Alternative Real Estate Finance - The Potential of Islamic Finance Azadeh Farhoush Prof. Ali Parsa 1 ERES 2012.

Alternative Real Estate Finance

- The Potential of Islamic

Finance

Azadeh Farhoush

Prof. Ali Parsa

1ERES 2012

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Contextual background

The need for an alternative model of financing in the post 2007/8 international banking crisis and the current European Union economic depression

The increasing diversity of sources of finance (Asia and the Middle East)

Importance of Middle Eastern Investors

Application of Islamic finance to real estate investment and development

Conclusion

Structure of Presentation

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Global financial crisis starting 2007, Euro crisis and the Arab spring have created uncertainty

Collapse of Lehman Brothers in the US and other banks in the UK and Europe

Massive bailout of conventional banking and finance institutions by governments in the US and Europe

Increasing scrutiny of conventional methods of finance and investment (security of investment)

Transparency and ethical issues related to conventional methods of finance and investment

Contextual Background

Contextual Background

Global market forces have a strong impact on real estate investment

Diminishing sources of finance for urban development

Need for alternative methods of financing real estate development and investment

Emergence of Islamic finance as a global alternative to real estate finance and investment

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Prohibition against making profit without any risk

Prohibition of generation of surplus money through investment of money

Prohibition of speculation and uncertainty (maysir, gharar)

Avoidance of business with forbidden branches (haram)

Support of investment to avoid hoarding

Transparency and sanctity of contracts

Key Principles of Islamic Finance

Growth of Islamic Finance

There is disparity about the actual size of Islamic finance, however, it is universally agreed that there has been substantial growth in recent years.

In 2011 about 348 financial institutions with Islam compliant activity were recorded (Source: The Banker)

Global Mutual Fund Industry: $25.6 trillion AuM/Q12011Global Islamic Fund Industry: $58bn AuM/2010

(Source: Ernst & Young Islamic Funds & Investment Report 2011)

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According to Zawya Research (2012) there has been substantial increase in the issuance of SUKUKs

2011 was the best year on record in terms of Sukuk issuance, with $79.5bn issued in the first 11 months of the year.The global Sukuk market reached a record level of around $180bn.Many countries are opening up Islamic banking on their territories – a trend that is expected to intensify in the short to medium term.

Growth of Islamic Finance

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“This is not to say that sharia-compliant banks have been not affected by the financial turmoil of Western markets. Islamic

institutions in the Middle East with exposures in real estate have experienced difficulties as property values experienced

corrections in various domestic markets. However, as Western markets continue a cycle of risk avoidance and investor pessimism, sharia-compliant bankers are seeing new

opportunities for the development of Islamic funds and other financial instruments that have been lacking behind conventional

banks. Islamic investors are seeking new investments, asset classes and mechanisms for greater risk diversification.”

Source: Joseph DiVanna (2011, 1 November). Islamic Finance Roars Again. Retrieved from http://www.thebanker.com/

Potential of Islamic Finance

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Despite the short term uncertainty about real estate markets international investors have continued cross border activity in real estate

European cities: Still popular investment targets

In Europe: 65% ($6.5bn) of total investment were cross-border investments in 2011

London: Most active city globally in 2011

Increasing importance of Middle Eastern investors outside the Middle East(Source: JLL, 2012)

Investment Target: Europe

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Prefer mature, developed markets:

• The UK, the US and France top 3

$4.4bn cross-border transactions 2011

$3.8bn just invested in Europe

(Source: JLL, 2012)

$2.5bn invested in the UK(Source: Saudi Gazette, 2012)

Middle Eastern Investment activity

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Modern IF about 40 years old limited research It is not allowed to invest in

• Pork products• Pornography• Financial services (conventional)• Arms or munitions• Tobacco• Gambling• Alcoholic liquor

Careful and detailed analysis has to be done before an investment decision, a lease out etc.

