Download The Potential of Islamic Finance

Alternative Real Estate Finance
The Potential of Islamic Finance
Azadeh Farhoush
Prof. Ali Parsa
ERES 2012
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Structure of Presentation
 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
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Contextual Background
 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
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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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Key Principles of Islamic Finance
 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
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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/Q12011
 Global Islamic Fund Industry: $58bn AuM/2010
(Source: Ernst & Young Islamic Funds & Investment Report 2011)
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Growth of Islamic Finance
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.
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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 DiVanna (2011, 1 November). Islamic Finance Roars Again.
Retrieved from http://www.thebanker.com/
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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
 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)
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Middle Eastern Investment activity
 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)
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Sharia Compliant
Real Estate Finance
 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.
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Basic Instruments of
Islamic Finance
Profit-and-Loss-SharingInstruments
Non-Profit-and-Loss-SharingInstruments
Musharakah
Profit and Loss
Sharing Agreement
Qard al-Hasanah
Beneficial Loan
Mudarabah
Profit Sharing
Agreement
Murabaha
Cost Plus
Financing
Sukuk
Islamic Bond
Ijarah
Leasing
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Application of Sharia finance to real
estate: SUKUK
 “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
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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
certificate
Sukuk Holder
proceeds
3
(Dar Al Istithmar, 2006)
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Application of Sharia finance to real
estate: SUKUK
 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: I-REITs
 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
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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:
 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 $260m
 The 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 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:
 Participation bonds
 Project Shares
 Land and Construction Funds
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Findings
 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
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Findings
 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
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Further Research
 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
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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 Parsa
Professor in Real Estate
School of the Built Environment
The University of Salford
M5 4WT United Kingdom
T +44 (0)161 295 5317
M +44 (0)7957 287 341
F +44 (0)161 295 5011
[email protected]
ERES 2012
Azadeh Farhoush
PhD Candidate
School of the Built Environment
The University of Salford
M5 4WT United Kingdom
T +44 (0)161 295 5317
F +44 (0)161 295 5011
[email protected]
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