structuring islamic reit part 2 - nov 2008

8/8/2019 Structuring Islamic REIT Part 2 - NOV 2008

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Understanding and Structuring aShariah Compliant Real Estate

Financial Product (Part II)

Prof Dr. Mohd Azmi [email protected]

Pre-conference workshop A, Sunday 9 Nov 2008,Dubai

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Meaning of REITs Real Estate Investment Trusts (REITs) An investment trust in which fund is collectively

pooled from investors (individuals andcompanies) and is used to invest in real estate.The investment is normally in the form of buying,managing, selling and leasing real estates or

purchasing shares in public listed real propertycompanies or investing in debt securities in realproperty companies (adapted fromwww.azmilaw.com)

Real estate investment trust or property trustfund means unit trust scheme that invests orproposes to invest primarily in income-generating

real estate (Securities Commission Malaysia,Guidelines on REITs, updated Aug 2008)Pre-conference workshop A, Sunday 9 Nov 2008, Dubai

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REITs as property investment

vehicle REITs are typically listed and quoted in

many stock exchanges. For example inMalaysia there are 2 Shariah compliantREITs and 11 conventional REITs listed in

Kuala Lumpur Stock Exchange (BursaMalaysia) with market capitalization of

US$1.53bil. In Singapore there are 21 conventional

REITs listed in Stock Exchange of

Singapore with market capitalization ofUS$20bil A rea, 2008

Pre-conference workshop A, Sunday 9 Nov 2008, Dubai4


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Types of REITs

Equity REITs

Own and operate income producing realestate Office

Hospital Apartment

Retail (shopping centres)

Hotels May perform development, construction and

leasing activities

Most common type of REITsPre-conference workshop A, Sunday 9 Nov 2008, Dubai

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Mortgage REITs

Lend money to real estate owners andoperators of existing property

May also buy mortgages

Hybrid REITs

Both own properties and give loans to real

estate owners



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Investing in REITswhy are REITs attractive to investors?

Incomestability

Quality real

estate

Capital stability

& growth

Liquidity

& valuation

REITs is typically distribute >90% of net cash flow

Income is underpinned by legally enforceable lease agreements

Low leverage

Little or no development risk

REIT unit price is much lower than those of general equities

Long-term unit price capital growth potential is driven by increase in

rental earnings and also by capital appreciation of the underlyingproperties

Provide institutional investors with an alternative to direct real estate

investment with increased flexibility

Provide retail investors with an opportunity to invest in high-value

institutional quality real estates assets that would otherwise not bepossible

Packaging illiquid real estate into liquid listed securities that offer

diversification, transparency, expert management and regular research

coverage

Institutions receive daily mark to market

value of their investment

Low transaction costs in buying/selling REIT units vs trading

underlying assets

Individuals can redeem

small investment quickly by selling the units

in the open market and with little cost

REITs allow institutional funds to make incremental investments inlumpy real estate as and when new investment funds are received

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Investing in REITs. (contd)

Expert

Management

Diversification

Defensive

Diversification by types of properties, tenants and locations

Benefit from experienced, professional real estate managers

Additional scrutiny by the trustee

Consistent yield-based investment has defensive asset class

characteristics

Income-generating investment grade property is a safe haven

during

uncertain times

Transparency

Subject to stringent corporate governance and disclosure

requirements

Government regulates on payout ratios, gearing, allowable investment,

etc.

Source: JPMorgan, 2005

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Meaning of Shariah compliant

REITs There is no universal definition although all

definitions have to comply with therequirements of the Shariah

Definition used by Securities Commission

Malaysia (Guidelines for Shariah compliantREITs, November 2005)

A Shariah compliant REIT is a collective

investment scheme in real estate, in whichtenants operate permissible activitiesaccording to the Shariah



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Shariah compliant REITs can be listed or

unlisted Examples of listed Shariah compliant

REITs are Al-Aqar KPJ REIT and Al-Hadharah Boustead REIT (both inMalaysia) whilst unlisted Shariah

compliant REITs , also known as Shariahcompliant real estate funds, are shown in

the following two slidesPre-conference workshop A, Sunday 9 Nov 2008, Dubai

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FundManager /Distributor

Name ofFund

Country Size(USDm)

Type Investor Advisor Description

GuidanceFinancial

Group

GuidanceFixed

Income Fund

USA 200 Residential Freddie Mac

real estate finance assets. The securities

will be issued and guaranteed by theFederal Home Loan MortgageCorporation (Freddie Mac). The fund willhold securities that are backed byShariah-compliant

Shamil Bank China RealtyFund

China 150 Commercial CITIC InternationalAssetsManagement Co.Ltd. (CITICIAM)

Shamil Bank Bahrain entered intoan MoU with prominent Chinesefinancial institutions, CITICIAM toset up and launch USD150m

closed-end China Realty Fund.

