Understanding and Structuring a

Shariah Compliant Real Estate

Financial Product (Part II)

Prof Dr. Mohd Azmi Omar

azmiomar@iium.edu.my

Pre-conference workshop A, Sunday 9 Nov 2008,

1
Dubai
 Contents
ƒ Meaning of REITs and Shariah compliant
REITs
ƒ Types of REITs
ƒ REITs structure
ƒ Meaning of Shariah compliant REITs
ƒ Case studies of Shariah compliant REITs

Pre-conference workshop A, Sunday 9 Nov 2008, Dubai 2

 Meaning of REITs
ƒ Real Estate Investment Trusts (REITs)
ƒ An investment trust in which fund is collectively
pooled from investors (individuals and
companies) 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 property
companies or investing in debt securities in real
property companies (adapted from
www.azmilaw.com)
ƒ Real estate investment trust or “property trust
fund” means unit trust scheme that invests or
proposes 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 3
 REITs as property investment
vehicle
ƒ REITs are typically listed and quoted in
many stock exchanges. For example in
Malaysia there are 2 Shariah compliant
REITs and 11 conventional REITs listed in
Kuala Lumpur Stock Exchange (Bursa
Malaysia) with market capitalization of
US$1.53bil.
ƒ In Singapore there are 21 conventional
REITs listed in Stock Exchange of
Singapore with market capitalization of
Pre-conference workshop A, Sunday 9 Nov 2008, Dubai 4
US$20bil (Aprea, 2008)
 Types of REITs
ƒ Equity REITs
ƒ Own and operate income producing real
estate
ƒ Office
ƒ Hospital
ƒ Apartment
ƒ Retail (shopping centres)
ƒ Hotels
ƒ May perform development, construction and
leasing activities
ƒ Most common type of REITs
Pre-conference workshop A, Sunday 9 Nov 2008, Dubai 5
 ƒ Mortgage REITs
ƒ Lend money to real estate owners and
operators of existing property
ƒ May also buy mortgages
ƒ Hybrid REITs
ƒ Both own properties and give loans to real
estate owners

Pre-conference workshop A, Sunday 9 Nov 2008, Dubai 6

Investing in REITs…why are REITs attractive to investors?

• REITs is typically distribute >90% of net cash flow

Income • Income is underpinned by legally enforceable lease agreements
stability • Low leverage
• Little or no development risk

• REIT unit price is much lower than those of general equities

Capital stability • Long-term unit price capital growth potential is driven by increase in
& growth rental earnings and also by capital appreciation of the underlying
properties

• Provide institutional investors with an alternative to direct real estate

investment with increased flexibility
Quality real • Provide retail investors with an opportunity to invest in high-value
estate institutional quality real estates assets that would otherwise not be
possible

• 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
Liquidity • Low transaction costs in buying/selling REIT units vs trading
& valuation 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 in
lumpy real estate as and when new investment funds are received

7
Investing in REITs…. (cont’d)

Diversification • Diversification by types of properties, tenants and locations

Expert • Benefit from experienced, professional real estate managers

Management • Additional scrutiny by the trustee

• Consistent yield-based investment has defensive asset class

Defensive characteristics
• Income-generating investment grade property is a ‘safe haven’ during
uncertain times

• Subject to stringent corporate governance and disclosure

requirements
Transparency
• Government regulates on payout ratios, gearing, allowable investment,
etc.

Source: JPMorgan, 2005

8
 Typical REITs Structure
Unit Holder

Investment

Returns

Management services Safeguard unit holder’s

interest
REIT REITs Trustee
Manager
Management fees Trustee fees
Ownership
Of Property

