REITs: Introduction
The next in line in the current theme on Islamic asset management is REITs or real estate investment trusts. As you can make out from the name, the classification of REITs is trust-based investment.
Although owning real estate is everyone’s dream, it is fine if you are buying for self-dwelling purposes. However, it becomes a little burdensome when you step out of your shell and start owning real estate for investment purposes. My personal experiences have not been so rosy in attempting this feat and I finally gave up and got out for the sake of peace of mind.
The definition of a REIT is an entity that owns a set of income-generating immovable properties for its shareholders. The properties could well be condominiums, warehouses, shopping malls, hospitals, schools, hotels and any other type of real estate that generates a steady income.
It is obvious that in the case of an Islamic REIT, it is mandatory that the properties are not used for any Shariah-repugnant purposes, such as hotels and restaurants serving wines and alcoholic beverages besides pork and pork-based food items.
Similar to the Islamic mutual funds that we just completed our discussion on, REITs are also a type of fund, which is managed by an independent fund manager — here the REIT operator.
Similar to the Sukuk that we have come to know of, REITs are also fixed income vehicles where the rental income is channeled to the investors pursuant to the deduction of maintenance costs and the operator’s fee. REITs are not for investors looking for swift capital appreciation and they mostly serve the post-retirement purpose and hence are the preferred option by pension funds.
A REIT can be privately placed as well as publicly traded — both are available in the market. Although privately held REITs remain insulated from stock market fluctuations, it has been generally observed that they do not remain private for long since there is a need by the operator to facilitate the exit route for its existing investors — and find new ones. It means going public achieves the purpose of keeping the REIT investment liquid — albeit at the risk of market swings. Adopting the IPO route also helps to boost the REIT operator’s profile.
By purchasing the shares of a publicly traded REIT, a common man can also reap the benefits of steady real estate returns which are out of his reach in the normal circumstances.
It is perfectly alright from a Shariah perspective if the REIT manager opts for a specialized asset class such as hospitals, schools, etc, or goes for a combined portfolio, provided the asset utilization is not breaching any Shariah boundary.
The investors have the option either to invest in a single REIT or in a REIT fund which in turn invests in different REITS in order to spread the risk as much as possible. There are pros and cons in both options. While the investors of a single REIT are aware of the specific set of assets and the risks involved therein, they may be able to mitigate the investment risks to a great extent by investing in a REIT fund where they are able to get the risk-adjusted yield.
Staring from the 1960s from the US, REITs are used to bridge the divide between the stock market and the real estate market. Traditionally, one’s gain has been another’s loss. Nevertheless, this is true only to the extent of investments in REITs, which is a fraction of the colossal investment amounts that still flow from stocks to real estate and vice versa.
A disadvantage of investing in REITs is that they must distribute a large part (80–90%) of income to shareholders, leaving nothing to be ploughed back to grow the asset base. As such, each time a REIT operator needs liquidity to buy new properties, it must either opt to raise the capital through a new share issue or seek leveraging either through bank facilities or issuing Sukuk. While raising the capital base cannot be a frequent phenomenon, the reliance on the capital market could be a costly affair.
The purpose of this educative series and the article is not to hurt any religious or commercial sentiments either consciously or even unwittingly.
Sohail Zubairi is an Islamic finance specialist and AAOIFI-certified Shariah advisor and auditor. He can be contacted at sazubairi1979@gmail.com.
Next Week: More on Islamic REITs.