Sharia Compliant Real Estate Finance

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 Profit-and-Loss-Sharing-

Instruments 

Non-Profit-and-Loss-Sharing-Instruments

 Musharakah

Profit and LossSharing Agreement

Qard al-Hasanah  

Beneficial Loan  

MudarabahProfit Sharing

AgreementMurabaha

Cost PlusFinancing

  Sukuk Islamic Bond

  Ijarah Leasing

Basic Instruments of Islamic Finance

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“Islamic Bond“

Represents ownership of an identifiable and Sharia compliant asset

Combinations with other instruments are common

The market is becoming increasingly important:

• Growth from $8bn in 2003 to $45bn in 2010

(Source: Karimzadeh, 2012)

Has become popular for real estate finance

Application of Sharia finance to real estate: SUKUK

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Sukuk al-Ijarah (I)

(Dar Al Istithmar, 2006)

Obligor (Seller)Obligor (Seller)

Sukuk HolderSukuk Holder

SPV (Lessor)

SPV (Lessor)

sells assets

emits sukuk certificates

Sukuk certificate

Sukuk certificate

passes proceeds

periodic payments

lease back

11

22

33

44

proceeds

55

Ijarah contract

Ijarah contract

66

distributesperiodic

payments

77

Obligor (Lessee)Obligor (Lessee) 88

sells back at maturity

In 2006, Nakheel Group, real estate developers in Dubai launched a $2.5bn Sukuk bond for the financing of real estate developments

In August 2006, Qatar real estate investment company issued a Sukuk worth $270m, the deal was structured by Standard Chartered Bank (2006)

(Source: Ibrahim, Ong & Akinsomi, 2012)

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Application of Sharia finance to real estate: SUKUK

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I-REITs funds invest in listed real estate securities that own or operate with real estate compliant to the Sharia

Guidelines for I-REITs set by the Shariah advisory council of the Securities Commission in Malaysia in 2005:

Investments in real estate with non-permissible activity accepted, but must be < 20%

Rental income out of non-permissible activity accepted, but must be < 20% of total turnover.

Consequently, transparency is very important as it must be clear and calculable where the income comes from

Application of Sharia finance to real estate: I-REITs

Outside of the GCC there have been activities infinancing real estate investments with Islamic financing and Shariah compliant real estate activities:The world’s first listed Islamic REIT and Asia’s first healthcare REIT, Al aqar KPJ REIT listed on the Malaysian stock exchange in August 2006 with an asset size of $260mThe largest Sharia compliant REIT by asset size, Sabana REITs in Singapore made an initial public offering of $510m in 2010, the average property valuation as at September 2010 was valued at $640m(source: Ibrahim, Ong & Akinsomi, 2012)

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Application of Sharia finance to real estate: IREITs

The evidence from our research in the Middle East indicates that it is possible to innovate financing methods, which are Sharia compliant

For example in Iran significant number of urban regeneration projects, which are based on real estate development are financed through the Sharia compliant methods. These include:Participation bondsProject Shares Land and Construction Funds

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Application of Sharia finance to real estate development

projects

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The presentation showed that there is a potential for Sharia compliant products

Good means to avert risk and address ethical concerns, especially in times of globalisation and market uncertainty

Can help to stabilise real estate markets as the methods are more transparent

Because of the social and ethical aspect, it is easier to market in this age of crisis

Not just for Muslims, and can reach investors who are important, but would not use conventional methods

Findings

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Main differences between Sharia compliant and conventional finance:

• Regulations

• Methods of finance and investment

• Composition of portfolio or structure of development

• Supervision and monitoring

• Usually higher costs (no standardisation, scholars involved

Investors want to get the same possibilities in Islamic finance compared to conventional finance

Findings

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There is still a lot to do to

• Standardisation, common legal framework, total abolition of conventional elements etc.

• Western countries usually have to change or amend their regulations

• Increase its popularity in the West

• New and so the profitability for the real estate sector has still to be experienced

Further Research

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Conclusion

Islamic finance can be taken as a guideline to avoid the problems we could see

ethically in finance, a product which could be used in the West even when it is not

called Islamic.

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Thank you for your attention

Contact data:

Ali ParsaProfessor in Real EstateSchool of the Built EnvironmentThe University of SalfordM5 4WT United KingdomT +44 (0)161 295 5317 M +44 (0)7957 287 341 F +44 (0)161 295 [email protected]

Azadeh Farhoush

PhD CandidateSchool of the Built Environment

The University of SalfordM5 4WT United Kingdom

T +44 (0)161 295 5317

F +44 (0)161 295 [email protected]