Net Property
Income
Maintenance and
Management
Services Rent
• Real estate and
Property real estate-related
Manager assets Tenant
•Other assets (e.g. non-
Maintenance and real estate related assets Rental Payment
management fees
9
 Meaning of Shariah compliant
REITs
ƒ There is no universal definition although all
definitions have to comply with the
requirements of the Shariah
ƒ Definition used by Securities Commission
Malaysia (Guidelines for Shariah compliant
REITs, November 2005)
ƒ “A Shariah compliant REIT is a collective
investment scheme in real estate, in which
tenants operate permissible activities
according to the Shariah”
Pre-conference workshop A, Sunday 9 Nov 2008, Dubai 10
 ƒ Shariah compliant REITs can be listed or
unlisted
ƒ Examples of listed Shariah compliant
REITs are Al-Aqar KPJ REIT and Al-
Hadharah Boustead REIT (both in
Malaysia) whilst unlisted Shariah
compliant REITs , also known as Shariah
compliant real estate funds, are shown in
the following two slides
Pre-conference workshop A, Sunday 9 Nov 2008, Dubai 11
 Shariah Compliant Real Estate Funds
Fund Name of Country Size Type Investor Advisor Description
Manager / Fund (USDm)
Distributor

Guidance Guidance USA 200 Residential Freddie Mac

Financial Fixed real estate finance assets. The securities
Group Income Fund will be issued and guaranteed by the
Federal Home Loan Mortgage
Corporation (‘Freddie Mac’). The fund will
hold securities that are backed by
Shariah-compliant

Shamil Bank China Realty China 150 Commercial CITIC International Shamil Bank Bahrain entered into
Fund Assets an MoU with prominent Chinese
Management Co. financial institutions, CITICIAM to
Ltd. (CITICIAM) set up and launch USD150m
closed-end China Realty Fund.
 Shariah Compliant Real Estate Funds
Fund Manager Name of Country Size Type Investor Advisor Description
/ Distributor Fund (USDm)

Kuwait Finance Baitak Asia South Asia 600 Commercial, Pacific Star Group A USD600m Shariah compliant
House Real Estate Residential real estate fund. The Baitak Asia
Fund Real Estate Fund will invest in
residential and commercial sites
in Asian countries. This will be
the first real estate deal in Asia
for Kuwait Finance House.
Kuwait Finance Shariah Europe 486 Commercial, Equity Estates BV The fund intends to invest Euro
House compliant Residential 400m in European property
European concentrating on high yielding
Real Estate office, logistics and light industrial
Fund properties in the Benelux, France
and Germany.

Dubai Shariah Al Shariah Far East 450 Commercial, ARA Asset The new fund will be managed by
compliant Bank compliant Far Retail, Management ARA Asset Management and
(DIB); Cheung Eastern Real Residential jointly promoted by DIB and
Kong Group Estate Fund Cheung Kong Group. The
Shariah compliant-compliant
investment vehicle has set aside
USD450m to invest in
commercial, retail and residential
projects in major Asian cities.
 Comparison between Conventional
REITs and Shariah Compliant
REITs
Conventional Shariah Compliant REITs
REITs
Income from real No restriction, Restricted to Shariah compliant usage
estate what ever is legal of real estate assets
Income from other No restriction, Restricted to Shariah-compliant
assets (non-real what ever is legal investments in other assets such as
estate related Sukuk
assets)
Business activities No restriction, Restricted to Shariah compliant usage
allowed in real what ever is legal of real estate assets
estate
Insurance No restriction Takaful (Shariah compliant insurance)
Financing No restriction Shariah compliant only
Appointment of None required Must appoint Shariah Advisers
Shariah Advisers
Pre-conference workshop A, Sunday 9 Nov 2008, Dubai 14
 Shariah compliant REITS: Basic
Issues
ƒ Objective
ƒ Structure
ƒ Regulatory Regime
ƒ Sources of income
ƒ Permissible investment
ƒ Purification of income
ƒ Investors
ƒ Comparison with Alternative Investment
ƒ Fees and Charges
ƒ Performance Indicators
15
 Objective of Shariah Compliant
REITS
ƒ To provide unit holders with a stable
distributions per unit with the potential for
sustainable long-term growth of such
distributions.
ƒ How?
ƒ By optimizing the performance and enhancing
the overall quality of a large and geographically
diversified portfolio of Shariah-Compliant real
estate assets through various permissible
investments and business strategies.

