Real Estate Financing and Sukuk

Sharia Coordination Department
Real Estate Financing and Sukuk
Mian Muhammad Nazir Senior Vice President

Dubai Islamic Bank PJSC
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Overview Commonly used modes in Real Estate Financing

Murabaha ready property Ijara ready property Forward Ijara under construction property Istisna under construction property Mudaraba Agency Wakala Musharaka Sukuk
Sharia offers various structures for Real Estate Financing based on the requirements of the respective parties Each Sharia compliant mode of financing distinctly exemplifies the essential feature of ownership and risk Growth witnessing assets exceeding $1.7 trillion and expected to reach $2.7 trillion by 2010. In year 2007, 76% of corporations non-loan fundings were Sharia compliant in the MENA region.
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Real Estate Financing and Sukuk Commonly Used Modes
Murabaha
(ready property)

Murabaha (Only in case of ready property)
Step by Step
Customer
Title and Possession to the Property Step 1 Promise to Purchase
Step 5 Sale of Property to Customer on Murabaha basis Step 3 Purchase of Property through purchase agreement Step 4 Purchase Price Step 2 Purchase Offer
Owner/Developer
Step 6 Sale Price

Deferred
Title & Possession to the Property
Islamic Bank

Murabaha
Murabaha is widely used mode of finance in Islamic Finance Industry in general and for Real Estate Financing in particular. However, it can only be used for: ready property; for a shorter financing tenor for the reason of fixed return Involves less risks as it creates debt obligation on the customer No ownership risk.
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Murabaha
The Bank buys the Property and sells it to the customer on Murabaha (cost + profit) basis. Murabaha sale price is paid normally on a deferred basis. Liability is known from day one No surprises or uncertain exposure.
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Ijara
ready property

Purchase and Ijara
ready property
Step by Step
Customer
Step 5 Lease of the Property to the customer through Lease Agreement Step 1 Promise to lease Step 6 Lease Rental Step 3 Acquisition of the Property through purchase agreement Step 4 Purchase Price Step 2 Purchase Offer
Usufruct of the Property
Owner / Developer
Title & Possession to the Property
Islamic Bank

Ijara
Ijara is less risky as compared to other financing structures Strict compliance with Sharia and the applicable law is required for enforceability. Best suited for Islamic Financial Institutions conventional institutions may have some regulatory problems in Ijara It is generally perceived that notwithstanding Sharia requirements, the documentation should be in accordance with the applicable law which is not free from risk from Sharia compliance perspective.
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Ijara
Liability is known from day one No surprises or uncertain exposure. Unlike conventional finance, Sharia has a special treatment to issues such as increased cost, mandatory cost, asset ownership, taxes, major maintenance, asset insurance and remedies in the event of total or partial loss.
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Ijara
Ijara structure involves purchasing an asset from the customer or a third party and leasing the same to the customer. Care needs to be taken in order to ensure that the transaction does not become a conditional sale or a contract of Inah. Sharia requires extraordinary caution in putting together a rental framework for a lease transaction which involves a variable element of rental
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Ijara
Ijara: Two types Ijara Muntahia Bittamleek (Finance lease) Operating Lease In Ijara Muntahia Bitammaleek, transfer of ownership at the expiry of lease term must be through a unilateral undertaking to be exercised at the expiry of the lease term and the transfer should either take the form of sale at nominal price or gift. Appropriate structure for all purpose financing
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Forward Ijara
under construction property
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Real Estate Financing and Sukuk Forward Ijara

for under construction property
Step by Step
Customer
Delivery of Leased Property to Customer at completion Step 1

Promise to Lease on Forward Ijara basis
Step 5 Lease of Property on the basis of Forward Ijara Step 3 Purchase of the described Property through Istisna Agreement Step 6 Lease Rental Step 4 Istisna Purchase Price Step 2 Purchase Offer
Owner / Developer
Delivery of the described Property after completion
Islamic Bank
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Ijara Mousoofa Fizzimma (Lease of specified item(s) which are to be delivered after manufacturing or construction)
Ijara in respect of an asset under construction takes the form of Ijara Mousoofa Fizzimma. Lease of the underlying assets starts on the date of delivery of the asset to the lessee and the lessees obligation to pay rental triggers with the commencement of the lease. An investor receives return on its investment out of the amount received from the lessee on account of 16

Ijara Mousoofa Fizzimma
Although investment in assets under construction through Ijara Mousoofa Fizzimma may not be free from certain downsides, it still has potential to serve both the parties, i.e. customer and financier addressing the Project Financing requirements. Appropriate structure for project financing. Example: QREIC Sukuk (Qatar)
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Istisna
under construction property
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Istisna
for under construction property
Step by Step
Customer
Delivery to the Customer after at completion Step 1

