Alternative Real Estate Finance The Potential of Islamic

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

Structure of Presentation Ø Contextual background Ø The need for an alternative model of financing in the post 2007/8 international banking crisis and the current European Union economic depression Ø The increasing diversity of sources of finance (Asia and the Middle East) Ø Importance of Middle Eastern Investors Ø Application of Islamic finance to real estate investment and development Ø Conclusion ERES 2012 2

Contextual Background Ø Global financial crisis starting 2007, Euro crisis and the Arab spring have created uncertainty Ø Collapse of Lehman Brothers in the US and other banks in the UK and Europe Ø Massive bailout of conventional banking and finance institutions by governments in the US and Europe Ø Increasing scrutiny of conventional methods of finance and investment (security of investment) Ø Transparency and ethical issues related to conventional methods of finance and investment ERES 2012 3

Contextual Background Ø Global market forces have a strong impact on real estate investment Ø Diminishing sources of finance for urban development Ø Need for alternative methods of financing real estate development and investment Ø Emergence of Islamic finance as a global alternative to real estate finance and investment ERES 2012 4

Key Principles of Islamic Finance Ø Prohibition against making profit without any risk Ø Prohibition of generation of surplus money through investment of money Ø Prohibition of speculation and uncertainty (maysir, gharar) Ø Avoidance of business with forbidden branches (haram) Ø Support of investment to avoid hoarding Ø Transparency and sanctity of contracts ERES 2012 5

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. Ø In 2011 about 348 financial institutions with Islam compliant activity were recorded (Source: The Banker) Ø Global Mutual Fund Industry: $25. 6 trillion Au. M/Q 12011 Ø Global Islamic Fund Industry: $58 bn Au. M/2010 (Source: Ernst & Young Islamic Funds & Investment Report 2011) ERES 2012

Growth of Islamic Finance According to Zawya Research (2012) there has been substantial increase in the issuance of SUKUKs Ø 2011 was the best year on record in terms of Sukuk issuance, with $79. 5 bn issued in the first 11 months of the year. Ø The global Sukuk market reached a record level of around $180 bn. Ø Many countries are opening up Islamic banking on their territories – a trend that is expected to intensify in the short to medium term. ERES 2012 7

Potential of Islamic Finance “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 Di. Vanna (2011, 1 November). Islamic Finance Roars Again. Retrieved from http: //www. thebanker. com/ ERES 2012 8

Investment Target: Europe 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 Ø In Europe: 65% ($6. 5 bn) of total investment were cross-border investments in 2011 Ø London: Most active city globally in 2011 Ø Increasing importance of Middle Eastern investors outside the Middle East (Source: JLL, 2012) ERES 2012 9

Middle Eastern Investment activity Ø Prefer mature, developed markets: • The UK, the US and France top 3 Ø $4. 4 bn cross-border transactions 2011 Ø $3. 8 bn just invested in Europe (Source: JLL, 2012) Ø $2. 5 bn invested in the UK (Source: Saudi Gazette, 2012) ERES 2012 10

Sharia Compliant Real Estate Finance Ø Modern IF about 40 years old limited research Ø 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. ERES 2012 11

Basic Instruments of Islamic Finance Profit-and-Loss-Sharing. Instruments Non-Profit-and-Loss-Sharing. Instruments Musharakah Profit and Loss Sharing Agreement Mudarabah Profit Sharing Agreement Murabaha Cost Plus Financing Sukuk Islamic Bond Ijarah Leasing ERES 2012 Qard al-Hasanah Beneficial Loan 12

Application of Sharia finance to real estate: SUKUK Ø “Islamic Bond“ Ø Represents ownership of an identifiable and Sharia compliant asset Ø Combinations with other instruments are common Ø The market is becoming increasingly important: • Growth from $8 bn in 2003 to $45 bn in 2010 (Source: Karimzadeh, 2012) Ø Has become popular for real estate finance ERES 2012 13

Sukuk al-Ijarah (I) 6 sells back at maturity Obligor (Lessee) periodic payments Ijarah contract 8 lease back sells 1 assets 5 7 distributes periodic payments Obligor (Seller) passes proceeds 4 SPV (Lessor) 2 emits sukuk certificates Sukuk Holder Sukuk certificate proceeds 3 (Dar Al Istithmar, 2006) ERES 2012 14

Application of Sharia finance to real estate: SUKUK Ø In 2006, Nakheel Group, real estate developers in Dubai launched a $2. 5 bn Sukuk bond for the financing of real estate developments Ø In August 2006, Qatar real estate investment company issued a Sukuk worth $270 m, the deal was structured by Standard Chartered Bank (2006) (Source: Ibrahim, Ong & Akinsomi, 2012) ERES 2012 15

Application of Sharia finance to real estate: I-REITs Ø I-REITs funds invest in listed real estate securities that own or operate with real estate compliant to the Sharia Ø Guidelines for I-REITs set by the Shariah advisory council of the Securities Commission in Malaysia in 2005: Ø Investments in real estate with non-permissible activity accepted, but must be < 20% Ø 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 incomes from ERES 2012 16

Application of Sharia finance to real estate: IREITs Outside of the GCC there have been activities infinancing real estate investments with Islamic financing and Shariah compliant real estate activities: Ø 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 $260 m Ø The largest Sharia compliant REIT by asset size, Sabana REITs in Singapore made an initial public offering of $510 m in 2010, the average property valuation as at September 2010 was valued at $640 m (source: Ibrahim, Ong & Akinsomi, 2012) ERES 2012 17

Application of Sharia finance to real estate development projects 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: Ø Participation bonds Ø Project Shares Ø Land Construction Funds ERES 2012 18

Findings Ø The presentation showed that there is a potential for Sharia compliant products Ø Good means to avert risk and address ethical concerns, especially in times of globalisation and market uncertainty Ø Can help to stabilise real estate markets as the methods are more transparent Ø Because of the social and ethical aspect, it is easier to market in this age of crisis Ø Not just for Muslims, and can reach investors who are important, but would not use conventional methods ERES 2012 19

Findings Ø 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 Ø Investors want to get the same possibilities in Islamic finance compared to conventional finance ERES 2012 20

Further Research Ø 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 ERES 2012 21

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. ERES 2012 22

Thank you for your attention Contact data: Ali Parsa Professor in Real Estate School of the Built Environment The University of Salford M 5 4 WT United Kingdom T +44 (0)161 295 5317 M +44 (0)7957 287 341 F +44 (0)161 295 5011 A. Parsa@salford. ac. uk ERES 2012 Azadeh Farhoush Ph. D Candidate School of the Built Environment The University of Salford M 5 4 WT United Kingdom T +44 (0)161 295 5317 F +44 (0)161 295 5011 A. Farhoush@edu. salford. ac. uk 23