Shariah Compliant Real Estate Funds


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Fund Manager

/ Distributor

Name of

Fund

Country Size

(USDm)

Type Investor Advisor Description

Kuwait FinanceHouse

Baitak AsiaReal EstateFund

South Asia 600 Commercial,Residential

Pacific Star Group A USD600m Shariah compliantreal estate fund. The Baitak AsiaReal Estate Fund will invest in

residential and commercial sitesin Asian countries. This will bethe first real estate deal in Asiafor Kuwait Finance House.

Kuwait FinanceHouse

ShariahcompliantEuropean

Real EstateFund

Europe 486 Commercial,Residential

Equity Estates BV The fund intends to invest Euro400m in European propertyconcentrating on high yielding

office, logistics and light industrialproperties in the Benelux, Franceand Germany.

Dubai Shariahcompliant Bank

(DIB); CheungKong Group

Al Shariahcompliant Far

Eastern RealEstate Fund

Far East 450 Commercial,Retail,

Residential

ARA AssetManagement

The new fund will be managed byARA Asset Management and

jointly promoted by DIB andCheung Kong Group. TheShariah compliant-compliantinvestment vehicle has set asideUSD450m to invest incommercial, retail and residentialprojects in major Asian cities.

Shariah Compliant Real Estate Funds


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Shariah compliant REITS: Basic

Issues Objective

Structure Regulatory Regime

Sources of income

Permissible investment

Purification of income

Investors Comparison with Alternative Investment

Fees and Charges

Performance Indicators15


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Objective of Shariah Compliant

REITS To provide unit holders with a stable

distributions per unit with the potential forsustainable long-term growth of suchdistributions.

How? By optimizing the performance and enhancingthe overall quality of a large and geographically

diversified portfolio of Shariah-Compliant realestate assets through various permissibleinvestments and business strategies.

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Shariah Compliant REITs and

Real Estate Funds Model 1:

Management of fund: Wakalah Acquisition of property: Murabaha or Ijarah or

Musharakah Mutanaqisah

Relationship with tenants: Ijarah

Model 2:

Management of fund: Mudarabah Acquisition of property: Murabaha or Ijarah or

Musharakah Mutanaqisah

Relationship with tenants: Ijarah17


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Mudarabah structure

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Propertymanager

FundManage

r

Lessee

MUDARIB

RABB-UL MALor his contracted representative

Assetmanagement

Fundmanagement

Partnership

RABB-UL MAL

Investors

EquityDividends

Fund

Seller

Assets

Financier/SPV

Ijarah orMurabahah

Ijarah$

Source: adapted from Thomas, 2005


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Murabahah structure

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Vendor

RealEstate

Bank

IslamicInvestors

Fund/InvestmentCompany

InvestmentSubsidiary


Occupyingtenants

Investmentsubsidiary

sale

Purchaseprice

Legaltitle

sale

Purchase price+ mark up

Legal title: onor off shore sub

$Ijarah


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Ijarah Structure

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Vendor/bank

RealEstate

Finco

IslamicInvestors

Fund/InvestmentCompany

InvestmentSubsidiary


Occupyingtenants

Sale of Ijarah

assets

Purchaseprice

Legaltitle

RedeemableIjarah/Ijarah MuntahiaBittamllek

Rent

$Ijarah


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Shariah compliant REITS

Tripartite agreement between three parties:

The Manager

The Trustee

Unitholders

Tripartite relationship is governed by a Deed

registered with the Regulator (e.g SecuritiesCommission Malaysia)

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DEED A Deed is a legal instrument used to grant a

right.

The trust deed is a legally binding agreementbetween the manager, trustee and unit holders.The agreement usually spells out clearly howthe unit trust scheme is to be administered. The

contents usually include:- Valuing and the pricing of units; Keeping of proper accounts and records;

Collection and distribution of income; Rights of unit holders; Duties and responsibilities of the manager; Duties and responsibilities of the trustees; and Protection of unit holders interest.

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http://en.wikipedia.org/wiki/Righthttp://en.wikipedia.org/wiki/Righthttp://en.wikipedia.org/wiki/Legal_instrumenthttp://en.wikipedia.org/wiki/Granthttp://en.wikipedia.org/wiki/Righthttp://en.wikipedia.org/wiki/Righthttp://en.wikipedia.org/wiki/Granthttp://en.wikipedia.org/wiki/Legal_instrument


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Shariah Aspects

Shariah compliant REITS (I-

REITs)

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ShariahGuidelines on

I-REITs

Rental from tenantWho operates mixed

activites

Rental is free fromNon-permissible

activities

How incomes fromI-REIT are earned?

How the funds aremanaged?

