ISLAMIC REAL ESTATE INVESTMENT TRUSTS (REITs): PROSPECTS & OPPORTUNITIES

1. ISLAMIC REAL ESTATE INVESTMENT TRUSTS (REITs): PROSPECTS & OPPORTUNITIES Assoc Prof Dr Engku Rabiah Adawiah bt Engku Ali Ahmad Ibrahim Kulliyyah of Laws International Islamic University Malaysia rabiah@iiu.edu.my eradawiah@yahoo.com

2. Agenda • What is a REIT? • Track-record of REITs in the Asian Region • Islamic REIT vis-à-vis Conventional REIT • Islamic REITs in Malaysia: Regulation & Experience • Global Islamic REITs: Issues & Challenges? • Prospects & Opportunities for Islamic REITs • The Way Forward

3. REIT is an investment vehicle structured as a unit trust that invests in stable income producing real properties & real property related assets REIT is driven entirely by recurrent income from its investment properties REIT is a low risk, passive investment vehicle with high certainty of cash flow from rentals derived from lease agreements with tenants REIT distributes all or at least a high proportion of its income to its unit holders, which are generally passed on without deduction of any REIT entity level tax REIT is established through a Deed of Trust executed by the parties. The Trustee acts for the unit holders The Deed of Trust governs the REIT and the roles and responsibilities of the trustee and the management company REIT can be listed on a stock exchange. Stock exchange listing allows wide investor base and creates liquidity in REIT units REIT offers investors good yields as well as a highly liquid method of investing in real estate REITS are governed by multiple levels of stakeholders, including unit holders, manager, trustee and regulating authorities ensuring investors’ protection What is REIT?

4. REIT: A Definition • “An investment vehicle that invests or proposes to invest at least 50% of its total assets in real estate. An investment in real estate may be by way of direct ownership or a shareholding in a single-purpose company whose principal assets comprise real estate” Note: Real estate means physical land and those human-made items which are attached to the land Source: SC Guidelines on REITs 2005

5. Track-record of REITs in the Asian Region • Japan – first REITs after revision of the Investment Trust Law in May 2000 • Korea – launched REITs after introduction of REIT Trust Act in July 2001 • Singapore – first REITs launched in July 2002 • Malaysia – first REIT listed in August 2005. At end of 2006, 12 REITs had been approved (total value of RM5.5b), of which 9 were listed • Generally – countries need revision or introduction of Trust Law to facilitate the creation of REITs

6. Fundamentally – not much difference Objective, administration and structure of an Islamic REIT – very similar to Conventional REIT Key difference – how the incomes of the Islamic REIT are derived and how the fund is being managed, e.g: type of tenants; and proportion of rental income derived from the tenants Islamic REIT – tenants in a property acquired must operate in businesses that comply with Syariah principles Conventional REIT – no such requirement Islamic REIT – fund must be managed in Shari`ah compliant manner Conventional REIT – no such requirement Islamic REIT Vis-à-vis Conventional REIT?

7. Islamic REIT: A Definition “In general, an Islamic REIT is a collective investment scheme in real estate, in which the tenant(s) operates permissible activities according to the Syariah” SC Guidelines for Islamic REITs For real estate investment to be Shari`ah compliant, regards should be given to the following: • Utilization of the real estate must be Shari`ah compliant, including tenancies & sub-tenancies • Financing of the acquisition / development of the real estate should be Shari`ah Compliant • Investment of cash / liquidity must be made in Shari`ah compliant instruments • Insurance scheme for protecting the real estate should also be Shari`ah compliant

8. General Regulatory Framework for REITs & Islamic REITs (Malaysian) • Malaysian REITs fall within the regulatory purview of the Securities Commission; and if listed, Bursa Malaysia Securities Berhad also • SC Guidelines – oversee the listing & sale of REITs & Islamic REITs on Bursa Malaysia • An Islamic REIT must comply with both Guidelines – the Guidelines for Islamic REITs (November 2005) & the general SC Guidelines on REITs (January 2005) • There must be Shari`ah committee / adviser for the Islamic REIT to oversee Shari`ah compliance

9. Malaysian SC’s Guidelines for Islamic REITs (November 2005) • Generally, tenants of a property acquired by an Islamic REIT must operate permissible activities in accordance with Shari`ah principles • If there are “mixed” tenants – the proportion of rentals from the operation of non-permissible activities to total turnover of the Islamic REIT in any current financial year must not exceed 20% • A building where all the tenants operates only non-permissible activities cannot be included in an Islamic REIT even if the total rental complies with the 20% ruling

10. Rental activities that are classified as non-permissible: Financial services based on riba (interest); Gambling/gaming; Manufacture or sale of non-halal products or related products Conventional insurance; Entertainment activities that are non-permissible according to the Syariah; Manufacture or sale of tobacco-based products or related products; Stockbroking or share trading in Syariah non-compliant securities; and Hotels and resorts Malaysian SC’s Guidelines for Islamic REITs (November 2005)

11. Malaysian SC’s Guidelines for Islamic REITs (November 2005) • For new tenant(s) – the Syariah committee / adviser must advise the Islamic REIT manager against accepting new tenant(s) who operate activities that are fully non-permissible • The Islamic REIT manager must ensure that all forms of investments, deposits and financing instruments comply with Shari`ah principles • Takaful schemes must be used to insure the real estate • Note: Unless otherwise approved by the trustee and the SC, the total borrowings of the fund to acquire properties shall not exceed 50% of the total asset value of the fund at the time the borrowings are incurred – (SC Guidelines on REITs)