16
 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: Ijarah
17
 Shariah Compliant REITs Structure
Shariah advisors
Unit Holder

Advise on Investment
Shariah
issues Returns

Management services Safeguard unit holder’s

interest
REIT Manager REITs Trustee
Management fees Trustee fees
Ownership
Of Property

Net Property
Income
Maintenance and
Management
Services Rent
Property
Properties Tenant
Manager
Maintenance and Rental Payment
management fees
18
 Mudarabah structure
Seller

RABB-UL MAL

Investors
Assets

Dividends Equity
Asset
MUDARIB management

Property Partnership Fund Ijarah or Financier/

manager Murabahah SPV

Ijarah
$
Fund
Manage Lessee
Fund
r management
RABB-UL MAL
or his contracted representative

19
Source: adapted from Thomas, 2005
 Murabahah structure
Islamic
Investors

Fund/
Investment
Company

sale
sale
Investment
Vendor Bank Purchase price Subsidiary
+ mark up
Legal
Purchase title Ijarah
$
price
Real
Occupying
Estate Legal title: on
tenants
or off shore sub

Investment
subsidiary
Source: adapted from Thomas, 2005 20
 Ijarah Structure
Islamic
Investors

Fund/
Investment
Company
Redeemable
Ijarah/Ijarah Muntahia
Bittamllek
Sale of Ijarah
assets
Vendor/ Investment
Finco Subsidiary
bank Rent
Legal
Purchase title Ijarah
$
price
Real
Occupying
Estate tenants

Source: adapted from Thomas, 2005 21

 Shariah compliant REITS
ƒ Tripartite agreement between three parties:

ƒ The Manager
ƒ The Trustee
ƒ Unitholders

ƒ Tripartite relationship is governed by a Deed

registered with the Regulator (e.g Securities
Commission –Malaysia)

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 DEED
ƒ A Deed is a legal instrument used to grant a
right.
ƒ The trust deed is a legally binding agreement
between the manager, trustee and unit holders.
The agreement usually spells out clearly how
the unit trust scheme is to be administered. The
contents usually include:-
ƒ Valuing and the pricing of units;
ƒ Keeping of proper accounts and records;
ƒ Collection and distribution of income;
ƒ Rights of unit holders;
ƒ Duties and responsibilities of the manager;
ƒ Duties and responsibilities of the trustees; and
ƒ Protection of unit holders’ interest.
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 Shariah Aspects

Shariah compliant REITS (I-

REITs)

24
 Rental is free from
Non-permissible
activities

How incomes from Rental from tenant

I-REIT are earned? Who operates mixed
activites

Methods of calculating
the ratio of rental of
Non-permissible activities

Shariah Instruments used in

Investing, deposit and
Guidelines on
Financing for I-REITs
I-REITs
How the funds are
managed? Takaful Coverage

Risk Management Issues

25
 Roles of the Shariah Advisor:
• 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 their
investments are managed in compliance to
Shariah
 Requirements Of Shariah-compliant Real
Estate Investment
1. 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-compliant
securities;
• and hotels and resorts.
– Shariah committee or advisors are allowed to use their own
discretion based on ijtihad to determine other activities that are
deemed non-permissible
27
 Characteristics Of Shariah-compliant Real
Estate Investment
2. ACQUIRING REAL ESTATE WITH EXISTING TENANT
WHO 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-permissible
activities that clearly exceed the benchmark.
• not permitted to own real estate, in which all tenants operate
non-permissible activities, even if the percentage of rental is
still below the benchmark (20%). This is to protect the image
of the Islamic REIT

28
 Shariah compliant Benchmark : [Area used
for Non Shariah Compliance/Total Area] ratio
and [Sales from Non Shariah compliant/Total
Sales].