Methods of calculatingthe ratio of rental of

Non-permissible activities

Instruments used inInvesting, deposit andFinancing for I-REITs

Takaful Coverage

Risk Management Issues

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Establish Shariah guidelines for fund manager

Monitor fund operations so as to ensure Shariah

compliance (usually done in quarterly reviews)

Make updates to Shariah guidelines as and

when necessary Devise capital gain and dividend cleansing

procedures if mandated by the fund

Provide comfort to investors that theirinvestments are managed in compliance toShariah

Roles of the Shariah Advisor:


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Requirements Of Shariah-compliant Real

Estate Investment1. PERMISSIBLE ACTIVITIES must ensure that the property is used for halal or permissible

activities.

Non-permissible activities include: financial services based on interest (riba); gambling/gaming; manufacture or sale of non-halal products or related

products; conventional insurance; entertainment activities that are non-permissible according

to the Shariah; manufacture or sale of tobacco-based products;

stockbroking or share trading in Shariah non-compliantsecurities;

and hotels and resorts. Shariah committee or advisors are allowed to use their own

discretion based on ijtihad to determine other activities that aredeemed non-permissible


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Characteristics Of Shariah-compliant Real

Estate Investment2. ACQUIRING REAL ESTATE WITH EXISTING TENANTWHO OPERATES MIXED ACTIVITIES one whose core activities are permitted by Shariah, & other

activities that may contain a small extent of prohibited elements, Shariah advisors must perform compliance assessment with

additional consideration.

Rental from non-permissible activities must not exceed 20% of

total turnover of the Islamic REIT Shariah advisors shall advise the Islamic REIT fund manager:

not to invest in the real estate involving non-permissibleactivities that clearly exceed the benchmark.

not permitted to own real estate, in which all tenants operatenon-permissible activities, even if the percentage of rental isstill below the benchmark (20%). This is to protect the imageof the Islamic REIT

hariah compliant Benchmark : [Area used


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hariah compliant Benchmark : [Area usedfor Non Shariah Compliance/Total Area] ratio

and [Sales from Non Shariah compliant/TotalSales].

sales $10m

sales$2m

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Estate Investment3. RENTING OUT REAL ESTATE TO A NEW TENANTS

The Shariah advisor must advise the Islamic REIT fundmanager not to accept a new tenant(s) whose activities are fullynon-permissible.

Shariah advisor must make sure that the Islaimic REIT fundmanager consistently supervise the activities of the tenant

If tenants activities is not obviously impermissible, the 20%

benchmark in determining the status of mixed rental incomeneed not be applied in case of renting out to a new tenant.This is because the exact rental receipt from non-permissible activities is still unknown.

In an obvious case whereby the new tenant involves in

activities which are deemed impermissible then it is notallowed for Islamic REIT fund manager to accept suchtenant.

For example, a well-known casino operator who plans torent the real estate of the Islamic REIT must not be

accepted as a new tenant


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Estate Investment4. METHOD OF CALCULATING THE RATIO OF

RENTAL OF NON-PERMISSIBLE ACTIVITIES

usage of space, hours of service and other methods deemedappropriate by the Shariah advisors using their own ijtihad.

E.g. supermarket - the rental of non-permissible activities -selling of alcohol can be based on the ratio of area occupied for

non-permissible activities to the total area occupied. E.g. if the total area rented out is 10,000 square feet and the

area allocated for the sale of alcoholic beverages is 1000square feet, then the ratio of area used for non-halal activities is10%.

Thus, the rental from non-permissible activities is 10% of thetotal rental paid by the supermarket. Rental income is deemedto be permissible as it is still within the acceptable benchmark of20% of total turnover of the Islamic REITs.


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Estate Investment5. INVESTMENT, DEPOSIT AND FINANCING FOR

ISLAMIC REIT

An Islamic REIT must also ensure that all forms of investment,deposit and financing instruments comply with the Shariahprinciples.

For example, in financing the acquisition of real estate, IslamicREIT fund manager must not engage in riba-based instrumentwhich would have an effect on the Islamicity of the IslamicREIT operation and transaction.


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Malaysian Shariah Permissible

Investments for I-REITs: Real estate physical land and all things thatare a natural part of the land as well as things

attached to the land both below and abovethe ground (50% of total assets)

Real estate-related assets - includes units of

other I-REITs , Shariah compliant securities ofproperty companies, and sukuks issued byproperty companies



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Single purpose companies private

companies whose principal assets comprisereal estate

Liquid assets Shariah compliant securities

of non property companies Asset-backed sukuks Sukuks based on

securitization transaction

Non-real estate-related assets cash, shariahcompliant deposits or other instruments

convertible into cash within 7 daysPre-conference workshop A, Sunday 9 Nov 2008, Dubai

