Real Estate Financing and Sukuk

Sharia Coordination Department

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Real Estate Financing and Real Estate Financing and SukukSukuk

Mian Muhammad Nazir Senior Vice President

Dubai Islamic Bank PJSC


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• Overview• Commonly used modes in Real Estate

Financing• Murabaha – ready property• Ijara – ready property• Forward Ijara – under construction property• Istisna – under construction property• Mudaraba• Agency – Wakala • Musharaka • Sukuk

Real Estate Financing and Sukuk


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• Sharia offers various structures for Real Estate Financing based on the requirements of the respective parties

• Each Sharia compliant mode of financing distinctly exemplifies the essential feature of ownership and risk

• Growth witnessing assets exceeding $1.7 trillion and expected to reach $2.7 trillion by 2010.

• In year 2007, 76% of corporations’ non-loan fundings were Sharia compliant in the MENA region.

• 2008 shows slow growth due to credit crunch.



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Murabaha (ready property)

Real Estate Financing and Sukuk Commonly Used Modes


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Murabaha (Only in case of ready property)

• Step by Step

Customer

Islamic Bank

Step 1Promise toPurchase

Step 3 Purchase of Property

through purchase agreement

Step 4Purchase Price

Title & Possession tothe Property

Step 6Sale Price

Deferred

Step 5Sale of Property to

Customer on Murabahabasis

Title and Possessionto the Property

Step 2Purchase Offer

Owner/Developer



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Murabaha

• Murabaha is widely used mode of finance in Islamic Finance Industry in general and for Real Estate Financing in particular.

• However, it can only be used for:• ready property; • for a shorter financing tenor for the reason

of fixed return • Involves less risks as it creates debt

obligation on the customer – No ownership risk.



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Murabaha

• The Bank buys the Property and sells it to the customer on Murabaha (cost + profit) basis.

• Murabaha sale price is paid normally on a deferred basis.

• Liability is known from day one – No surprises or uncertain exposure.



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Ijara ready property



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Purchase and Ijara ready property

• Step by Step

Customer

Islamic Bank

Step 1Promise to

leaseStep 3

Acquisition of the Property through purchase agreement

Step 4Purchase Price

Title & Possession tothe Property

Step 6Lease Rental

Step 5Lease of the Property

to the customer throughLease Agreement

Usufruct of the Property


Owner / Developer



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Ijara

• Ijara is less risky as compared to other financing structures

• Strict compliance with Sharia and the applicable law is required for enforceability.

• Best suited for Islamic Financial Institutions – conventional institutions may have some regulatory problems in Ijara

• It is generally perceived that notwithstanding Sharia requirements, the documentation should be in accordance with the applicable law which is not free from risk from Sharia compliance perspective.



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Ijara

• Liability is known from day one – No surprises or uncertain exposure.

• Unlike conventional finance, Sharia has a special treatment to issues such as increased cost, mandatory cost, asset ownership, taxes, major maintenance, asset insurance and remedies in the event of total or partial loss.



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Ijara

• Ijara structure involves purchasing an asset from the customer or a third party and leasing the same to the customer.

• Care needs to be taken in order to ensure that the transaction does not become a conditional sale or a contract of Inah.

• Sharia requires extraordinary caution in putting together a rental framework for a lease transaction which involves a variable element of rental



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Ijara

• Ijara: Two types• Ijara Muntahia Bittamleek (Finance lease)• Operating Lease

• In Ijara Muntahia Bitammaleek, transfer of ownership at the expiry of lease term must be through a unilateral undertaking to be exercised at the expiry of the lease term and the transfer should either take the form of sale at nominal price or gift.

• Appropriate structure for all purpose financing needs



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Forward Ijara under construction property



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Forward Ijara for under construction property

• Step by StepCustomer

Islamic Bank

Step 1Promise toLease on

Forward Ijarabasis

Step 3 Purchase of the described Property

through Istisna Agreement

Step 4Istisna Purchase Price

Delivery of the describedProperty after completion

Step 6Lease Rental

Step 5 Lease of Property

on the basis of Forward Ijara

Delivery of LeasedProperty to Customer

at completion


Owner / Developer



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Ijara Mousoofa Fizzimma (Lease of specified item(s) which are to be delivered after manufacturing or construction)

• Ijara in respect of an asset under construction takes the form of Ijara Mousoofa Fizzimma.

• Lease of the underlying assets starts on the date of delivery of the asset to the lessee and the lessee’s obligation to pay rental triggers with the commencement of the lease.

• An investor receives return on its investment out of the amount received from the lessee on account of rental which is adjusted against the actual rental.



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Ijara Mousoofa Fizzimma

• Although investment in assets under construction through Ijara Mousoofa Fizzimma may not be free from certain downsides, it still has potential to serve both the parties, i.e. customer and financier – addressing the Project Financing requirements.

• Appropriate structure for project financing. Example:• QREIC Sukuk (Qatar)



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Istisnaunder construction property



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Istisnafor under construction property

• Step by Step

Customer

Islamic Bank

Step 1Promise to

Purchase onParallel Istisna

basis

Step 3 Purchase of the described Property

through Istisna Agreement

Step 4Istisna Purchase Price

Delivery of the describedProperty after completion

Step 6Parallel IstisnaPurchase

Price

Step 5Sale of the describedProperty on Parallel

Istisna basis

Delivery to the Customer after

at completion


Owner / Developer



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Istisna• In Istisna sale, the seller sells a described

property to be delivered to the purchaser once the same is completed.

