Baljeet Kaur Grewal began by highlighting two factors that have contributed to the growth of the real estate sector. “If we look at both the Asian and GCC regions, they have common factors that are driving the real estate sector — liquidity and strong economic fundamentals. In Asia, economic growth last year was 7.2%, coupled with a high savings rate and low interest rate environment. In addition, the growth of tourism in Asia has raised the rent in residential spaces. These factors contributed to the real estate boom in Asia. GCC, on the other hand, is a surplus economy — the current surplus in the GCC economy is about 20% of GDP. In addition, there was US$560 billion oil revenue in 2006. Real estate is also a key growth factor in this region. The real estate sector has increased by 15% in Kuwait and 20% in Saudi,” she elucidated.

Dr Veerinderjeet Singh noted that the Islamic REITs Guidelines by the Securities Commission have provided regulatory clarity including tax transparency, quality of asset and role of asset managers. In addition, the government is also providing tax incentives to develop the REITs market in Malaysia. “If 90% of income is distributed to investors, then the REIT will enjoy tax exemption,” he disclosed.

Christina Maynes noted the trend of Islamic securities moving away from structured financing. “We are seeing a lot of Islamic securities that are actually similar to the conventional senior unsecured obligations — they are only asset-based, not asset backed, and it is quite surprising,” she revealed.

In responding to Abdulkader’s question on legal risks in real estate transactions, Baljeet said it depends on how developed the legal jurisdiction of a country is. For example, for a country like Malaysia, where the legal system is based on English law, the legal risks are somewhat mitigated because issues like transfer of ownership are clearly defined. Maynes added that while legal risks exist in the real estate sector, there is a lack of precedence and defaults to test these risks.

A participant expressed concern about the over-concentration of the Islamic finance industry on the real estate sector. In response, Maynes said that the industry has efficient regulators and these regulators will provide guidance on maximum real estate exposure and single-client exposure. In certain regions like Cambodia, where there were only real estate assets, Maynes said Moody’s brought in real estate experts to rate the exposure of the issuer.

Abdulkader then asked Baljeet whether KFH would continue to focus on real estate or diversify. Baljeet said as long as real estate is generating attractive returns, KFH will remain in play. “Real estate is a traditional hedge for Islamic banks. In GCC, for example, real estate makes up half of the GDP. In addition, most GCC countries have more than 60% population under the age of 30 — this means that housing requirements will balloon in the future. More interestingly, a few countries have allowed foreign ownership in real estate — Dubai relaxed its rule two years ago while Saudi took the same step last year. That’s why real estate will always remain a cultural investment, at least for the GCC market. At KFH, we thought real estate may get ‘sick’ but it will never die. Thus I perceive KFH being long run in this sector and we’ll learn to manage the risks,” she said.

Looking at the investors’ profile, Dr Veerinderjeet stressed that the Islamic REIT in Malaysia is largely subscribed by domestic institutional investors and there are only a few foreign investors. Baljeet explained the logic behind this phenomenon. “Currently, GCC investors are enjoying 35% IRR (internal rate of return) on their real estate investment. If we look at Malaysia’s REIT, the return is only 7.5% and Singapore’s REIT pays about 12%. That’s why there aren’t a lot of GCC investors in these papers. They prefer direct investments in KLCC (Kuala Lumpur City Center) real estate, for example. They prefer to invest in tangible asset rather than paper asset. In addition, since there is no REIT in the Middle East, investors are also not familiar with these types of investments,” she disclosed.

Dr Veerinderjeet then noted that Malaysia could still improve its return on REITs via a revision of the tax structure. “Although a REIT is tax exempt if it distributes 90% of its income, foreign investors who receive this distribution would still be subject to withholding tax — 15% for individuals, 20% for institutional investors and 27% for companies. Singapore, in comparison, only charges a 10% withholding tax on institutional investors while individuals are exempted. Therefore, we need to change the withholding tax regime in Malaysia to make REITs more attractive to foreign investors,” he concluded.