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http://shariah%20compliant%20reits%20part%202.ppt/#64.%20Screening%20Methodology%20for%20Shari'ah-Compliant%20Stockshttp://shariah%20compliant%20reits%20part%202.ppt/#79.%20Types%20of%20Sukukhttp://shariah%20compliant%20reits%20part%202.ppt/#79.%20Types%20of%20Sukukhttp://shariah%20compliant%20reits%20part%202.ppt/#64.%20Screening%20Methodology%20for%20Shari'ah-Compliant%20Stocks


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Estate Investment6. TAKAFUL COVERAGE

The Guideline issued by the SecuritiesCommission also stipulates that an IslamicREIT must use Takaful schemes to protect

its real estate. However in case that Takaful schemes are

unable to provide the insurance coverage,then the Islamic REIT is permitted to useconventional schemes


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Estate Investment7. RISK MANAGEMENT ISSUES

Islamic REIT is permitted to participate in forward

sales or purchases of currency, and is encouragedto deal with Islamic financial institutions.

If the Islamic REIT deals with Islamic financial

institutions, then it will be bound by the concept ofwa'd(a unilateral promise where only one party isobligated to fulfil his promise or responsibility). The

party that is bound is the party that initiates thepromise.

However, if the Islamic REIT deals with conventional

financial institutions, it is permitted to participate inthe conventional forward sales or purchase of
http://shariah%20compliant%20reits%20part%202.ppt/#81.%20Islamic%20Forward%20Rate%20Agreementhttp://shariah%20compliant%20reits%20part%202.ppt/#81.%20Islamic%20Forward%20Rate%20Agreement


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Nature of work undertaken by

Management Company (Wakil) Managing the Properties effectively Maintaining net property income

Maximizing the return and performance of eachProperties and their growth via enhancement ofproperties

Raising the profile of Properties Acquiring property assets with good yield and growth

potential for both locally and abroad that meet theManagers investment criteria

Employing optimum capital structure.

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WakalahFees

Annual Management Fee

Annual Maintenance and Management Fee

Annual Trustee Fee

Shariah Committee Members Fee

Fund Expenses

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Management Expense Ratio (MER)

Management Expense (ME) = Annual management fee+ Annual management and maintenance fee + Annual

Trustee fee + Shariah fee + Fund expenses

MER = [(ME + Non-Recoverable Expenses) / (Average

Value of a REIT calculated on a daily basis)] x 100

Shariah-compliant MER? up to?

To protect investors from high loading charges byShariah compliant Reits management companies.

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WakalahModel.

Management Company (ie Wakil) does not bearpotential of loss (ie. risk) of investment.

Management Company is entrusted to invest the REITFund in return for a Fee (ujrah).

Potential loss of investment is borned by Unitholders.

Management Company receives fee payment (ie fees)eventhough Unitholders are suffering capital losses.

Nominal fees (ie absolute amount) may fall when net

asset value of REIT declined. Percentage fee remained unchanged.

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Risk-ReturnPrinciple

Juristic Principle (Al-Qawaid Fiqiah) -

Al-Ghurmu Bil Ghunmi

No Risk No Gain

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RISKS faced by Unitholders

Investment by Unitholders is based on Risk-ReturnPrinciple al-Ghornm bil Ghonm where:

1. Original investment not guaranteed

2. Income may rise or fall3. May not receive any income at all.

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Types of Risk in Shariah Compliant

REIT Organizational and Operational Risk

Risk relating to investment in real estate Risk relating to Properties

Shariah non-compliance risk Risk relating to an investments in the units

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Alternative to REIT WakalahModel

Unitholders and Management Company (MC)

Al-Mudarabah

Profit-Sharing

MC fees = portion of rental income.

Unitholders and Trustee

Wakalah

To ensure MC adheres strictly to the provisions ofthe Deed.

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Investor/Unit trust fund receives income frominvested companies in the form of dividend and

capital gain. Not all income are consideredclean. Some are derived from non halalsources such as interest income

Purification of income requires identifying theprohibited income received from investedcompanies and deducting it from the total

income prior to distribution The income net of purification is then distributed

to the investors

Purification of Income


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The prohibited income cannot be distributed toinvestors but instead donated to charities

It is also possible for the fund manager to allowdiscretion to investors in deciding the recipientcharitable organization

No consensus among Shariah scholars inimplementing purification

No standard available from AAOFFI but provides

a method to compute the prohibited income

Purification of Income


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AAOIFI: First step: Determine the proportion of

prohibited income: (Total Prohibited

Income/No. of Shares) Second step: Determine the quantum ofprohibited income: (No. of shares owned x

Proportion of prohibited income) FTSE GII recommends 5% of the dividend

received is taken out and given to charities

S&P SI provides the following formula toestimate tainted dividend

Div*(Non-permissible Revenue/Revenue)


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Case Studies of ShariahCompliant REITs in Malaysia

KPJ Al-`AQARREIT

AL-HADHARAHBOUSTED REIT

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AlAl--Aqar KPJ REITAqar KPJ REIT

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Al-Aqar KPJ REIT

First Shariah compliant REIT Established on 28 June 2006

Comprises of six hospitals building worthRM461.24m or USD$131.9m

Manager: Damansara REIT Managers Pte.