$2m sales

sales $10m

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 Characteristics Of Shariah-compliant Real
Estate Investment
3. RENTING OUT REAL ESTATE TO A NEW TENANTS
– The Shari’ah advisor must advise the Islamic REIT fund
manager not to accept a new tenant(s) whose activities are fully
non-permissible.
– Shari’ah advisor must make sure that the Islaimic REIT fund
manager consistently supervise the activities of the tenant
• If tenant’s activities is not obviously impermissible, the 20%
benchmark in determining the status of mixed rental income
need 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 not
allowed for Islamic REIT fund manager to accept such
tenant.
• For example, a well-known casino operator who plans to
rent the real estate of the Islamic REIT must not be
accepted as a new tenant

30
 Characteristics Of Shariah-compliant Real
Estate Investment
4. METHOD OF CALCULATING THE RATIO OF
RENTAL OF NON-PERMISSIBLE ACTIVITIES
– usage of space, hours of service and other methods deemed
appropriate 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 1000
square feet, then the ratio of area used for non-halal activities is
10%.
– Thus, the rental from non-permissible activities is 10% of the
total rental paid by the supermarket. Rental income is deemed
to be permissible as it is still within the acceptable benchmark of
20% of total turnover of the Islamic REITs.

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 Characteristics Of Shariah-compliant Real
Estate Investment
5. 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 Shariah
principles.
– For example, in financing the acquisition of real estate, Islamic
REIT fund manager must not engage in riba-based instrument
which would have an effect on the Islamicity of the Islamic
REIT operation and transaction.

32
 • Malaysian Shariah Permissible
Investments for I-REITs:
– Real estate – physical land and all things that
are a natural part of the land as well as things
attached to the land both below and above
the ground (50% of total assets)
– Real estate-related assets - includes units of
other I-REITs , Shariah compliant securities of
property companies, and sukuks issued by
property companies

Pre-conference workshop A, Sunday 9 Nov 2008, Dubai 33

 – Single purpose companies – private
companies whose principal assets comprise
real estate
– Liquid assets – Shariah compliant securities
of non property companies
– Asset-backed sukuks – Sukuks based on
securitization transaction
– Non-real estate-related assets – cash, shariah
compliant deposits or other instruments
convertible into cash within 7 days
Pre-conference workshop A, Sunday 9 Nov 2008, Dubai 34
 Characteristics Of Shariah-compliant Real
Estate Investment
6. TAKAFUL COVERAGE
– The Guideline issued by the Securities
Commission also stipulates that an Islamic
REIT 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 use
conventional schemes

35
 Characteristics Of Shariah-compliant Real
Estate Investment
7. RISK MANAGEMENT ISSUES
– Islamic REIT is permitted to participate in forward
sales or purchases of currency, and is encouraged
to deal with Islamic financial institutions.
– If the Islamic REIT deals with Islamic financial
institutions, then it will be bound by the concept of
wa'd (a unilateral promise where only one party is
obligated to fulfil his promise or responsibility). The
party that is bound is the party that initiates the
promise.
– However, if the Islamic REIT deals with conventional
financial institutions, it is permitted to participate in
the conventional forward sales or purchase of 36

currency
 Shariah compliant Contracts in REITS:
WAKALAH Model
• Unitholders and Management Company(MC)
Wakalah – Fee-based
Unitholders appoint MC to invest funds in properties.
MC earns fees.

• Unitholders and Trustee

Wakalah – Fee-Based
Unitholders appoint Trustee to serve as a custodian for all the
assets of the Shariah compliant REIT.
Trustee earns fees.

• The Wakalah principles are incorporated in the Deed of Shariah

compliant Reits.

37
 Nature of work undertaken by
Management Company (Wakil)
• Managing the Properties effectively
• Maintaining net property income
• Maximizing the return and performance of each
Properties and their growth via enhancement of
properties
• Raising the profile of Properties
• Acquiring property assets with good yield and growth
potential for both locally and abroad that meet the
Manager’s investment criteria
• Employing optimum capital structure.

38
 Wakalah Fees
• Annual Management Fee

• Annual Maintenance and Management Fee

• Annual Trustee Fee

• Shariah Committee Members Fee

• Fund Expenses

39
 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 by

Shariah compliant Reits management companies.

40
 Wakalah Model.
• Management Company (ie Wakil) does not bear
potential of loss (ie. risk) of investment.
• Management Company is entrusted to invest the REIT
Fund 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.

