A lesson in islamic real estate financing

Malaysian Business, Feb 1, 2008

INVESTING in the Pavilion Kuala Lumpur - Klang Valley's latest shopping mall - has turned out to be a successful venture for Kuwait Finance House (Malaysia) Bhd (KFHMB). Subsequent to this landmark investment by a Middle-Eastern bank in Malaysia's real estate sector, KFHMB has structured a number of real estate deals in the country.

Located at Jalan Bukit Bintang, the Pavilion Kuala Lumpur consists of two apartment towers, a seven-storey retail complex, a 19-storey office tower and a six-star hotel. The retail complex was opened to the public on September 20 last year.

In the case of the Pavilion, a real estate fund provided Mudharabah capital to the Mudharib (entrepreneur), i.e. Company 1 to co-invest in the retail mall portion of the project with Company 2. In a separate arrangement, KFHMB entered into a Musyarakah agreement with the fund to underwrite the sale of the two condominium blocks and the developer was paid according to progress of project during construction. The condominiums are then sold for capital gain.

The Oval, Lorong Kuda, Kuala Lumpur Golden Triangle

The Oval consists of two 41-storey towers comprising 140 units of condominiums and located within walking distance of KLCC. It is currently under construction and is expected to be completed in 2010.

The financing structure for the project involved Mudharabah funding/contracts. KFHMB and a group of investors, collectively known as Rabb al Mal entered into Mudharabah contract separately with the special purpose vehicle (SPV) as the Mudharib. The Mudharib will then enter into a master underwriting agreement with the developer. If there are no buyers for the units, KFHMB and the financiers will still be obligated to pay progress payments to the developer. The Mudharib will then sell the apartments to end buyers and the profit will be shared between the Rab al Mal and Mudharib based on an agreed profit sharing ratio.

Sunway South Quay, Bandar Sunway, Selangor

Sunway South Quay is a 71.2-hectare exclusive gated community development within a lakefront neighbourhood. It comprises luxury lakeside bungalows, high-end condominiums, serviced apartments, lakeside boutique shops and office suites.

The financing structure for the project is the Musyarakah structure where KFHMB participate in equity stake and provide musyarakah capital to the developer for the development of the project. There is Board representation in the development company to monitor the project development.

Avare, Lorong Kuda, KL Golden Triangle

The Avare is an exclusive 41-storey condominium tower consisting of 78 high-end condominiums, within walking distance of KLCC.

The financing structure for the project is the Musyarakah structure where KFHMB purchase goods on customers behalf against undertaking to buy goods from KFHMB. The bank then immediately sell the goods to customers at a deferred sale price, payable on the basis of deferred payment at the end or during the agreed Murabahah period. The Murabahah agreement is to part finance purchase of land, general working capital, part finance construction cost and capital expenditure.

Islamic REITs

In general, Islamic REITs (Real Estate Investment Trusts) are similar to other conventional REITs, that is, it is a collective investment scheme in real estate. REITs are capital market vehicles for owning real estate and deriving income. They give investment and tax advantage over direct investment in real estate.

Islamic REIT is similar to the concept of Mudharabah, whereby the investors enter into a business venture with the entrepreneur, known as the Mudarib. The entrepreneur contributes his effort and expertise in the business venture (viewed as a form of capital) while the investor provides financial capital for investment.

The purchase of units by a unit holder in the REIT is similar to a financial investment made in a Mudharabah scheme by the investor, whereby the funds are provided to the entrepreneur /management company so that it can invest in real property assets to generate income for the REIT/Mudharabah scheme. Islamic REITs may have investors who are the unit holders, but such Islamic REITs do not have `entrepreneurs' because the party/parties managing the fund will receive a fee for their effort and expertise in relation to the management of such fund.

Islamic REIT may also be compared with the concept of Musyarakah, whereby arrangements involve persons pooling their resources to embark on a business venture where profits and losses are shared between the parties involved on an agreed ratio. Mudharabah splits the functions between the manager and the provider of funds. The manager only manages the business venture and cannot provide capital to the Mudharabah but there is no such division of functions in a Musyarakah.

Any financial loss in a Mudharabah venture is borne by the fund provider, not the entrepreneur. In contrast, all parties in a Musyarakah arrangement will bear the financial loss in accordance with their agreed ratio. Islamic REIT is different from a Musyarakah arrangement, in that the unit holders cannot participate in the management of the business venture/fund.