Lead adviser: AmMerchant Bank Pte. Trustee: Amanah Raya Pte. Units holdings:

KPJ : 160 million unitsInstitutional investors: 165 million unitsRetail investors: 15 million units

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Al-Aqar KPJ Islamic Reits

Oversubscribed by 4.13 times

Islamic Reits drew 5,115 non-Muslim andnon-Bumiputra investors.

Open up at RM0.99, a premium of 4.2%,or 4 sen, over its retail offer price ofRM0.95

30,810 units done at the opening bell Closed at 3.5 sen up at RM0.985

Al-Aqar REIT raised RM177.25 million

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KPJ Al-


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REIT Properties:1. Ampang Puteri Specialist

Hospital Building

2. Damansara SpecialistHospital Building

3. Johor Specialist Hospital

Building

4. Ipoh Specialist Hospital

Building

5. Puteri Specialist HospitalBuilding

6. Selangor Medical Centre

Building

Tenants

(Subsidiariesof KPJ)

Maintenance

Manager for

the properties(HealthcareTechnical

Services Sdn.

Bhd.)

Al-'AqarKPJ REIT

Trustee(Amanah RayaBerhad)

Unit Holders

Manager

(DamansaraREIT Mgmt.

Sdn. Bhd.

Investment

Dividend

Ownership ofProperty

Net PropertyIncome

Custodianship service

Trustee fees

Management services

Management fees

Rent

Rental Payment

Maintenance andManagement

Services

Maintenance andmanagement fees

Advise onShariahrelated matters

`AQARREIT

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Al-AqarKPJ REIT: Fees and Expenses

Annual management Fee

Maintenance and management fees

Annual trustee fee

Shariah Committee Members fee

Others

Auditors fees

Valuation fees

Relevant professional fees

Profit payments and expenses in respect of Islamicfinancing facility

Printing, posting, general and operating expenses for the

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Al-Aqar KPJ Islamic REIT

Worlds first Islamic REIT IPOThe worlds first Islamic real estate investment trust (I-

REIT) Al Aqar KPJ REIT IPO was launched withAmMerchant Bank appointed as the advisor, managingunderwriter and sole placement agent.

Under the IPO, a total of 340 million units were issuedand of these, KPJ Healthcare would hold 160 millionunits (47%), while 165 million units would be issued toinstitutional investors at US$0.27 (RM1) per unit and 15

million units to the public at US$0.26 (RM0.95) each.About US$49 million (RM180 million) was expected to beraised from the IPO.

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Al-Hadharah Bousted REIT

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Al-Hadharah Bousted REIT

Lauched on 15Lauched on 15thth Jan 2006Jan 2006

11stst II--REIT made up of plantation assets i.e. oil palmREIT made up of plantation assets i.e. oil palmestatesestates

Involves saleInvolves sale--lease back mechanismlease back mechanism

Acquires 8 plantation assets from Bousted GroupAcquires 8 plantation assets from Bousted Groupinvolving 8 palm oil estates and 2 palm oil mills, allinvolving 8 palm oil estates and 2 palm oil mills, alllocated in Peninsular Malaysia.located in Peninsular Malaysia.

Total purchase consideration RM472 million ( USD136Total purchase consideration RM472 million ( USD136million)million)

Tenants pay a cumulative fixed rental of RM41.3 millionTenants pay a cumulative fixed rental of RM41.3 millionper annum on a bimonthly bases for the 1per annum on a bimonthly bases for the 1stst tenancy termtenancy term

of 3 years.of 3 years.57


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REIT Properties:Oil Palm Estate and Estate

with Palm Oil Mill in 8different locations:

1. Batu Pekaka, Kedah2. Bukit Mertajam, Penang3. Malaya, Perak4. Bekoh, Johor5. Kulai Young, Johor6. Telok Sengat, Johor7. Chamek, Johor8. Lepan Kabu, Kelantan

Tenants(Subsidiaries ofBousted Group)

Plantation

Adviser(Appointed byBousted REIT

Manager).

Al-HadharahBousted REIT Trustee(CIMB TrusteeBerhad)

Unit Holders

Manager

(Bousted REITManager Sdn.

Bhd.

Investment

Dividend

Ownership ofProperty

RentalIncome

Custodianship service

Trustee fees

Management services

Management fees

Rent

Rental Payment

Monitoring ofPlantation assets

Maintenance andmanagement fees

Advise onShariahrelated matters

AL-HADHARAHBOUSTED REIT

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Bousted Al-Hadharah Islamic REITS

Vendor sells assets to SPV (Al-Hadarah

REITS). SPV leases back the assets to the Vendor.