41
Risk-Return Principle

Juristic Principle (Al-Qawaid Fiqiah) -

“Al-Ghurmu Bil Ghunmi”
No Risk No Gain

42
 RISKS faced by Unitholders

• Investment by Unitholders is based on Risk-Return

Principle “ al-Ghornm bil Ghonm” where:

1. Original investment not guaranteed

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

43
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

44
 Alternative to REIT Wakalah Model

• 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 of
the Deed.

45
 Purification of Income
• Investor/Unit trust fund receives income from
invested companies in the form of dividend and
capital gain. Not all income are considered
“clean”. Some are derived from non halal
sources such as interest income
• Purification of income requires identifying the
prohibited income received from invested
companies and deducting it from the total
income prior to distribution
• The income net of purification is then distributed
to the investors
 Purification of Income
• The prohibited income cannot be distributed to
investors but instead donated to charities
• It is also possible for the fund manager to allow
discretion to investors in deciding the recipient
charitable organization
• No consensus among Shari’ah scholars in
implementing purification
• No standard available from AAOFFI but provides
a method to compute the prohibited income
• AAOIFI:
– First step: Determine the proportion of
prohibited income: (Total Prohibited
Income/No. of Shares)
– Second step: Determine the quantum of
prohibited 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 to
estimate tainted dividend
• Div*(Non-permissible Revenue/Revenue)
 Case Studies of Shariah
Compliant REITs in Malaysia

KPJ Al-`AQAR AL-HADHARAH

REIT BOUSTED REIT

49
Al-Aqar KPJ REIT

50
 Al-’Aqar KPJ REIT
• First Shariah compliant REIT
• Established on 28 June 2006
• Comprises of six hospitals building worth
RM461.24m or USD$131.9m
• Manager: Damansara REIT Managers Pte.
• Lead adviser: AmMerchant Bank Pte.
• Trustee: Amanah Raya Pte.
• Units holdings:
KPJ : 160 million units
Institutional investors: 165 million units
Retail investors: 15 million units

51
 Al-’Aqar KPJ Islamic Reits
• Oversubscribed by 4.13 times
• Islamic Reits drew 5,115 non-Muslim and
non-Bumiputra investors.
• Open up at RM0.99, a premium of 4.2%,
or 4 sen, over its retail offer price of
RM0.95
• 30,810 units done at the opening bell
• Closed at 3.5 sen up at RM0.985
• Al-’Aqar REIT raised RM177.25 million
52
 KPJ Al-
`AQAR
Unit Holders
REIT
Advise on
Shariah Investment
related matters
Dividend
Manager Management services Custodianship service
(Damansara Al-'Aqar Trustee
REIT Mgmt. KPJ REIT (Amanah Raya
Management fees Trustee fees
Sdn. Bhd. Berhad)
Ownership of
Property
Net Property
Income

Maintenance Maintenance and

REIT Properties:
Manager for Management 1. Ampang Puteri Specialist
Hospital Building Tenants
Services Rent
the properties 2. Damansara Specialist (Subsidiaries
(Healthcare Hospital Building of KPJ)
Technical 3. Johor Specialist Hospital
Maintenance and Rental Payment
Services Sdn. Building
management fees 4. Ipoh Specialist Hospital
Bhd.)
Building
5. Puteri Specialist Hospital
Building
6. Selangor Medical Centre 53
Building
 Al-’Aqar KPJ 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 Islamic
financing facility
Printing, posting, general and operating expenses for the
administration of the fund.
54
 Al-Aqar KPJ Islamic REIT
• World’s first Islamic REIT IPO
The world’s first Islamic real estate investment trust (I-
REIT) – Al Aqar KPJ REIT IPO – was launched with
AmMerchant Bank appointed as the advisor, managing
underwriter and sole placement agent.
• Under the IPO, a total of 340 million units were issued
and of these, KPJ Healthcare would hold 160 million
units (47%), while 165 million units would be issued to
institutional 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 be
raised from the IPO.

