Realty check

Real estate has long been an attractive asset class for Middle East investors, offering security and strong returns. However, concerns have been expressed recently that investors, including some banks, are over-exposed to the sector, and that the huge amount of property scheduled to come online in markets like the UAE in the next few years could contribute to a housing crash.

Perhaps with this in mind, Middle East institutions are coming up with new products and investment strategies to profit from real estate without leaving themselves overly vulnerable if the market dips.

The real estate sector is making a move towards securitisation, allowing new instruments to be developed. Real Estate Bourses Net Company (RBNCO) specialises in registering and listing real estate projects through a specialised stock exchange. Clearing and settlement is done electronically with instant and neutral real estate speculation readings and indicators.

Real estate assets can be changed into securities that can be traded, increasing transparency and opening the market to retail investors. Safar Al Harthi, chairman of RBNCO, says that countries including Saudi Arabia, the UAE, Qatar, Bahrain, Jordan, Egypt and Morocco are currently establishing real estate bourses.

Meanwhile Al Mazaya Real Estate Development recently launched the region's first real estate index in cooperation with Sahara Group. The Al Mazaya Real Estate Index measures the price of properties across the GCC, allowing prices in different countries to be compared.

New instruments are also drawing attention. Real Estate Investment Trusts, or REITs, have been popular in many more mature markets, including the US and UK. A REIT is a company structure for a corporation investing in real estate which allows it to reduce the amount of income tax it pays. The structure requires specific legislation and may not be successful in countries with low or zero tax regimes, but it is becoming popular in Europe, the US and, increasingly, Asia. A joint venture between DIFC, Abu Dhabi Commercial Bank and the real estate division of Macquarie Bank is due to list a REIT on the DIFX at some point in the future.

Pakistan is also reported to be licencing REITs; its June 9 budget stated that all sellers of land to a REIT would be granted a tax holiday until 2010. Japan was the first Asian country to allow REITs, followed by South Korea, Singapore, Hong Kong, Taiwan and Malaysia.

Dubai Islamic Bank offers a Shariah compliant way for Islamic investors to benefit from REITs without investing directly into them. Its Shariah compliant four-year Capital Protected Global REIT Note delivers returns based on the performance of REIT indices.

"As you would invest in a Dow Jones index, we invest in a REIT index," says Naveed Ahmad, head of investment and product development, wealth management, Dubai Islamic Bank. "We're investing in companies or indexes that eventually put their money into REITs.

"For Shariah compliant investors, REITs provide somewhat of a stable income without that much volatility. When you've got a regular income stream that is very good for Shariah compliant investors because it's very difficult for them to get that in any other way, aside from the sukuk market. Real estate investments where there's a lease income provide that sort of income stream."

Customers' funds are protected through a Shariah compliant principal protection mechanism structured by Deutsche Bank. The minimum investment is $10,000 per note and there are no management fees.

Dubai Islamic Bank previously launched a REIT note through its wealth management platform, and Ahmed thinks the instrument has huge possibilities.

"I think that definitely as the market matures REITs are going to be a very exciting opportunity," says Ahmad. "The only thing is that REITs were initially created for taxation purposes. If there isn't any worry about taxation, people may say: ‘Why do we invest in a REIT?' The only other interest might be from mass retail customers who say, ‘We can't go and buy 10 buildings, let's go into a REIT', and then gauge the performance from there."

However, for the moment, funds are the most popular means for the region's investors to obtain returns from the sector. Al-Futtaim Investment Management Limited (AFIM), based in DIFC, has launched a $500m real estate development fund, which will focus on large-scale mixed-use urban developments in the Middle East and North Africa region.

Al-Futtaim MENA Real Estate Development Fund will focus on key cities within the MENA region including Abu Dhabi, Casablanca, Algiers and Cairo. Several potential deals have already been identified in these cities. Marwan Shehadeh, Managing Director, Al-Futtaim Capital and Senior Executive Officer of AFIM said: "There has been a growing appetite for the real estate asset class among regional institutional investors and we wanted to open up and share our experience and track record with such institutions. We believe this kind of investment vehicle will allow investors to get exposed to a very promising asset class which will give them an opportunity to earn strong risk-adjusted returns." Morgan Stanley will act as the fund's structuring adviser and placement agent.

Real estate is a particularly suitable asset class for Islamic investors, so it is no surprise that Shariah compliant funds have been successful. Kuwait's Global Investment House (Global) has structured Islamic real estate funds, and is perhaps the first to offer a real estate fund that invests on an ijara basis across the whole Middle East and North Africa region.

"Following an approach which is either income, whereby you acquire the assets, or the development, comes with an element of risk," said Rakesh Patnaik, head of real estate investment funds, Global, speaking at the Funds World Middle East 2007 conference. "What we have done in our product is eliminated those elements of risk by creating a structure that preserves capital and at the same time ensures the investors a fixed return."

Funding can take two approaches: lease-to-own or sale-and-leaseback.

Patnaik explained the ijara lease-to-own concept: "In simple terms, the fund is a source of capital which would finance the real estate construction costs. While we finance a parcel of land or a construction project, we first own it and then we lease it to the developer, who becomes the borrower of capital from the fund. For the capital we lease to the project, we take a fixed ijara payment on a quarterly basis from the borrower of capital, which is what we deliver to the shareholders of the fund. It's a very simple concept."

This structure means that investors are not exposed to construction risk, market risk or default risk.

Patnaik added: "With the pay and leaseback option - in which companies who want to go asset-light would sell the assets to a fund and take it off their balance sheet - the fund then becomes the lessor and the previous owner becomes the lessee. Therefore we have a lease payment back to us with a buyback guarantee at the end of the fund's life."

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