CELESQ Webinar
Attracting and Using Middle Eastern Money - Investing in Real
Estate in a Shariah Compliant Way
Steven J. Adelkoff, Jonathan Lawrence, Remsen M. Kinne IV
June 23 2009
Attracting and Using Middle Eastern Money - Investing
in Real Estate in a Shariah Compliant Way
 Introduction
 Basic Shariah Rules
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What is Shariah?
 “O you who believe! Stand out firmly for Allah, as
witness to fair dealing, and let not the hatred of
others to you make you swerve towards inequality
and depart from justice.”
Qur’an 5:8
 In the business context, Shariah is a means of
conducting business through a distinct set of rules
designed to facilitate fairness.
 High correlation between Shariah compliant
investing and socially responsible investing
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Where are Shariah rules codified?
 Interpretations of the Qur’an from various Islamic
schools of thought
 Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI)
 The fact remains: Shariah mandates are not always
consistently applied from Scholar to Scholar.
Information is asymmetric, and Shariah Advisers
and lawyers skilled in the area become useful to
work through the counter-intuitive results
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Shariah terms
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Halal – that which is permitted or compliant
Haram – that which is not permitted
Riba – charging of interest
Gharar – the taking of unreasonable risk; gambling
Sukuk – Shariah compliant debt
Ijara – Shariah compliant lease
Takaful – Shariah compliant form of insurance
Maduraba/Musharaka – forms of partnership
Murabaha – a form of Shariah compliant forward sale for
commodities that is used as a fixed income substitute
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Industry prohibitions
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Gambling
Pork production or consumption
Adult Entertainment
Banking and finance
Alcohol production or consumption
Weapons production
Tobacco production or use
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Shariah-compliant investment screens
 Screens haram industries
 Screens use various ratios to determine if a company
is too leveraged
 AAOIFI Shariah Standard No. 21 forms the basis of
the theoretical underpinnings for screens and ratios.
 Debt to assets of 30% or less (3/4/2 of Standard 21)
 Impermissible income of 5% or less (3/4/3 of Standard 21)
 Many companies are now failing the total debt to
market capitalization ratio test
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Riba
 The charging of sums for borrowed money (i.e.
interest) is forbidden
 But the pledging of Halal assets, the guarantying of
obligations and the leasing of property under what
we might consider a finance lease (or ijara) is
permissible
 Murabaha is the selling of a commodity at an
agreed upon mark-up, and is used in Shariah as a
fixed income investment substitute.
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Riba
Things to Watch Out For:
 Default Interest
 Administrative fees for late payments
 Consideration in respect of third party guaranties
(see AAOIFI Shariah Standard No. 5)
 Preferred Shares are generally not permitted
(AAOIFI Shariah Standard No. 21); but dividends
distributed from profits are permitted.
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Gharar
 The act of taking on unreasonable uncertainty
 Examples of Gharar:
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Gambling
Insurance
FX Trading
Options on stock (AAOIFI Shariah Standard No. 21,
paragraph 16 of Appendix B)
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Attracting and Using Middle Eastern Money - Investing
in Real Estate in a Shariah Compliant Way
 Conventional Leasing v Shariah Compliant Leasing
(Ijara)
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Ijara
 Literal translation: providing goods or services for
temporary use against a wage
 Qur’an legitimacy: “said one of them, ‘O my father
engage him on wages’” (Qur’an Surah al-Qasas
verse 26) and “if you had wished, surely you could
have exacted some recompense for it” (Qur’an
Surah al-Kahf verse 77)
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Ijara (cont’d.)
