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]