Real estate: Recognizing global quality


Shariah compliant real estate investment has long been an established product offering for Islamic investment managers. The allure of bricks and mortar remains, frequently with an attractive income component compared to equities or Sukuk.

While tenant use of course needs to be monitored, the basics of real estate investment suit Shariah principles well, with a genuine business being undertaken, either to build and let or sell new property or hold existing properties for their rental income.

Broadly speaking, where Islamic investors want to buy real estate there is now the necessary critical mass of professionals able to assist. 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 2018
Political events in the US and the UK, historically the most favored markets for cross-border Islamic real estate investment, failed to dampen investor appetite. Whilst hard data is hard to come by, the falling value of the sterling seems to have led to a record-year for investment into the UK, with investors taking a longer-term view beyond Brexit negotiations. As the US economy accelerates, US President Donald Trump’s words and actions have not negatively impacted sentiment, but the diminishing gap between purchase yields and reference finance rates has somewhat limited activity.

Elsewhere Europe remained in favor, and while most were priced out of Germany, the Netherlands offered relative value with investment activity through the year. Australia also returned as a destination, with investors drawn by the strength of the economy, itself fuelled by strong population growth.

Within the Middle East, building on their success during 2017, Saudi Arabia stole most of the headlines with growing issuance of REITs on their public markets. Whilst they remain largely domestically focused, they have delivered what many others have not.

Among all this there is a fear that quality is being compromised in return for maintaining, or even increasing, the net cash yield to investors that was previously being offered. World economies are doing well, global appetite for real estate acquisition is increasing and in most markets reference finance rates are increasing. Something has to give.

Preview of 2019
Save for any major political event, I don’t see any change in investor appetite during 2019, with cross-border investment remaining the focus for many and literally a world of opportunities available. However, these will remain largely on a transaction by transaction basis.

The benefits of diversification through fund strategies, perhaps with lower leverage and longer-term holds have not been communicated well to investors. Or better, no-one has sought to achieve this on a significant scale yet. Combined with purchase and holding taxes continuing to rise, it feels like we should be on the verge of successful fundraising for at least one major fund initiative where quality assets can be owned for the long term, and investors offered some form of liquidity should they wish. Fingers crossed that 2019 is the year that this gets delivered.

There is a growing voice of recognition that Islamic investment has many similarities to socially responsible investment in the non-Shariah investment world. Whilst there is nothing stopping non-Islamic investors coming into Shariah compliant transactions, the marketing and positioning of the offering often dissuades a wider audience from considering the opportunity. As fintech initiatives positively disrupt the status quo, their approach may be adopted by others wanting to be more inclusive.

The squeeze on levels of dividend to investors will continue, and I see the market for investment managers more clearly separating between those chasing yield through sacrificing quality and those maintaining a focus on positive real estate attributes and properties delivering a fair dividend to investors, even if this is lower than was available previously.

As in previous years, I see little change in the size of Islamic bank balance sheets, which would otherwise allow direct Shariah compliant finance to be sourced on larger mainly commercial real estate investments. On a positive note, syndication of such facilities among banks is increasing, and I hope will continue in 2019.

Voters rarely shed a tear worried about the fortunes of real estate investors, and so regrettably I can’t rule out further tax increases impacting both Islamic and non-Islamic investors alike. These tend to come with some warning though.

With sound economic fundamentals and a wider variety of Shariah real estate investment opportunities available, 2019 should be a great year, but I would encourage all investors to focus on the strength of the underlying real estate and not solely the projected dividend distributions.

To quote Henry Royce of Rolls-Royce fame: “The quality will remain long after the price is forgotten.”

Original article appeared in Islamic Finance News 2019 Annual Guide.