55
Al-Hadharah Bousted REIT

56
Al-Hadharah Bousted REIT
‹ Lauched on 15th Jan 2006
‹ 1st I-REIT made up of plantation assets i.e. oil palm
estates
‹ Involves sale-lease back mechanism
‹ Acquires 8 plantation assets from Bousted Group
involving 8 palm oil estates and 2 palm oil mills, all
located in Peninsular Malaysia.
‹ Total purchase consideration RM472 million ( USD136
million)
‹ Tenants pay a cumulative fixed rental of RM41.3 million
per annum on a bimonthly bases for the 1st tenancy term
of 3 years.
57
 Advise on
Unit Holders
Shariah Investment
AL-HADHARAH
related matters BOUSTED REIT
Dividend
Manager Management services Custodianship service
(Bousted REIT Al-Hadharah Trustee
Manager Sdn. Bousted REIT (CIMB Trustee
Management fees Trustee fees Berhad)
Bhd.
Ownership of Rental
Property Income

REIT Properties:
Oil Palm Estate and Estate
Plantation Monitoring of with Palm Oil Mill in 8
Adviser Plantation assets different locations: Tenants
Rent
(Appointed by 1. Batu Pekaka, Kedah (Subsidiaries of
2. Bukit Mertajam, Penang Bousted Group)
Bousted REIT
3. Malaya, Perak
Manager). Maintenance and Rental Payment
4. Bekoh, Johor
management fees 5. Kulai Young, Johor
6. Telok Sengat, Johor
7. Chamek, Johor
8. Lepan Kabu, Kelantan

58
 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.

59
 CONTRACTS: SPA & Ijarah
• Sale and Purchase Agreement: The sale
and purchase agreements between the
Vendors and the Trustee, on behalf of Al-
Hadharah Bousted REIT, in relation to the
sale and purchase of the Plantation Assets

60
 CONTRACTS
• Ijarah Arrangements:
• The arrangements by al-Hadharah Bousted REITS
(AHBR)where the Trustee on behalf of AHBR as
landlord agrees to let the Plantation Assets to the
Vendors as tenants for a period of three years which
are renewable four times up to twelve years and
thereafter renewable for up to an additional fifteen
years comprising five additional terms of not more
than three years each, save and except for the
tenancy of the Malay Reserved Land which are not
automatically renewable.

61
 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 crude
palm oil prices and fresh fruit bunch prices.
– The profit shared (50:50) and payable in the
form of dividend to unit holders.
• Capital gain

62
Prospects
of Shariah
Compliant
REITs

63
 1. Enhancement of tax transparency
system & reduction of Investor’s tax

2. Operates in a more transparent and well

regulated and transparent esp. with the issuance
of 2 Guidelines by Securities Commission

3. High-Quality Assets which generate a stable

Stream of cash flow backed by a steady portfolio
of tenants.

4. Offers investors and subscribers with high yield

Returns and certainty of income.

64
 Enhancement of Tax Policy by
Malaysian Authorities
• Tax Transparency (Effective from YA 2007)
– REITs will be exempted from tax on all income if it
distributes at least 90% of income to investors
– If distributes less than 90% of income, REIT will be
subject to income tax on chargeable income at normal
corporate 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 investment
65
 Tax Reduction for REITs investors
(Malaysia)
REIT Current tax Amended tax
Distributions treatment treatment
Individuals & Resident Taxed at own Withholding tax of
non-corporate marginal rate of tax 15%
investors Non-Resident Withholding tax at Withholding tax of
28% 15%
Corporate Resident Taxed at normal Existing tax
Investors corporate tax rate treatment (27%
(28% currently) effective YA
2007)
Non-Resident Withholding tax at Existing tax
28% treatment (27%
withholding tax
from 1.1.2007)
Institutional Foreign Withholding tax at Withholding tax of
Investors 28% 20%

66
 Conclusion
Shariah compliant REITs have the potential to
appeal 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 of
directly held real estate
• Allows investors access to investment grade assets
within 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
 THANK YOU

