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.

ISLAM AND CREDIT CARDS

It is often the case that the battle between Islamic and conventional credit cards is on product features. The impact of the competition in this lead the consumer’s preference to ask:

• Which one offers more value for money?
• Which one offers low penalty rate?
• Which one offers free bonus points more?
• Which one looks fancier?
• Which one gives annual fee waiver?

However one should ask, are these the selling point for Islamic credit card? It is sad to see that many marketing strategies for Islamic credit cards talked about product features rather than selling the ethical values and concept underneath to the consumers. The equation that always in the mind of consumer about Islamic financial product is cheap. Meaning to say that, in any Islamic debt-financing facilities, the rate of return to the financier should be at the lowest point of the profitability quadrant. Why such discrimination exists?

Islam permits the use of credit card so long it does not involve the element of usury. As an example if the withdrawing cash advance from the credit facility will result payment of an interest, it is prohibited. Similarly if there is an additional interest charge due to delay in payment, it is prohibited also. Therefore, if the credit card serves as a charge card, where you only pay the principle amount that you use plus the service charges, it is permitted.

In credit card transaction, the doctrine of Bai Al-Inah is used to validate the transaction. The argument of validity of bai al Inah is debated between Muslim The doctrine of bai al-Inah or buy back sale is not recognized by some scholars including the Ulama from the Middle-East. But in Malaysia, the doctrine of Bai Al-Inah is recognized, and is used as one of the basis to justify the implementation of credit card under the Shariah discipline.

In the context of Bai Al Inah, the use of doctrine Al Masalih Al Mursalah is adopted in order to justify the using of such transaction in the credit cards or personal financing. In the new era of globalization, many financial dealings were not exactly the same to the practice in time of Prophet (s.a.w.). Innovation of financial products was evolved due to the changes in the technology and time. People try to innovate a new thing that can make life better off. This is not only goods and service innovation but to the financial products as well. The idea was to ensure a comfortable life, which is also a wish of Allah (s.w.t.) as evident in the following ayat (Al-Baqarah 2 :185) :

“ Allah (s.w.t.) intends every facility for you; He does not want to put you to difficulties.”

The used of Masalih Al Mursalah can be applied in the credit card transaction, since Allah (s.w.t) want us to have easiness in the life but off course to be harmonized with the Quran and Sunnah so it will not deviate from the Shariah teaching.

In the credit card transaction among the advantages of using it is convenience to the buyer, security wise, and cost effective are considered to benefits the user in terms of giving a comfortable life. Although the usage of credit cards is unlimited especially in the digital world, issues surrounding the applications of credit cards need to be addressed so that the acceptance among Muslims can be improved.

RISK MANAGEMENT IN ISLAMIC FINANCIAL INSTITUTIONS

Risk management is at the heart of banks' financial intermediation process, and has assumed utmost importance at a time when complexity and volatility in financial markets have become both differentiating factors building competitive advantages and sources of risk entanglement. Basel II and widespread write-downs have highlighted the importance of sufficient capital adequacy and, more importantly, set a framework for improving the overall risk management architecture in banks.

Compared to conventional financial institutions, Islamic financial institutions face many challenges in adequately defining, identifying, measuring, selecting, pricing and mitigating risks across business lines and asset classes.

Risk issues at Islamic financial institutions include:

a) The range of asset classes found in Islamic banks;
b) The relatively weak position of investment account holders;
c) The importance of the Shariah supervisory board and the bank's ability to provide the board with adequate information as well as abide by its rulings;
d) Rate-of-return risk;
e) New operational risks.

Islamic finance is a growing subset of the global financial system, and is increasingly becoming a mainstream industry. Notwithstanding a series of specific features that somewhat distinguish IFIs from a number of their conventional peers, the building blocks are very similar for every banking institution. If fully adhering to the core principles of financial Islam, Sukuk in particular should really be equity based, as should risk-sharing securities. Indeed, venture capital and equity are the most common, and the most Halal forms of ethical finance, as all parties share risk and reward.

However, for the majority of existing institutional financing, in the form of Sukuk, investors ask for, and indeed receive, debt securities. Equity is expensive, hence the structural engineering of asset-backed, risk-sharing securities. Securitization is the debt structure that best satisfies the underlying profit-sharing principles of Shariah compliant investment.

In a large number of contracts, risk categories of a different nature are entangled. For example, in an Ijarah contract, the IFI buys an asset that is subsequently leased or rented to a customer against periodic rental payments.The management of leased assets' residual value is a feature that differs materially from credit risk management and assumes access to robust and reliable market data as to asset-price volatility and behaviour across economic cycles and business conditions, all the more so as IFIs tend to run a portfolio of asset inventories that they buy and then sell or lease.

Inventory management is another aspect that separates IFIs, from a risk management perspective, from their conventional peers, and similar issues arise when it comes to diminishing Musharaka contracts. Should the customer default, said the report, the IFI's share in the financed asset would be used as collateral, the value of which might be volatile and naturally subject to scrutiny and management independently from the customer's perceived creditworthiness. Diminishing Musharaka contracts are increasingly used as a financing mechanism for Shariah compliant home purchase, particularly in Dubai.

Similarly, in Istisna'a contracts, IFIs are deemed to remain the beneficial owners of financed assets until the borrowing company pays back the final installment under the Istisna'a agreement. In the case where the borrower defaults before the Istisna'a maturity, the IFI is entitled to dispose of the financed assets, which are generally illiquid because they are specific to the nature of the plant, the industry or the enterprise to which the IFI's funds were initially allocated. In the case of default, the IFI, more than any conventional bank, becomes a merchant, behaving in the field of commerce rather than in that of pure financial intermediation.

This puts additional pressure on IFIs to equip themselves with the correct technical and professional expertise for both credit assessment and the management of underlying asset valuation, trading and liquidity, should loan foreclosure and collateral realisation occur.

In short, IFIs naturally have a high level of collateralization on their credit portfolios, and thus are in a position somewhat to reduce their economic, if not regulatory, exposures at default.

Therefore, IFIs should be in a better position to manage their credit portfolios in terms of sector diversification. Sector diversification is all the more important from a capital perspective as Islamic banks usually face concentration risks by name and geography, and are also skewed heavily towards real estate financing and investment, further weighing on the quality of their assets, and thus on their credit ratings.