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Jun 28 2012

UK real estate is becoming a major asset class for Islamic finance

By Charlotte Kan The inauguration of The Shard of Glass skyscraper in London has put UK real estate firmly in the spotlight as an increasingly important asset class for Islamic finance.

Perched 310 meters above the London cityscape, making it the tallest building in the European Union, the Shard has already become an iconic landmark globally. It is also a strong symbol of the rise of Islamic finance, as the project was 95% funded by the Qatar National Bank in a Shariah-compliant transaction.

Located only a few miles upstream from the tower are the Chelsea Barracks. The redevelopment of the former British military barracks was also supported by Qatari financing, in yet another illustration of the growing fondness of the Islamic finance industry for prestigious UK real estate projects.

Such deals are often perceived as a way for Middle Eastern investors to exercise their "soft power" and spread influence by investing in high-profile real estate projects and world-famous hotels and office buildings. However, they also make a lot of financial and legal sense, argues Jonathan Lawrence, who advises on Islamic finance transactions at law firm K&L Gates in London.

One of the reasons why UK real estate has become increasingly important for the Islamic finance industry is that it has used real estate as an investible, tangible asset class on which to base its financial structures.

"Assets should lie at the root of most of these structures. However, the past year or so has seen the growth of Islamic funds and Islamic banks providing mezzanine finance. In such structures, a conventional senior bank lends the majority of the debt on an interest payment basis, the investors inject their equity and the mezzanine finance tranche is put into the structure in an Islamic compliant way. This is a feasible way of ensuring that deals get done. The senior conventional bank and the Islamic compliant mezzanine lender enter into an intercreditor agreement which governs the way each loan is treated and takes account of the Islamic sensibilities of the mezzanine lender," Lawrence says.

"London prime residential properties are still a focus whether for personal use or investment purposes. An Islamic compliant fund was launched in September 2011 to offer Islamic investors exposure to the London prime residential market," he adds.

Non-UK Shariah-compliant investors have tended to focus on prime or trophy assets such as the Shard and the Chelsea Barracks site. However, student accommodation in the UK has also been a major target for Islamic funds given the existence of rental guarantees, steady demand and upward-only rental payments. Lawrence believes we may see further developments in the broadening of the sector's outlook, as Shariah-compliant investors are considering a wider view of social infrastructure to include property investments in the UK healthcare, education and social housing sectors.

Another key attraction for Islamic finance participants in UK investments overall is the country's favorable legal framework.

"English law and the English legal system have proved particularly useful in propelling the UK into the forefront of safe havens for Islamic compliant investors. Although deals are structured for their Islamic compliance, the underlying governing law of the documentation will be English law and any disputes will most probably be referred to the English courts that are respected as impartial and relatively fast in deciding disputes. There is therefore a feeling of security in transacting in the UK," Lawrence says.

As with any financial transactions, there are risks involved in investing in the UK real estate market.

"Commercially, these types of deals are as subject to the fluctuations of the UK real estate market as any other transaction. Although it could be argued that they are better insulated, as the investments to date have tended to be into high-end developments and high-profile assets which, by definition, tend to hold their value longest. Technically, there is a danger that investors try and extricate themselves from deals by claiming that the Islamic compliance of the structure is not as they thought. This can be guarded against in the documentation by each party confirming that they will not seek to use non-Islamic compliance as a reason to terminate a deal," Lawrence explains.

© Zawya 2012


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