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

Screening Methodology for Shari'ah-Compliant Stocks

• Currently there is no international Shari'ah standard for

stock screening
• Different funds or fund managers utilise different
standards based on their respective Shari'ah councils
• In Malaysia we have the list issued by Syariah Advisory
Council of Securities Commission, Dow Jones-RHB
Islamic Malaysia Index and FTSE Bursa Malaysia
namely FBM Hijrah Shariah Index and FBM EMAS
Shariah Index
• At the global level we have the Dow Jones Islamic
Market Indexes, FTSE Global Islamic Index Series and
S&P Islamic Index Series and MSCI Islamic Index
Series
69
Screening Methodology for Shari'ah-Compliant Stocks
• Rules to ensure that ordinary shares are Shari'ah
compliant
• 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 the
company 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

70
 Screening Methodology for Shari'ah-Compliant Stocks

• Next, a set of measures called financial filters is also used

to refine the selection.
• The filters use a number of financial ratios and compare
them against their respective benchmarks to weed out
non-Shari’ah compliant stocks
• The data for ratios are obtained from Balance Sheet and
Income Statement. Dow Jones and S&P Indexes use
stock market data as well
• In general these ratios can be grouped into 3; liquid
assets, 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%

71
 Screening Methodology for Shari'ah-Compliant Stocks :
Securities Commission of Malaysia

• Securities Commission of Malaysia applied additional

criteria to companies which are involved in multiple
business, i.e., companies whose business activities
comprise both Shari'ah permissible and non-permissible
elements. The analysis is done at the holding company,
subsidiary company and associate company levels. The
additional 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 public
interest (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 of
the non-Muslim community which are accepted by Islam

72
 Screening Methodology for Shari'ah-Compliant
Stocks
Securities Commission of Malaysia

• It maybe possible that a company’s main business is

Shari’ah compliant but the revenue from the subsidiary
whose activities are not Shari’ah compliant may lead to
that company being considered as non-Shari’ah
compliant

73
 Screening Process of SAC, Securities Commission,
Malaysia
Stage 1 Stage2 Stage 3
Activity, Industry
Quantitative Analysis Qualitative Analysis
& Product
• Financial services • TO and PBT of non-
approved activities
Company

based on riba (interest)

Permissible
Image – public
• Gambling/gaming •SOP of non-approved
• Manufacture and / or
No securities Yes perception or image of Yes
the company,
sale of non-halal •Interest Income
importance of the
products •Dividend received
companies to ummah,
• Manufacture or sale of from investment in
uruf (custom), umum
tobacco-based products non-approved
balwa (common
or related products securities
plight), rights of non-
non-
• Conventional muslims etc.
insurance (gharar) •All of the above must
• Entertainment be below certain
• Stockbroking or share threshold
trading in Shari’ah non-
compliant securities
•Other activities
deemed non- No
permissible
No
Yes
Drop
Drop

Drop
•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)
Stage 1 Stage 2
Activity, Industry
and Product Financial Ratio Filters
•Total Debt to Trailing 12-Month
Non-Permissible Moving Average Market
Activities: Capitalization ≤ 33%
•Pork Production No Yes
Company •Non-Halal Food Permissible
•Account Receivables to Trailing
Products 12-Month Moving Average
•Alcohol Beverages Market Capitalization ≤ 33%
•Gaming
•Interest based •Cash + Interest Bearing Securities
Financial Institution to Trailing 12-Month Moving
•Entertainment Average Market Capitalization ≤
•Arms, Defense 33%
•Tobacco
•Activities Contrary No
to Islam

Yes Drop

Drop
* List is updated every quarter 75
Sharia Non-compliant Business (Industry
Classification 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 & Casualty
Insurance
• 8538 Reinsurance
• 8575 Life Insurance
• 8733 Real Estate Holding &
Development
• 8773 Consumer Finance
• 8775 Specialty Finance
• 8777 Investment Services
• 8779 Mortgage Finance
76
Screening Process of FTSE Global Islamic Index Series
(In collobration with Yasaar, 2006 onwards )
Stage 1 Stage 2
Activity, Industry Financial Ratio Filters
and Product
Non-Permissible • 5 ratios are
Activities: computed
•Pork Production
No Yes
Company •Non-Halal Food Permissible
Products
•Alcohol Beverages
•Gaming 5%
•Interest based
Financial Institution
•Entertainment Cleanse
•Arms, Defense tainted
•Tobacco dividend
•Activities Contrary
No
to Islam

