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May 26, 2016

Real estate investment and Islamic finance make a near-perfect partnership, with property providing just the sort of tangible asset that is central to Sharia-compliant notions.

And what is true for investment is equally true on the other side of the equation, the raising of finance.

Central to Sharia-compliant finance, explains Claudio Sgobba, Director in JLL’s debt advisory team in London, is a prohibition on “making money out of money”. There can be no charging of interest and neither can there be any mixing of funds raised or invested in a Sharia-compliant manner with non-compliant monies.

Real estate investment, rooted, as the name describes, in real as opposed to notional property, is tailor-made for Sharia-compliant finance.

Furthermore, certain types of social investment may not only provide a steady return but can count towards the annual charitable giving that is required of wealthy Muslims. More on that in a moment.

Growing demand

Sharia-compliant funds are providing an important source of cash for the UK and continental European real estate market.

“Saudi Arabia, Kuwait and Qatar dominate in terms of demanding Sharia-compliant investment and fundraising,” says Sgobba.

“There is also some demand from the United Arab Emirates and Bahrain. The UAE seem to have more flexibility in terms of finance. We often find that when a European or U.S. investment manager requests Sharia-compliant funds, they are doing so on behalf of investors in those three main countries.”

He reckons about 60 percent of JLL’s Gulf client base who invest in Germany and the UK requires Sharia-compliant investments and finance. “The UK is the number one Islamic finance centre in the western hemisphere,” he says.

“London has a critical mass of qualified professionals in this area and English law is quite often used to govern Islamic financial transactions.”

The Shard, Battersea Power Station and Chelsea Barracks – three iconic London construction projects – were all three built using Sharia-compliant finance, for example.

Becoming Sharia-compliant

Aside from not charging interest, what does it take to be Sharia-compliant? The answer breaks down into three parts: there are the rules governing the structure of the investment, the types of real estate finance vehicles and the type of asset that is allowed.

First, the structure. Because of the ban on interest, the investor, in effect, becomes a business partner with the entity that is raising money. The return comes from the revenues that the asset generates, not from debt interest. “In Sharia-compliant investments, the lender must risk something,” says Sgobba.

Broadly speaking, there are two types of Sharia-compliant financial vehicles: one is asset based and the other is asset backed. The difference lies in the security available to the investor in the event of a default. In an asset-based vehicle, the lenders can demand only that the originator of the investment sell the underlying asset, after which time they become unsecured creditors.

By contrast, with an asset-backed vehicle, the creditors have a claim to the underlying asset itself.

As for the lists of allowable real estate investment opportunities, this would normally exclude bars, gambling premises, breweries and distilleries. The hospitality sector is generally shunned by Saudi and Kuwaiti investors because of links to the sale and consumption of alcohol and other forms of entertainment.

Some investors would allow hotel investments provided revenues from alcohol sales are less than five percent of what the asset generates.

The independence given to scholars and investors in interpreting Islamic principles has widened the spectrum of what is deemed Sharia-compliant.

“There are many different opinions as to what is Sharia-compliant,” he says. “There may be hundreds of qualified scholars across the world, but only a few who have gained recognition from the financial industry and Islamic investors alike.”

“Each deal is ultimately passed through a board of scholars to see whether the established criteria for any investment are met.”

A focus on social investments

In recent years, Islamic investment activity has moved away from “trophy” assets such as large income generating office buildings and towards social investments with a steady return: healthcare and senior housing are proving popular.

“Charity is a core practice in Islam, and investments in socially beneficial transactions can be seen as a form of sadaqah, a discretionary and discreet act of charity” he says.

“Some corners of the finance industry understand Sharia compliance in terms of the boundaries of what is allowed under Islamic law. Whereas other investors actively seek opportunities that are not only compliant with, but supportive of, their faith. For example, investing in a luxury development may be compliant with the Sharia but it is not a beneficial act in itself, yet investing in senior housing is a good deed as well as good business.”

 

Claudio Sgobba
Director, EMEA Debt Advisory

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