• Istisna requires combination of either lease of the purchased assets back to the seller or sale of the purchased assets to the customer, provided that the purchase is not from the same customer.

• Used in QREIC Sukuk involving purchase of the described assets by sukuk-holders and leasing back to the Seller.



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Mudaraba



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Mudaraba• Step by Step


Islamic Bank (Rab Al Mal)

Developer (Mudarib)

Step 1Business

Plan

Step 3 Joint Capital (after commingling of

Mudaraba Capital with Net AssetsOf Mudarib if any)

Step 6Mudaraba

Capital

Mudaraba Agreement

Project

Net ProfitMudarib Profit

Mudaraba ProfitMudarib’sShare

Rab al Mal’sShare


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Mudaraba• Mudaraba is a very flexible real estate financing

structure.

• Mudaraba can be of two types:

• Project basis – no need for Sharia compliance of financial ratio, however, underlying activities must be Sharia compliant.

• Unrestricted Mudaraba on commingling basis which requires Sharia compliance of the customers’ business activities as well as the financial ratio.

• Mudaraba operates on trust which means a partnership in profit.

• The Mudaraba capital can be cash and/or tangible assets.



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Mudaraba• Mudaraba financing is an investment, therefore, it

requires an investment plan.

• Mudarib’s performance is assessed on the basis of the Investment Plan it has provided to the financier in order to obtain financing.

• In 2007, Mudaraba was considered to be a preferable financing structure because it does not involve sale of the assets. (Example: DIFC Sukuk)

• However, recent discussions amongst Sharia scholars on redemption through purchase undertaking resulted in reduction of the use of Mudaraba structure.



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Agency



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Agency• Step by Step


Islamic Bank (Principal)

Developer (Agent)

Step 1Investment

Plan

Step 3 Investment Amount

Step 6Investment

Amount

Agency Agreement

Project

Profit

Incentive

AgencyFee


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Agency (Wakala)

• Investment agency structure for real estate financing is another flexible structure.

• It operates on the principal similar to Mudaraba except the Profit distribution.

• However, this structure is less used in real estate financing due to certain academic discussions amongst the Sharia scholars.



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Musharaka



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Musharaka (two structures)

• Sharikatul Aqd (Contractual Partnership)

• Musharaka Mutanaqisa (Diminishing Musharaka)

• Normal Musharaka (Example: JAFZA Sukuk)

• Sharikatul Milk (Co-ownership).• Volcano Sukuk, DIB Sukuk, and EIB Sukuk



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Musharaka Mutanaqisa• Step by Step


ContributionCash

Islamic Bank

Project

Musharaka Entity

Customer / Developer

InvestmentProfit

ProfitProfit

+Incentive

Purchase Undertaking

Musharaka Agreement

Purchase of Units in Musharaka

ContributionCash + Kind


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Musharaka – Bank leases its share in Musharaka to the Customer• Step by Step


ContributionCash

Islamic Bank

Project

Musharaka Entity


InvestmentProfit

ProfitProfit

+Incentive

Lease Rental

Musharaka Agreement

Lease of Bank’s Share

ContributionCash + Kind


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Musharaka – Sharikatul Milk (Ready Property)• Step by Step


Islamic Bank

Ready Property


Purchase Price

LeaseRental

Lease Rental

Purchase Undertaking

Musharaka Agreement

Periodic Purchase of Undivided Share

ContributionCash

ContributionCash


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Sukuk (Islamic Bonds)



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• Sukuk certificates represent ownership in the underlying assets, usufruct and services or the assets of particular projects or investment activities.

• The ownership must be real, not beneficial, i.e. economic benefits or entitlements. (AAOIFI’s resolution).

• Provides viable alternative to conventional bonds and securities.

• Receivables cannot be underlying assets for Sukuk.



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Sukuk (Islamic Bonds)• Global Sukuk issuance reaches $109 billion. • Indicating impressive growth in MENA

region.


MENA Bond issuanceSukuk vs. Conventional Bonds

Global Local Currency and Dollar Sukuk Issued by Country (2007)


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• Sukuks are issued on any of the foregoing Sharia contracts.

• For real estate, Sukuk can be issued using any of the Sharia contracts for the following:

(i) the development of a particular real estate project; or

(ii) the working capital or the construction cost



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• Choosing a structure for a Sukuk depends on the following:• Purpose for which the money is required;• Assets which will be used to raise money; • Income stream and payment; and• Tenor

• Using a right structure in view of the transaction requirements is a real Sharia issue. • Examples: Al Dar, Nakheel, Tamweel, PCFC

and DCA.



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• Sukuk are more economical than conventional financing

• Investor gets comfort from the fact that, being a public transaction, the structure, commercial issues and documentation may have gone through the eyes of experts (including Sharia scholars)

• Tradability of Sukuk depends on the assets’ ownership and the Sharia structures on which they are based.

• Most of the Sukuk structures are tradable.



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Sukuk (Islamic Bonds)• Increase in volume and popularity throughout

the world would definitely make the Sukuk a better alternative for Project Financing.

• However, in order to make Sukuk less expensive and preferable financing choice, standardization and regulation at local and industry level is very much required.

• Sukuk is also suitable for closely held family real estate development businesses.

• In view of the recent academic controversies, new structures such as Sharika tul Milk, Asset Purchase and Lease Back, have become increasingly popular.



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Thank You

Documents

Real Estate Financing and Sukuk