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The development of Islamic capital market products has been highly innovative in Malaysia. This is vital in order to ensure that the country’s Islamic capital market adapts to and takes advantage of the ever-changing international environment. Malaysian Islamic equity markets, for example, have pioneered various innovative Shariah compliant products over the past few years. Of significance is the introduction of the first Islamic real estate investment trusts (REITs).
Combining real estate and trust funds
REITs are collective investment vehicles (typically in the form of trust funds) that pool money from investors to buy, manage and sell real estate. The objective is to obtain reasonable returns on investment. Returns are generated from rental income plus any capital appreciation that comes from holding the real estate assets over an investment
period. Unit holders receive their returns in the form of dividends or distribution and capital gains for the holding period.
REITs, in general, combine the best features of real estate and trust funds, and sits between bonds and equities. There are basically listed and non-listed REITs. While the former may be bought and sold through a stockbroker like listed stocks, the latter, on the other hand, may be bought from and sold to the management company or through other authorized agents. REITs, particularly the listed ones, are liquid assets and can be sold fairly quickly to raise cash and take advantage of other investment opportunities. By buying a unit of REIT, the holder actually owns a fraction of a pool of real estate that generates income via renting, leasing and selling the said property. As an added bonus, REITs provide a platform for international investors to invest in a particular country’s real property without the hassle and responsibilities associated with direct ownership of such assets.
Islamic REITs
The Securities Commission of Malaysia released the Guidelines for Islamic Real Estate Trusts (Islamic REITs Guidelines) in November 2005, making the country the first jurisdiction to introduce such guidelines in the global Islamic finance sector and set a global benchmark for the
development of Islamic REITs. The thrust of the Islamic REITs Guidelines is to provide a new investment opportunity for those who wish to invest in real estate through Shariah compliant capital market instruments. The guidelines facilitate the creation of a new asset class for investors and allow fund managers to further diversify their investment sources and portfolios.
Following the issuance of the Islamic REITs Guidelines, KPJ Healthcare became the first Malaysian company to establish and launch Islamic REITs. KPJ Healthcare identified seven hospitals within the group as its main asset class for the establishment of the REITs. In February 2007, Al-Hadharah Boustead REIT became the second Islamic REIT listed on Bursa Malaysia and the first Islamic plantation REIT to provide an opportunity for investors to participate in plantation ownership.
The Islamic REITs Guidelines complement existing guidelines on REITs, with the latter providing general rules on all aspects of investments in REITs and the former acting as a guide on Shariah compliance in structuring and managing investments of Islamic REITs.
As required under the Islamic REITs Guidelines, market players must appoint a Shariah committee/adviser to review, monitor and approve investments by Islamic REITs. The main criteria covered include rental of real estate for business purposes, investment, deposit and financing, Takaful schemes and forward sales or purchases of currency for risk management.
Rental of real estate is permissible, except where the property is used for non-permissible activities such as financial services based on riba (interest), gambling/gaming, conventional insurance, entertainment activities that are forbidden by Shariah law, manufacturing or sale of tobacco-based products or related products, stockbroking or share trading in non Shariah compliant securities, and hotels and resorts.
Apart from the activities listed above, the Shariah committee adviser can apply Ijtihad (the process of making a legal decision by independent interpretation of the sources of the law, the Quran and the Sunna) for other non-permissible activities to be included as a criterion in assessing the rental income for Islamic REITs. The benchmark for non permissible activities is set at 20% of total turnover of the Islamic REIT.
To further promote Malaysia as an Islamic financial center, the government has provided several tax incentives for foreign investors. Withholding tax on dividends received was reduced from 20% to 10% and a REIT is fully exempted from paying income tax on taxable income if it distributes at least 90% of income to investors. Encouraged by this development, foreign investors are beginning to actively seek Shariah compliant financial instruments as an opportunity to invest in Malaysia’s real property market.
As an added attraction, the government recently proposed in Budget 2008 to allow foreign investors to increase their equity ownership in a REIT management company up to 70% (previously 49%). With this measure, the Malaysian REIT industry, including Islamic REITs, is expected to gain through the transfer of knowledge and expertise, as higher foreign ownership will enhance the level of REIT management expertise. Over time, such a move will benefit the REIT industry, not only through the injection of fresh capital and innovative methods, but also through the development of the industry’s broad skills base and the introduction of new technology.
The emergence of greater competition through enhanced foreign participation will therefore bolster activity and efficiency within the industry. Higher foreign ownership will allow foreign corporations with REIT management expertise to set up operations with a higher degree of control in Malaysia.
Opportunities
Being tangible in nature, real estate remains the preferred asset class among discerning Muslim investors and institutions. Affluent and savvy Arab investors are increasingly seeking viable investments using Islamic financing structures to satisfy their investment objectives. In this regard, Islamic real estate investment fits the bill perfectly as real estate can provide such investors with selected projects that yield good returns and a stable income. The increasing demand for Shariah compliant real estate investment is reflected by the global rise in the number of Islamic REITs, mainly in the Middle East, and other parts of Asia.
In addition to the boom in the real estate sector in the Gulf Cooperation Council (GCC) countries, there is a growing interest to channel the petrodollars towards opportunities in the Far East. Already, GCC investors are eyeing Asian countries such as India, China and Malaysia for infrastructure and property investments. Asian countries also welcome Arab funds that had deflected from the US following 9/11.
Malaysia, for example, has reaped the benefits from its efforts to attract Middle Eastern investments. In August 2007, the Iskandar Development Region (IDR) in Johor secured more than RM4.1 billion (US$$1.1 billion) in initial investments from a consortium of four reputable Middle East companies. This groundbreaking investment is the single largest foreign real estate development in Malaysia, one of the largest real estate developments in the region and one of the largest single foreign investments ever in Malaysia. It is hoped that the consortium’s investment debut in Malaysia will entice further investments from the Gulf and stimulate local economic activities. Following the developments in the real estate sector in the Middle East and Asian region, it is envisioned that there will be further growth opportunities for Islamic REITs.
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