Vendor pays fixed rentals for 30 years

Rentals passed to Unitholders as income.

Unitholders no fixed income and capital

protection.

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CONTRACTS: SPA & Ijarah

Sale and Purchase Agreement: The sale

and purchase agreements between theVendors and the Trustee, on behalf of Al-Hadharah Bousted REIT, in relation to the

sale and purchase of the Plantation Assets

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CONTRACTS

Ijarah Arrangements: The arrangements by al-Hadharah Bousted REITS

(AHBR)where the Trustee on behalf of AHBR aslandlord agrees to let the Plantation Assets to theVendors as tenants for a period of three years whichare renewable four times up to twelve years andthereafter renewable for up to an additional fifteenyears comprising five additional terms of not morethan three years each, save and except for the

tenancy of the Malay Reserved Land which are notautomatically renewable.

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Sources of Income for Al Hadharah


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Sources of Income for Al-Hadharah

Bousted REIT Investors Rental

Performance-based profit sharing Annual profit sharing of net incremental

income based on a formula pegged to crudepalm oil prices and fresh fruit bunch prices.

The profit shared (50:50) and payable in the

form of dividend to unit holders. Capital gain

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Prospects

of ShariahCompliant

REITs

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1. Enhancement of tax transparencysystem & reduction of Investors tax

2. Operates in a more transparent and wellregulated and transparent esp. with the issuance

of 2 Guidelines by Securities Commission

3. High-Quality Assets which generate a stableStream of cash flow backed by a steady portfolioof tenants.

4. Offers investors and subscribers with high yieldReturns and certainty of income.

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Enhancement of Tax Policy by


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Enhancement of Tax Policy by

Malaysian Authorities Tax Transparency (Effective from YA 2007)

REITs will be exempted from tax on all income if itdistributes at least 90% of income to investors

If distributes less than 90% of income, REIT will besubject to income tax on chargeable income at normalcorporate income tax (eg. 28%)

Implications:

Encourages REITs Manager to distribute at least 90%of income to investors.

Certainty of income to investors

Ensuring higher yields from investment65

Tax Reduction for REITs investors


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Tax Reduction for REITs investors

(Malaysia)REIT

DistributionsCurrent taxtreatment

Amended taxtreatment

Individuals &non-corporateinvestors

Resident Taxed at ownmarginal rate of tax

Withholding tax of15%

Non-Resident Withholding tax at28%

Withholding tax of15%

CorporateInvestors

Resident Taxed at normalcorporate tax rate(28% currently)

Existing taxtreatment (27%effective YA2007)

Non-Resident Withholding tax at

28%

Existing tax

treatment (27%withholding taxfrom 1.1.2007)

Institutional

Investors

Foreign Withholding tax at

28%

Withholding tax of

20%

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Conclusion


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Conclusion

Shariah compliant REITs have the potential toappeal to investors because:

Shariah-compliant investment

Higher Certainty of income in the form of dividend Funds will typically have multiple properties in its

portfolio as well as diversified tenant pool which reduces

reliance on a single property and tenant in the case ofdirectly held real estate

Allows investors access to investment grade assetswithin the property market for the small initial capital

outlay Investors have the opportunity to invest in properties

which are managed by professional management

companies.67


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THANK YOU

68Pre-conference workshop A, Sunday 9 Nov 2008, Dubai


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Screening Methodology for Shari'ah-Compliant Stocks

Currently there is no international Shari'ah standard forstock screening

Different funds or fund managers utilise differentstandards based on their respective Shari'ah councils

In Malaysia we have the list issued by Syariah AdvisoryCouncil of Securities Commission, Dow Jones-RHBIslamic Malaysia Index and FTSE Bursa Malaysianamely FBM Hijrah Shariah Index and FBM EMASShariah Index

At the global level we have the Dow Jones IslamicMarket Indexes, FTSE Global Islamic Index Series andS&P Islamic Index Series and MSCI Islamic Index

Series69
http://a/SCREENING%20RATIOS.xlshttp://a/SCREENING%20RATIOS.xls


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Screening Methodology for Shari'ah-Compliant Stocks

Rules to ensure that ordinary shares are Shari'ahcompliant

The stock screening process is divided into two stages: Evaluation in terms of company activities, products and industry

Negative screen

Computation of a set of financial ratios & compare them against

specified benchmarks

The screening process begins by screening thecompany in terms of its activity, products and industry

alcohol, tobacco, pork-related products, conventional

financial services, weapon and defense, entertainment(hotels, casinos/gambling, cinema, pornography, music,etc.) are excluded

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Screening Methodology for Shari'ah Compliant Stocks


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Screening Methodology for Shari ah-Compliant Stocks

Next, a set of measures called financial filters is also usedto refine the selection.

