Real Estate Financing and Sukuk Dubai Islamic Bank PJSC

Real Estate Financing and Sukuk Dubai Islamic Bank PJSC
Mian Muhammad Nazir Senior Vice President Dubai Islamic Bank PJSC 1

Real Estate Financing and Sukuk
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 2

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. 3

Commonly Used Modes Murabaha (ready property) 4

Real Estate Financing and Sukuk (Only in case of ready property)
Murabaha (Only in case of ready property) Step by Step Customer Islamic Bank Step 1 Promise to Purchase Step 3 Purchase of Property through purchase agreement Step 4 Purchase Price Title & Possession to the Property Step 6 Sale Price Deferred Step 5 Sale of Property to Customer on Murabaha basis Title and Possession to the Property Step 2 Purchase Offer Owner/Developer 5

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. 6

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. 7

Ijara ready property 8

Purchase and Ijara ready property Step by Step Customer Islamic Bank Step 1 Promise to lease Step 3 Acquisition of the Property through purchase agreement Step 4 Purchase Price Title & Possession to the Property Step 6 Lease Rental Step 5 Lease of the Property to the customer through Lease Agreement Usufruct of the Property Step 2 Purchase Offer Owner / Developer 9

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. 10

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. 11

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 12

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 13

Real Estate Financing and Sukuk under construction property
Forward Ijara under construction property 14

Real Estate Financing and Sukuk for under construction property
Forward Ijara for under construction property Step by Step Customer Islamic Bank Step 1 Promise to Lease on Forward Ijara basis Step 3 Purchase of the described Property through Istisna Agreement Step 4 Istisna Purchase Price Delivery of the described Property after completion Step 6 Lease Rental Step 5 Lease of Property on the basis of Delivery of Leased Property to Customer at completion Step 2 Purchase Offer Owner / Developer 15

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. 16

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) 17

Real Estate Financing and Sukuk under construction property
Istisna under construction property 18

Real Estate Financing and Sukuk for under construction property
Istisna for under construction property Step by Step Customer Islamic Bank Step 1 Promise to Purchase on Parallel Istisna basis Step 3 Purchase of the described Property through Istisna Agreement Step 4 Istisna Purchase Price Delivery of the described Property after completion Step 6 Purchase Price Step 5 Sale of the described Property on Parallel Istisna basis Delivery to the Customer after at completion Step 2 Purchase Offer Owner / Developer 19

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. 20

Mudaraba 21

Mudaraba Step by Step Islamic Bank (Rab Al Mal) Developer (Mudarib) Step 1 Business Plan Step 3 Joint Capital (after commingling of Mudaraba Capital with Net Assets Of Mudarib if any) Step 6 Mudaraba Capital Mudaraba Agreement Project Net Profit Mudarib Profit Mudaraba Profit Mudarib’s Share Rab al Mal’s 22

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. 23

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. 24

Agency 25

Agency Step by Step Islamic Bank (Principal) Developer (Agent) Step 1 Investment Plan Step 3 Investment Amount Step 6 Amount Agency Agreement Project Profit Incentive Agency Fee 26

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. 27

Musharaka 28

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 29

Musharaka Mutanaqisa Step by Step Contribution Cash Islamic Bank Project Musharaka Entity Customer / Developer Investment Profit + Incentive Purchase Undertaking Musharaka Agreement Purchase of Units in Musharaka Cash + Kind 30

Musharaka – Bank leases its share in Musharaka to the Customer Step by Step Contribution Cash Islamic Bank Project Musharaka Entity Customer / Developer Investment Profit + Incentive Lease Rental Musharaka Agreement Lease of Bank’s Share Cash + Kind 31

Musharaka – Sharikatul Milk (Ready Property) Step by Step Islamic Bank Ready Property Customer / Developer Purchase Price Lease Rental Purchase Undertaking Musharaka Agreement Periodic Purchase of Undivided Share Contribution Cash 32

Sukuk (Islamic Bonds) 33

Sukuk (Islamic Bonds) 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. 34

Sukuk (Islamic Bonds) Global Sukuk issuance reaches $109 billion. Indicating impressive growth in MENA region. MENA Bond issuance Sukuk vs. Conventional Bonds Global Local Currency and Dollar Sukuk Issued by Country (2007) 35

Sukuk (Islamic Bonds) 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 36

Sukuk (Islamic Bonds) 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. 37

Sukuk (Islamic Bonds) 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. 38

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. 39

Thank You 40

Real Estate Financing and Sukuk Dubai Islamic Bank PJSC

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