 Sunnah legitimacy: “whoever hired a worker must
inform him of his wages” and “ give a worker his
wages before his sweat is dried”
 Scholar reasoning: Ijara is a convenient means for
people to acquire the right to use assets that they
do not own since not all people may be able to own
tangible assets
 AAOIFI Standard No. 9
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Lease terms
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Amendments to terms
Duration
Commencement date
Deposit monies to secure the lease
Two contracts for same asset for same period
Sub-leases
Sale and leaseback
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Use of the real estate
 Prohibitions:
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Gambling
Alcohol
Pork
Western style insurance and banking
Defence industry
Adult entertainment
 Controlling sub-leases and assignments
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Treatment of rent
 Fixed for life of lease or adjusted periodically
 Rent variation via reference to benchmark based on
clear formula
 Payment by lump sum or instalments
 Late payment
 Lease repricing
 Rent acceleration
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Obligations of lessors and lessees
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Maintenance
Major repairs
Insurance cost
Property defects
Lessee misconduct
Insurance
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Guarantees and rental income
 Security to secure rental payments and against
misuse of the property
 Instalments may be accelerated on failure to pay
one instalment
 No increase in rental due to delay
 Charitable donation in lieu of penalty payment
 Future rental payments may not deducted from
security enforcement
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Selling of or damage to the leased asset
 Termination of Ijara lease on sale of property to
lessee
 Lessee’s consent not necessary for sale to third
party
 Total destruction: Ijara lease terminates
 Partial destruction: Lessor liable for damage or
destruction of leased asset unless result of lessee’
misconduct or negligence
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Termination, expiry and renewal
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Termination by mutual consent
Unilateral termination
Breach of lease terms
Death of a party
Total destruction of real estate
Expiry at term
Continuation for good cause
Renewal by agreement or automatically
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Leases that end in lessee ownership
 Ijara Wa Iqtina
 Resolution of the International Islamic Fiqh Academy
No. 110 (4/12)
 Finance lease
 Unilateral promise of ownership transfer by lessor at
end of lease term
 Unilateral promise with purchase schedule
 Purchase at end of lease term or in stages
 Lessor may not force lessee to buy
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Leases that end in lessee ownership (cont’d)
 Ijara Mawsoofa Bil Thimma
 Often used in project finance
 Redeemable lease which buys out completed project
 Agreed in advance with initial construction deal
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Attracting and Using Middle Eastern Money - Investing
in Real Estate in a Shariah Compliant Way
 Sukuk - Shariah Compliant Leverage
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Underlying principles
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Asset backing
Entrepreneurial investment
Defined credit participation
Specific real business risk (vs. guaranteed interestbased return)
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Definition of Sukuk
 Sukuk terminology
 Shariah-compliant securitized credit financial
instruments
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Definition of Sukuk (cont’d)
 Participation certificates
 Evidence investors’ right to return based on
profitable investment
 Return results from actual asset ownership
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Structure
 Shariah-compliant underlying asset
 Originator/sponsor sells asset to special purpose vehicle
 Asset sale transaction may be, for example, a lease back or a
sale-repurchase
 Concurrent transaction by SPV with asset user, for example
lease and purchase
 SPV issues securities to investors
 Investors hold direct ownership interest in underlying asset
through SPV
 Pass-through payments
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Sukuk documentation
 Documentation issues
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Other key issues
 Bona fide purpose
 Return from profitable activity only
 Return not from debt, cash or other prohibited
assets
 Insurance
 Credit enhancement, liquidity support, limitations of
prepayment risks, guarantees
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Governance and Regulatory Considerations
 Shariah rulings
 Commercial securities, taxation laws
 Regulatory organizations
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Recent Developments
 Principal guarantees/repurchase agreements
 Accounting standards
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Attracting and Using Middle Eastern Money - Investing
in Real Estate in a Shariah Compliant Way
 Shariah Scholars and Advisers
 Anti-Money Laundering
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Shariah scholars
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Part Judge, Part Jurist
Usually operates in Shariah Boards of three or more
Issues a Fatwa (Fatawa in the plural)
No particular governing body or rules, just schools of thought
and AAOIFI
 High demand and short supply
 Certain Scholars are exceedingly influential in certain countries
 There are no standard setting bodies, and Scholars have
latitude. Information is asymmetrical. But sometimes Scholars
disagree.
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Shariah advisers
 Has relationships with various Scholars
 Has structuring expertise and knows what the
Scholars will accept
 Is the bridge builder between conventional structuring
of equity, debt or investment partnerships and
Shariah
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Purification
 The act of purging oneself of impure profit, by
contributing the profit to charity
 A function of the Shariah Board is to tell investors
what percentage of their profit is subject to
purification
 Shariah Boards use to recommend the charities to
contribute Haram profits; modern practice is simply to
allow investors to contribute impure profits to the
charity of their choosing
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Tales of anti-money laundering Compliance in Shariah
The Challenges of AML-KYC in Shariah Investing
 Who mandates which charities may receive
purification dollars?
 The home address of “Two Oak Trees down the
long road, and take a left at the Big Stone”
 When utility bills are in Arabic
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Further resources
 www.aaoifi.com Accounting and Auditing Organization
for Islamic Financial Institutions
 www.islamic-finance.com
 www.securities.com/ifis Islamic Financial Information
Services (subscription required)
 www.shariahcap.com Shariah Capital
 www.sii.org.uk/web5/infopool.nsf/html/qintifq Securities
& Investment Institute: Islamic Finance Qualification
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Attracting and Using Middle Eastern Money - Investing
in Real Estate in a Shariah Compliant Way
 Conclusion
 Any questions?
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