Shariah compliant real estate investment has long been an established product offering for Islamic investment managers. As global markets wobble and recessions loom, the allure of bricks and mortar is strengthened, with investors seeking safety, an income and the prospect of capital appreciation.
Real estate suits Shariah compliant investing well with a genuine business being undertaken, either to build from scratch or to purchase an existing property for its rental income. The mechanisms to assess the compliance of tenants are well established, with increasing recognition that such principles fit well within the responsible investment ethos of ESG criteria.
While there is a global band of professionals able to assist with selecting, structuring and closing acquisitions, what remains lacking is a scale to Islamic banks outside of the Middle East and Southeast Asia able to provide Shariah compliant finance for larger transactions, with conventional finance and a structure to insulate investors from the non-compliant payment of interest required in a pragmatic approach to allowing transactions to occur.
Review of 2022
While the COVID-19 pandemic was put largely behind us, Russian President Vladimir Putin became the new foe, with his invasion into Ukraine escalating global tensions and energy prices. Along with supply chain issues, the last thing a post-COVID-19 world gorging on government handouts needed was higher gas and electricity prices, with inflation becoming rampant and interest rates deployed as the tool of choice to tackle the beast.
Summer was a tipping point, with investors, whether Islamic or not, determining that the world had indeed changed and with a swift repricing of assets before autumn reached the northern hemisphere. With benchmark interest rates escalated and banks often reluctant to provide the senior financing that previously fueled the net cash yield craved by Shariah compliant investors, a change of tack was required.
With the middle market of safe income streams that deliver a levered middling to high single-digit return gone, the investor market became noticeably split with respect to risk appetite.
For many, buying all-cash at prices 20% lower than before the summer was compelling, and while the cash yield may not deliver what they previously expected, medium-term prospects for capital appreciation were compelling, particularly if inflation could be directly captured through rental growth.
Others chose to look to post-high interest rates and a post-inevitable recession world, and to embrace some risk, sensing that available terms may not be this good for a long time. Mezzanine financing, often troublesome to agree from an Islamic perspective, for development and investment transactions became attractive, as well as taking the equity position on development opportunities due to complete post-chaos.
As the year drew to a close, activity levels noticeably fell, with investors, whatever their chosen strategy, deciding to see what the new year brings, anticipating that opportunities would not disappear over the coming few weeks. The sellers’ market up to the summer of 2022 had most certainly changed to a buyers’ market.
Preview of 2023
It is hard to project anything more positive than it is going to get worse before it gets better. The combination of inflation and the interest rates being used to tackle it will inevitably leave many economies at least dancing on the edge of recession. But maybe the tipping point will again be the summer?
With apologies for having yet again to reference interest rates in an article about Islamic real estate, but having to acknowledge their impact on economies and their use as a benchmark for Shariah financing rates, the peaks in the projected interest rates of the US, the UK and European markets favored by international investors are shown to be between May and July 2023.
Not long to wait, and the opportunities will likely present themselves before then.
Cash will be king, with such acquirers seeking healthy and frankly reasonable price discounts to reflect the strength of their position.
But I also see a potential revival in Islamic senior financing, including Sukuk issuance. With all-in finance costs now typically exceeding yield returns previously required on equity positions, this provides an attractive opportunity, including a senior security position on the underlying asset.
And lest we forget, higher energy prices are a key contributor to the current situation. While those countries on the selling side will obviously continue to benefit, it is also another reminder of the importance of energy efficiency, with a property’s green credentials continuing to move up the ranking of investment considerations, along with the old favorites of lease length, tenant strength and cash yield.
Conclusion
Opportunities are being created. They may be as simple as buying at a discount and benefiting from the last ebbs of falling inflation as real estate delivers its historically proven hedging ability. Or it could be reacting with new and innovative products that fulfill Islamic investors’ desires. Either way, let’s get through this and come out stronger.
Philip Churchill is the founder and managing partner of 90 North Real Estate Partners. He can be contacted at [email protected].