1/6/2021

Real estate: An enduring appeal

Viewpoint

Shariah compliant real estate investment has long been an established product offering for Islamic investment managers. Perhaps now more than ever, the allure of bricks and mortar remains, as investors seek an attractive income component ahead of what can be achieved with other investments.

Real estate suits Shariah compliant investing well with a genuine business being undertaken, either to build to rent or sell new property or hold existing properties for their rental income. The mechanisms to assess the compliance of tenants are well established, as is the capability of landlords to apply the lease terms themselves appropriately.

While there is now a global band of professionals able to assist with selecting, structuring and closing acquisitions, what remains lacking is the scale at which Islamic banks outside of the Middle East and Southeast Asia are 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 2020

2020 can be divided into three segments, with the significant differences between each one triggered of course by the impact of COVID-19.

The first two or three months started with great optimism both for intra-region and international real estate investment. The preferred sectors of 2019 rolled into 2020 with offices remaining very attractive for investors, along with a broad range of residential related properties, including multi-family properties in the US and student accommodation in the UK. Logistics were certainly already
in demand, but achieving the yield investors wanted was difficult.

And then of course the pandemic hit. All focus moved to managing existing investments as managers, financiers and investors worked through the implications for their properties. Where due diligence had commenced on new acquisitions before the lockdowns commenced, the ability to successfully close them relied on the flexibility and pragmatism of all parties. There was little to no new transaction activity through to the end of August.

While it was certainly a very different summer, come September, as in previous years, investor interest recovered and there was a realization that real estate could offer the fundamentals that they
were seeking.

There was little appetite for risk for the remainder of the year, with an almost universal declaration among investors wanting long-leased properties with defensive tenants. Ideally these should be logistics properties, or if offices, let to companies in the food, government, medical or technology sectors, so as to be able to withstand any further pandemic onslaught.

However, any expectation of a ‘COVID-19 discount’ was short-lived. The Islamic real estate industry exists of course as a component of the global real estate business, which had reached very similar
conclusions with respect to investment requirements over the summer. For certain properties, a ‘COVID-19 discount’ very quickly turned to a ‘COVID-19 premium’, fuelled by defensive characteristics and six months of pent-up demand.

For logistics properties, which had already been favoured before the pandemic, something of a feeding frenzy occurred, with yields seemingly falling by the day and fortunate sellers being able to
dictate transaction terms.

This increased activity occurred during the continued inability or unwillingness to travel, along with the return of lockdowns to many countries. The use of advisors within the respective countries and technology has solved the problem. Just as we have all become used to conducting meetings through video connections, so property tours were undertaken using drones, professionally shot
video content or simply a camera phone.

Preview of 2021

Much depends on whether the rush to invest in the last quarter of 2020 was pent-up demand or the start of a prolonged global trend for real estate investment. Many investors have become used to a preferred minimum net cash yield, but this may need to be reset if the very attractive gap between property yields and reference interest rates tightens.

We should continue to see continued appetite for secure properties, but this will include a widening of investment criteria as the intense competition for the most obviously defensive properties is recognized. I suspect that this will include a wider recognition of healthcare assets and a growing appetite for residential properties which, while lower-yielding, are supported by the eternal need for
housing.

In the 11 years since the world came out of the last economic shock in the summer of 2009, the Islamic real estate industry has not returned to funds as a conduit for investment in any meaningful way, and so I see almost no prospect for significant pickup in fund activity as we work through this current economic shock.

Conclusion

We made it through, picked up the pieces and are moving forward again. The enduring appetite for real estate has yet again been tested and has proven its resilience.

This article was first published in Islamic Finance 2021 Annual Guide