C onventional real estate investment trusts (REITs) are a well-established asset class, the attraction being the tax advantages with trusts able to distribute gross profits. As many Muslim investors, especially from the Gulf, were interested in international property acquisitions, Shariah compliant REITs were seen as having enormous potential. The failure for Islamic REITs to take off was partly a matter of timing, as by the time they were launched, there were doubts about prospects for commercial property prices. The subsequent slump in the US in both commercial and residential property has been negative for real estate companies, and part of the world-wide fall out has been a postponement of investments in REITs, including Islamic REITs. Markets always turn, however, and the breathing space should be used by prompters of Islamic REITs to educate potential investors, and perhaps more importantly their financial advisors, of the merits of REITs. In many markets, commercial property prices are becoming good value, and there will certainly be money to be made from investment in Islamic REITs in the coming years. It is important, however, that these are seen as long-term investment vehicles and those placing funds should have the resources to ride out the cycles in property markets without being forced to liquidate their investments.
PROFESSOR RODNEY WILSON:
F irst, the difficulties of ensuring that REITs based on commercial properties are based on income that is not “contaminated” by unacceptable property occupiers. Second, the lack of an availability of residential REITs, which is due to a reluctance of property buyers to adopt genuinely Islamic financing in respect of their homes. Third, the costs and complexity of conventional solutions. Finally, and this is a recurring issue, the greed of investors, who still seem to have unrealistic expectations in relation to risk and reward. The solutions lie in adopting a genuinely “asset-based” financing model based on ownership of property within partnership-based legal frameworks. These solutions may be marketed as follows: In both cases, Islamic REITs are capable of providing optimal and sustainable solutions — to businesses and individuals, respectively — for their financing requirements. CHRIS COOK: Principal, Partnerships Consulting
The biggest issue is Shariah compliance with regard to the use of the property. For example, if there is a conventional bank or insurance company on the premises, then this will most likely disqualify the REIT as some of the income will come from an inappropriate source. DAUD VICARY ABDULLAH: Chief operating officer, Asian Finance Bank
The idea of an Islamic REIT makes sense where investments can be made using Shariah compliant financing and insured with Takaful. However, there are a few problems specific to Islamic REITs that may discourage interest in them. As with Shariah compliant stock investing, Islamic REITs are required to maintain compliance with acceptable levels of conventional debt and de minimis income from prohibited sources (as prescribed by Shariah scholars). For example, the Malaysian Securities Commission’s “Guidelines for Islamic Real Estate Investment Trusts” set a 20% ceiling on income from non-Shariah compliant businesses conducted by tenants. The difficulties arise in the restrictions on tenants’ businesses in commercial buildings. It may be difficult to ensure that most of the tenants are engaged in halal business. Furthermore, the restrictions placed on the business activities of new tenants may lead to Islamic REITs having more difficulty filling vacancies than conventional REITs. One alternative would be to invest in residential property for rental or buildings designed for a specific (and halal) business (e.g. medical facilities). However, this may adversely affect the performance of the REIT by minimizing opportunities for diversification. BLAKE GOUD: Executive director, Institute of Halal Investing
The development of Islamic REITs depends on investors. When investors make an investment decision, they look primarily at the potential returns. We must examine if the returns of Islamic REITs are lower than that of its conventional peers and other asset classes. In Malaysia, the government has given issuers of Islamic REITs a number of incentives but little has been allocated for the demand side. More perks for investors may persuade them to consider Islamic REITs as an asset class in their investment portfolio. AZRUL AZWAN: Senior economist, Bank Islam
A number of conventional REITs have either mortgage-based or hybrid strategies in which they invest in mortgage-backed loans or acquire existing mortgages within their portfolio, or buy mortgage securities — all representing no-go areas for Islamic finance due to interest and debt-trading. InEquity REITs are likely to be a safer option (notwithstanding debt to asset screening issues for real estate companies). In the relatively recent run, and especially over the last six months, the effects of the subprime crisis are unlikely to have encouraged the progress of Shariah compliant REITs. InMoreover, REITs typically not only own the real estate in their portfolio but they also manage it; this may be viewed by some entrepreneurs as an unwanted headache or risk (vis-à-vis lack of management expertise or appetite), as opposed to investing in simple equities. A major benefit of REITs is the diversification of risk they offer, and understanding this better should improve prospects for Shariah compliant REITs even further. It is expected that equity REITs will catch on over the next few years, with a number of potential ventures in the offing. DR SALMAN KHAN: Senior product manager, BMB Islamic
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