INTRODUCTION ON REIT & I-REIT

My colleague and I are in the midst of doing our project on Islamic Real Estate Investment Trust (I-REIT) and feel that we could share the basic of REIT and I-REIT to all – for better understanding and reading pleasure ….

REIT

REIT is an investment trust which is collectively pooled from investors and is used to invest in real estate only. The investment is normally in the form of buying, managing, selling and leasing real estate or purchasing shares in public listed real estate companies or investing in debt securities or real estate companies. The Securities Commission of Malaysia defines REIT as “an investment vehicle that proposes to invest at least 50% of its total assets in real estate, whether through direct ownership or through a single purpose company whose principal asset comprise real asset”. However, different countries adopt a different approach in determining the requirement for a REIT especially with regards to ratio of investing in real estate, e.g., the main requirement for a REIT in the US is that it must invest at least 75% of company's total assets in real estate.

The objective of REITs 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.

As an investment, REIT combines the best features or real estate and stocks. It gives investors and practical and effective means to include professionally managed real estate in a diversified investment portfolio. 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.

I-REIT

Generally, an I-REIT is an investment vehicle that invests primarily in:

(a) income-producing Shariah-compliant real estate, and/or;

(b) single purpose companies which are Shariah compliant whose principal assets comprise Shariah compliant real estate

I-REITs provide a new investment opportunity for investors who wish to invest in real estate through Shariah compliant capital market instruments. An I-REIT is an effective means of gaining investment exposure to large Shariah-compliant commercial properties. Investments in I-REITs provide opportunities to hold stakes in high-grade Shariah-compliant real estate which may otherwise have been difficult or impossible for a retail investor to hold

In line with Malaysia’s Capital Market Master plan to promote the country as an international Islamic financial centre, guidelines for I-REITs were released by the Shariah Advisory Council (SAC) of the Securities Commission of Malaysia. In November 2005, Malaysia became the first jurisdiction to introduce such guidelines in the global Islamic finance sector and in the process, set a global benchmark for the development of such REIT. The thrust of the I-REITs Guidelines is to provide a new investment opportunity for those who wish to invest in real estate through Shariah compliant capital market instruments and to facilitate the creation of a new asset class for investors and allow fund managers to further diversify their investment sources and portfolios.

ISLAMIC BANKING

Like their interest-based counterparts, Islamic banks have been badly affected by the global economic crunch which has already caused the property markets in the GCC. It was only in July 2008 that Moody's Investor Service foresaw a golden era for Islamic banking. It then "conservatively" estimated the global potential of the Islamic banking market at US $4,000 billion, compared to US$700 billion at the time - most of it in the GCC region. With such potential, Moody's then said, it had become clearer why governments, eager to please their Muslim populace, were encouraging more Islamic banks to start up and expand outside domestic markets.

Yet the Islamic banking industry brings with it a new set of risks for managers to handle. These institutions are hamstrung by the lack of a viable Islamic inter-bank market. While deposits may be redeemed immediately, Islamic bank assets are usually backed by real estate, and are therefore illiquid. This forces Islamic banks to hold more cash or liquid asset than conventional peers to pare illiquidity risks.

High oil prices were the main factor to the growth of Islamic banking in recent years. It was said in mid-2008 that Islamic banks with hefty balance sheets were not only to gain more retail customers through extensive branch networks, which were often capped in the GCC region for international banks such as Standard Chartered and HSBC, but also were to capture a larger slice of the vast infrastructure finance projects then planned in the region.

Islamic banks are less vulnerable to the effects of the financial crisis because:

* The Islamic banking sector is relatively small and young
* Islamic banks do not make use of the inter-bank money market (frozen because of mistrust between banks)
* Islamic banks have no money invested in uncovered loans and financial derivatives.

Islamic banks enjoy a built-in stabilizer to help them cope with economic downturns, as instead of paying interest to depositors, those with investment mudaraba accounts share in the banks profits. Thus, if profitability declines in an economic downturn, depositors receive lower returns, but if profits rise they enjoy higher returns.

This profit sharing reduces risk for the banks and means they are less likely to become insolvent. However as the banks build up a profit equalization reserve, which can be used to finance pay-outs during difficult years, depositors benefit from some protection of their returns during economic downturns.

The last year has been difficult, if not disastrous, for equity investors, given the fall in stock market prices globally. Investors in equities screened for shariah compliance have also suffered, but less than their conventional counterparts, because they have not invested in the shares of riba-based banks which have fared especially badly during the global financial turmoil. Investors seeking Shariah compliance have portfolios which are more heavily weighted in sectors such as healthcare or utilities where revenue streams are maintained even during cyclical down-turns

Islamic banks, many of which are investment houses, have been heavily exposed to the real estate market, which saw prices start to plummet at the end of last year. They channeled the wealth accumulated during the six year oil boom that ended in mid-2008 into regional real estate through private equity and asset management. The global liquidity constraints will force Islamic banks to look for new customers and sources of funding, including moving into corporate banking, trade finance and retail banking.