Promise to Purchase on Parallel Istisna basis
Step 5 Sale of the described Property on Parallel Istisna basis Step 3 Purchase of the described Property through Istisna Agreement Step 6
Parallel Istisna
Owner / Developer
Step 4 Istisna Purchase Price
Purchase Price
Step 2 Purchase Offer
Delivery of the described Property after completion
Islamic Bank
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Istisna In Istisna sale, the seller sells a described property to be delivered to the purchaser once the same is completed.
Istisna requires combination of either lease of the purchased assets back to the seller or sale of the purchased assets to the customer, provided that the purchase is not from the same customer. Used in QREIC Sukuk involving purchase of the described assets by sukuk-holders and leasing back to the Seller.
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Mudaraba
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Mudaraba
Step by Step
Islamic Bank (Rab Al Mal)
Mudaraba Agreement
Step 1 Business Plan Rab al Mals Share Step 6 Mudaraba Capital Step 3
Project
Joint Capital (after commingling of

Mudaraba Capital with Net Assets Of Mudarib if any)
Developer (Mudarib)
Mudaribs Share
Mudarib Profit Net Profit Mudaraba Profit

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Mudaraba
Mudaraba is a very flexible real estate financing structure.
Mudaraba can be of two types: Project basis no need for Sharia compliance of financial ratio, however, underlying activities must be Sharia compliant. Unrestricted Mudaraba on commingling basis which requires Sharia compliance of the customers business activities as well as the financial ratio. Mudaraba operates on trust which means a partnership in profit.
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Mudaraba
Mudaraba financing is an investment, therefore, it requires an investment plan. Mudaribs performance is assessed on the basis of the Investment Plan it has provided to the financier in order to obtain financing. In 2007, Mudaraba was considered to be a preferable financing structure because it does not involve sale of the assets. (Example: DIFC Sukuk) However, recent discussions amongst Sharia scholars on redemption through purchase undertaking resulted in reduction of the use of Mudaraba structure.
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Agency
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Agency
Step by Step
Islamic Bank (Principal)
Agency Agreement
Step 1 Investment Plan
Agency Fee
Project
Step 3
Step 6 Investment Amount
Investment Amount
Developer (Agent)
Incentive
Profit
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Agency (Wakala)
Investment agency structure for real estate financing is another flexible structure. It operates on the principal similar to Mudaraba except the Profit distribution. However, this structure is less used in real estate financing due to certain academic discussions amongst the Sharia scholars.
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Musharaka
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Musharaka (two structures)
Sharikatul Aqd (Contractual Partnership)
Musharaka Mutanaqisa (Diminishing Musharaka) Normal Musharaka (Example: JAFZA Sukuk)
Sharikatul Milk (Co-ownership). Volcano Sukuk, DIB Sukuk, and EIB Sukuk
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Musharaka Mutanaqisa Step by Step
Purchase of Units in Musharaka Purchase Undertaking
Islamic Bank
Contribution Cash Profit Musharaka Agreement Contribution Cash + Kind
Customer / Developer
Profit + Incentive
Musharaka Entity
Profit
Investment
Project
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Musharaka Bank leases its share in Musharaka to the Customer Step by Step
Lease of Banks Share Lease Rental
Islamic Bank
Contribution Cash Profit Musharaka Agreement Contribution Cash + Kind
Profit + Incentive
Musharaka Entity
Profit
Investment
Project
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Musharaka Sharikatul Milk (Ready Property) Step by Step
Periodic Purchase of Undivided Share Purchase Undertaking
Islamic Bank
Contribution Cash Musharaka Agreement Lease Rental Purchase Price Contribution Cash
Lease Rental
Ready Property
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Sukuk (Islamic Bonds)
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Sukuk certificates represent ownership in the underlying assets, usufruct and services or the assets of particular projects or investment activities. The ownership must be real, not beneficial, i.e. economic benefits or entitlements. (AAOIFIs resolution). Provides viable alternative to conventional bonds and securities.
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Global Sukuk issuance reaches $109 billion. Indicating impressive growth in MENA region.
Global Local Currency and Dollar Sukuk Issued by Country (2007)
MENA Bond issuance Sukuk vs. Conventional Bonds
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Sukuks are issued on any of the foregoing Sharia contracts. For real estate, Sukuk can be issued using any of the Sharia contracts for the following: (i) the development of a particular real estate project; or (ii) the working capital or the construction cost
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Choosing a structure for a Sukuk depends on the following: Purpose for which the money is required; Assets which will be used to raise money; Income stream and payment; and Tenor Using a right structure in view of the transaction requirements is a real Sharia issue. Examples: Al Dar, Nakheel, Tamweel, PCFC and DCA.
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Sukuk are more economical than conventional financing Investor gets comfort from the fact that, being a public transaction, the structure, commercial issues and documentation may have gone through the eyes of experts (including Sharia scholars) Tradability of Sukuk depends on the assets ownership and the Sharia structures on which they are based.
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Sukuk (Islamic Bonds) Increase in volume and popularity throughout the world would definitely make the Sukuk a better alternative for Project Financing.
However, in order to make Sukuk less expensive and preferable financing choice, standardization and regulation at local and industry level is very much required. Sukuk is also suitable for closely held family real estate development businesses. In view of the recent academic controversies, new structures such as Sharika tul Milk, Asset Purchase and
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Thank You
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Real Estate Financing and Sukuk

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Sharia Coordination Department