue from non-permissible activities to total revenue must be less than or equal to 5 percent.
Malaysia has the largest number of REIT listed on the Malaysian stock exchange which conforms to Shariah law.
Properties to be acquired by an Islamic REIT must undergo a Shariah compliant assessment, the assessment is to be carried out by an appointed Shariah committee or adviser. Total non-permissible activities from rental income to total turnover of the subject property must not exceed 20 percent, for any property purchased by the Islamic REITs. . The Islamic REIT fund manger should not invest in any property in which non-permissible activities exceed 20 percent. The Shariah committee must advise the Islamic REITs not to accept a new tenant whose activities are fully non-permissible. It is possible to calculate the rental of non-permissible activities from a tenant(s) operating mixed activities based on the ratio of area occupied by non-permissible activities to total area occupied. The percentage would determine the ratio of rental of non-permissible activities to total rent paid by the tenant
An Islamic REIT must ensure that all investment, deposit and financing instruments comply with the principles of Shariah. . Islamic REITs must use the takaful schemes to insure its real estate. If the takaful schemes are unable to offer insurance coverage, only then, are Islamic REITs are permitted to use conventional insurance. Islamic REITs are permitted to participate in forward sales or the purchase of currency, and encouraged to transact with Islamic financial institutions. If the Islamic REITs transacts with financial institution, then Islamic REITs are bound by the concept of wa’d (Also called Wadia or Al Wadi’ah, a contract of safekeeping under Sharia law. In contemporary Islamic finance a deposit or deposit account. A depositor places property with another party for safekeeping). However, Islamic REITs are permitted to participate in conventional forward sales and purchase of currency with conventional financing institutions.
The GCC in the last decade has seen a sharp increase in real estate developments and investments, however due to the recent global economic crisis there has been a deceleration in investments in the real estate sector.