The filters use a number of financial ratios and comparethem against their respective benchmarks to weed outnon-Shariah compliant stocks

The data for ratios are obtained from Balance Sheet andIncome Statement. Dow Jones and S&P Indexes usestock market data as well

In general these ratios can be grouped into 3; liquidassets, interest income and leverage

The ratio benchmark ranges from:

Liquid asset: 17% to 70% Interest income and/or Income from Shariah Non-compliant

activities : 5% to 15% Leverage: 30% to 33%

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Screening Methodology for Shari'ah-Compliant Stocks :


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Securities Commission of Malaysia

Securities Commission of Malaysia applied additionalcriteria to companies which are involved in multiplebusiness, i.e., companies whose business activitiescomprise both Shari'ah permissible and non-permissible

elements. The analysis is done at the holding company,subsidiary company and associate company levels. Theadditional criteria include: Core activities of the company are activities not against the

Shari'ah principles as mentioned earlier Haram element is small compared to core activities, i.e.,

compared against benchmark Public image/perception of company is good

Core activities of the company are important and of publicinterest (maslahah) to the muslim ummah and the country Proportion of haram element is small and in matters such as

umum balwa (common plight), uruf (customs) and the rights ofthe non-Muslim community which are accepted by Islam

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Screening Process of SAC, Securities Commission,Malaysia


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Malaysia

Com

pany

Activity, Industry

& Product

Financial servicesbased on riba (interest) Gambling/gaming Manufacture and / orsale of non-halal

products Manufacture or sale oftobacco-based productsor related products Conventionalinsurance (gharar) Entertainment Stockbroking or sharetrading in Shariah non-compliant securitiesOther activitiesdeemed non-permissible

Quantitative Analysis

TO and PBT of non-approved activities

SOP of non-approved

securities

Interest Income

Dividend receivedfrom investment in

non-approved

securities

All of the above must

be below certain

threshold

Image publicpublicperception or image ofperception or image ofthe company,the company,importance of theimportance of thecompanies tocompanies to ummah,ummah,

urufuruf (custom),(custom), umumumumbalwabalwa(common(common

plight), rights of nonplight), rights of non--muslims etc.muslims etc.

Perm

issible

Stage 1 Stage2 Stage 3

No Yes Yes

Drop

DropDrop

Yes

NoNo

Qualitative Analysis

List is updated every end of May and end of Nov. Previously it was

end of April and October 74

Screening Process of Dow Jones Islamic Index (2003)


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Company

Activity, Industry

and Product

Non-Permissible

Activities:

Pork Production

Non-Halal Food

Products

Alcohol Beverages

Gaming

Interest based

Financial Institution

Entertainment

Arms, Defense

Tobacco

Activities Contrary

to Islam

Stage 1 Stage 2

Financial Ratio Filters

Total Debt to Trailing 12-Month

Moving Average Market

Capitalization

33%

Account Receivables to Trailing

12-Month Moving Average

Market Capitalization

33%

Cash + Interest Bearing Securities

to Trailing 12-Month Moving

Average Market Capitalization

33%

Drop

Drop

No

NoPermissible

Yes

Yes

* List is updated every quarter75

Sharia Non-compliant Business (Industry


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p ( yClassification Benchmark, ICB)

2717 Defense 3535 Distillers & Vintners

3577 Food Products

3745 Recreational Products

3785 Tobacco

5337 Food Retailers &Wholesalers

5553 Broadcasting &Entertainment

5555 Media Agencies

5752 Gambling

5753 Hotels 5755 Recreational Services

5757 Restaurants & Bars

8355 Banks 8532 Full Line Insurance

8534 Insurance Brokers

8536 Property & CasualtyInsurance

8538 Reinsurance

8575 Life Insurance

8733 Real Estate Holding &Development

8773 Consumer Finance

8775 Specialty Finance

8777 Investment Services 8779 Mortgage Finance

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Screening Process of FTSE Global Islamic Index Series


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(In collobration with Yasaar, 2006 onwards )

Company

Activity, Industry

and Product

Non-Permissible

Activities:

Pork ProductionNon-Halal Food

Products

Alcohol Beverages

Gaming

Interest basedFinancial Institution

Entertainment

Arms, Defense

Tobacco

Activities Contrary

to Islam

Stage 1 Stage 2Financial Ratio Filters

5 ratios are

computed

Drop

Drop

No

Yes

No YesPermissible

Cleansetainted

dividend

* List is updated every quarter

5%

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FTSE FINANCIAL FILTERS


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FTSE FINANCIAL FILTERS

FTSE GlI**

I LIQUIDITY

3 Acc Rec + Cash/Total Asset < 50%

6 Cash + Int Bearing Sec/Total Assets < 33%

II PROHIBITED INCOME

1 Interest Income/Group Turnover < 5%

7 Non Permissible Income other than Interest Income/Revenue < 5%III DEBT

2 Total Debt/Total Asset < 33%

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Screening Process of S&P Shariah Indices