Yes Drop

Drop
77
* List is updated every quarter
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%

78
 Screening Process of S&P Shariah Indices
Stage 1 Stage 2
Activity, Industry Financial Ratio Filters
and Product
Excludes: • 4 ratios
•Pork Production
•Non-Halal Food
No Yes
Company Products Permissible
•Alcohol Beverages
•Gaming
•Interest based
Financial Institution
•Entertainment
•Arms, Defense Cleanse
•Tobacco tainted
•Gold & silver dividend
trading as cash on
No
deferred basis
•Activities Contrary
to Islam Yes
Drop

Drop
79
* List is updated every quarter
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%

80
 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

81
• Stage 2: Financial Filters
Ratio Benchmark

Total Debt/Total Assets < 33.33%

Cash + Interest-bearing securities / Total < 33.33%

Assets
Account Receivables / Total Assets < 70%

• Stage 3: Dividend Purification

– Argues that part of company’s total income is
derived from interest income. Hence a portion
of dividend paid out to shareholders must be
deducted and given out to charity

82
• Dividend adjustment factor is used to
determine “clean dividends”
• Calculated as follows:
– (Total Earnings – Interest Income) / Total Earnings
• Note that Total earnings are defined as gross
income, and interest income as operating and
non-operating interest

83
 Types of Sukuk
• Leased-based Sukuk – Sukuk Ijarah
– Sukuk of Freehold Existing Assets
– Sukuk of Existing Assets Subject to Head Lease
– Sukuk of Future Tangible Assets (Mausufah Fi
Dhimma (advance lease)
– Sukuk of Existing Specified Services
– Sukuk of Described Future Services
• Partnership-based Sukuk
– Sukuk Mudaraba
– Sukuk Musharaka
– Sukuk Wakala
84
 Types of Sukuks
• Sale-based Sukuk
– Murabaha
– Istisna'a
– Salam
• Hybrid Sukuk
– Sukuk Al Istithmar
• Other Types of Sukuk:
– Sukuk Wakalah

85
 Islamic Forward Rate Agreement

• An agreement between 2 parties to

exchange one payment of profit
(interest) denominated in a single
currency for another payment of profit
(interest) denominated in the same
currency, based on a notional principal
amount, at a single specified period.
• The principle used is Wa'd (unilateral
promise)
86
 Forward Currency Contract

• A contractually binding agreement between two

parties to sell and buy two different currencies
now, 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 the
contract is made. Normally, it differs from
the rate of a spot transaction
- Delivery of the currencies will be made at
an agreed future time, either a specific date
or any time between two specific dates,
depending on the contract terms
87
 Illustration on Forward Currency contract
Example:
™ Company ABC signs an agreement to do a forward currency contract with
bank XYZ and the rate will be RM5.20 for EURO1.00.
(Note: Exchange rate for forward contract will differ from the spot value)

™ Delivery has been determined to be in three months time

After three months

Dealing date
After two days - Value date
Fixing the rate for (forward contract)
the forward - Spot value date
contract

1 April 2005 3 April 2005 3 July 2005

88
 Cont’d
• FCC is not allowed because it violates the
rule of exchange of currencies, i.e. spot
delivery during the contractual session
(qabd al-badalayn fi halat al-’aqd)
• Alternatively, the mechanism of al-wa’d is
used.

89

FORWARD EXCHANGE
CONTRACT
The contract is made on the
dealing date (1/4/2005)
This agreement is binding and
enforceable to both parties
Exchange rate is fixed on the
dealing date (1/4//2005)
Delivery is made on the value
date (3/7/2005)
Comparison
PROMISSORY FORWARD EXCHANGE
On the dealing date (1/4/2005), a unilateral
promise is given by one party to do a contract on
3/7/2005, but the real contract will only take
place on the value date (3/7/2005)
Promise given (dealing date) is only binding on
the party who makes the promise
Exchange rate is fixed on the dealing date
(1/4//2005)
The real contract and spot delivery will be made
on the value date (3/7/2005)
90