12. Taxation Issues… • Malaysia relaxed its stamp duty on properties being sold under REITs to avoid double-taxation • Effective 1/1/2007 (for 5 years), dividends from REITs listed on Bursa Malaysia will be subjected to a final withholding tax of 15% for non-corporate investors • Foreign institutional investors will be subjected to a final withholding tax of 20% • Local & foreign corporate investors will be subjected to existing tax treatment & tax rate (27% in 2007) • From 2007, all income from REITs – exempted from tax, provided 90% of total income of REITs is distributed to investors

13. How would a Malaysian Islamic REIT be administered ? • All REITs are governed by multiple levels of stakeholders to ensure maximum investors’ protection: • Unit holders; • Manager; • Shari`ah committee/adviser; • Trustee; and • Regulatory authorities • Islamic REITs – must comply with both SC Guidelines on REITs and SC Guidelines for Islamic REITs • All REITs are established through a Deed of Trust executed by the trustee who acts on behalf of the unit holders. • The Deed of Trust governs the REITs and the roles of the trustee and the management company

14. Structure of an Islamic REIT Shariah Committee/ Adviser Unit Holders Unit holders Appoint Trustee Oversee Shari`ah Compliance Units subscribed in IPO and/or acquired in the open market Income Management fees Management Company ISLAMICREIT Acts on behalf of Unit Holder Trustee Management services Direct Ownership of Properties Net Property Income Property Management Fees Properties Property Manager Property Management Services Adapted from Farris Aziz Faizal, Senior Manager CIMB Islamic

15. Examples of Islamic REITs in Malaysia • First Islamic REIT – Al `Aqar KPJ REIT: • launched on 24th July 2006 with an issue of 340m units • listed on Bursa Malaysia on 10th August 2006 • backed by health-care assets (specialist hospitals)– valued at RM481m • Al Hadharah Boustead REIT: • launched on 15th January 2007 with an issue of 220m units • listed on Bursa Malaysia in February 2007 • backed by plantation assets

16. STRUCTURE OF AL-`AQAR KPJ REIT Shariah Committee Members Unit Holders Advise the Al `Aqar KPJ REIT on Shariah related matters Holding of Units Distributions Acts on behalf of Unit Holders Management Services Manager (Damansara REIT Managers S/B) Al `Aqar KPJ REIT Trustee (Amanah Raya Berhad) Management Fees Trustee Fees Ownership of Properties / Building Property Management Fees Net Property Income Maintenance & management services Maintenance Manager (Healthcare Technical Services) REIT Properties Comprising of 6 Specialist Hospitals 6 Hospital Tenants(which are subsidiaries of KPJ) Rent Maintenance & management Fees Rental payments

17. Global Islamic REITs? • No clear-cut regulatory framework • No clear-cut Shari`ah standards • Would AAOIFI or other Islamic standard-setting bodies take up the responsibility?

18. Issues… • Prohibited sectors? Would the same sectors listed under DJIM / FTSE stock selection criteria be equally applicable to Islamic REITs? • Possible categorization of sectors based on modes of usage: • Accommodation; • Hospitality (hotels & resorts); • Offices; • Storages & warehouse • Medical treatment • Education & research • Shopping complex / mall • Entertainment, etc.

19. Issues… • What about the benchmarking? Would different host-country / jurisdiction have different benchmarks? • What about the various financial ratios – e.g. 33% leverage? Are they still applicable to Islamic REITs? • Ideally – Islamic REITs should adhere to the ratio, and financing needs should use Islamic based transactions • As of now – these issues are left to the ijtihad (juristic deliberations) of the Shari`ah committee / advisors to the Islamic REITs

20. Shariah compliance Income stability Capital stability & growth Quality real estate Liquidity Diversification Expert management Transparency Prospects & Opportunities for Islamic REITs? • Keen interest by investors in real estate projects and property funds due to its perceived stability and potential value appreciation • Why Islamic REIT? Tax savings & liquidity (compared to normal real estate funds) • Prospect? Definitely! • With the infrastructure in place – Islamic REITs can grow multi-fold • What are Investors looking for in Islamic REITs?

21. Potential Investor Base? • Pension and provident funds – likely to be a major player because of tax treatment of REITS and the mandates to invest more in real estate • Retail and private banking investors – focus on yields versus alternative local investment products, thus, REITs product should be priced competitively • Fixed return funds – typically takaful / insurance companies who look for safe predictable returns, low volatility and strength of management • International real estate & equity funds – focus on key fundamentals, e.g. global diversification, high net of tax returns compared to other markets, stability of underlying capital and experience and reliability of manager

22. Quality Islamic REITs: Quality Management: Criteria for successful Islamic REITs • Quality underlying real estates with sustainable growth prospects • Asset diversification • Long-term investment planning – growth by asset value enhancement & further asset acquisition • Result-oriented manager • Transparency to investors • Independence of management (outset & ongoing) • Strong management team • Effective Shari`ah governance

23. The Way Forward… • The Malaysian Islamic REITs regulatory infrastructure – lay a fresh foundation for the growth of an Islamic REITs market in Malaysia • This in turn will hopefully contribute & spur the growth & expansion of Islamic REITs infrastructure & market – regionally & globally • The success of Islamic REITs depends on its ability to create value & deliver its full potentials – lessons can be learnt from other successful REIT markets • What matters most: • The quality of the Islamic REITs • The quality of the management of the Islamic REITs

24. Thank You Wassalamualaykum wrt wbt