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Company

Activity, Industry

and Product

Excludes:

Pork Production

Non-Halal FoodProducts

Alcohol Beverages

Gaming

Interest based

Financial InstitutionEntertainment

Arms, Defense

Tobacco

Gold & silver

trading as cash on

deferred basis

Activities Contrary

to Islam

Stage 1 Stage 2Financial Ratio Filters

4 ratios

Drop

Drop

No

Yes

No YesPermissible

Cleansetainted

dividend

* List is updated every quarter79

S&P FINANCIAL FILTERS


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S&P FINANCIAL FILTERS

S&P SI

I LIQUIDITY

2 Acc Rec/12 Mth MA Market Cap < 49%

5 Cash + Int Bearing Sec/12 Mth MA Market Cap. < 33%

II PROHIBITED INCOME

7 Non Permissible Income other than Interest Income/Revenue < 5%

III DEBT

1 Total Debt/12 Mth MA Market Cap < 33%

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MSCI Sh i h I d


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MSCI Shariah Index Established in May 2007

Stage 1: Core Business Negative Screen: Alcohol

Tobacco

Pork-related products

Financial services

Defense/weapons

Gambling

Music

Hotels Cinema

Adult Entertainment

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Stage 2: Financial Filters

Stage 3: Dividend Purification

Argues that part of companys total income is

derived from interest income. Hence a portionof dividend paid out to shareholders must bededucted and given out to charity

Ratio Benchmark

Total Debt/Total Assets < 33.33%Cash + Interest-bearing securities / TotalAssets

< 33.33%

Account Receivables / Total Assets < 70%

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Dividend adjustment factor is used todetermine clean dividends

Calculated as follows: (Total Earnings Interest Income) / Total Earnings

Note that Total earnings are defined as grossincome, and interest income as operating andnon-operating interest

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T f S k k
http://shariah%20compliant%20reits%20part%202.ppt/#29.%20Slide%2029


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Types of Sukuk

84

Leased-based Sukuk Sukuk Ijarah Sukuk of Freehold Existing Assets

Sukuk of Existing Assets Subject to Head Lease Sukuk of Future Tangible Assets (Mausufah FiDhimma (advance lease)

Sukuk of Existing Specified Services Sukuk of Described Future Services

Partnership-based Sukuk

Sukuk Mudaraba Sukuk Musharaka

Sukuk Wakala

T f S k k


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Types of Sukuks

85

Sale-based Sukuk

Murabaha Istisna'a

Salam

Hybrid Sukuk

Sukuk Al Istithmar

Other Types of Sukuk:

Sukuk Wakalah

I l i F d R A
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86

Islamic Forward Rate Agreement

An agreement between 2 parties to

exchange one payment of profit(interest) denominated in a singlecurrency for another payment of profit

(interest) denominated in the samecurrency, based on a notional principal

amount, at a single specified period. The principle used is Wa'd (unilateralpromise)

Forward Currency Contract


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87

y

A contractually binding agreement between twoparties to sell and buy two different currenciesnow, at certain price, but the delivery will be at an

agreed future time. Elements:

- Binding agreement to sell or buy

- The rate of exchange is fixed when thecontract is made. Normally, it differs fromthe rate of a spot transaction

- Delivery of the currencies will be made atan agreed future time, either a specific dateor any time between two specific dates,depending on the contract terms


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C td


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89

Contd

FCC is not allowed because it violates therule of exchange of currencies, i.e. spot

delivery during the contractual session(qabd al-badalayn fi halat al-aqd)

Alternatively, the mechanism of al-wad isused.

Comparison


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FORWARD EXCHANGECONTRACT PROMISSORY FORWARD EXCHANGE

The contract is made on thedealing date (1/4/2005)

On the dealing date (1/4/2005), a unilateralpromise is given by one party to do a contract on

3/7/2005, but the real contract will only takeplace on the value date (3/7/2005)

This agreement is binding andenforceable to both parties

Promise given (dealing date) is only binding onthe party who makes the promise

Exchange rate is fixed on thedealing date (1/4//2005)

Exchange rate is fixed on the dealing date(1/4//2005)

Delivery is made on the valuedate(3/7/2005)

The real contract and spot delivery will be madeon the value date (3/7/2005)
http://shariah%20compliant%20reits%20part%202.ppt/#31.%20Characteristics%20Of%20Shariah-compliant%20Real%20Estate%20Investment

structuring islamic reit part 2 - nov 2008

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