Islamic Finance Real Estate Tools
In the world of Islamic Finance, real estate is an ideal asset class.
There is a property occupied by a tenant who pays rent in exchange for the right to use that property.
Rent is paid to the landlord, who uses the rent to pay off various expenses, including financing costs – any money left over is the landlord’s profit.
The transaction is fair, tangible and morally uncertain. There is no speculation or unjust gains.
There are some exceptions to this, of course.
The use of the property in occupation is also a relevant factor in Islamic finance.
A building that contains a bar, a casino and a bank, for example, will not be appropriate for Islamic finance because its underlying operations — alcohol, gambling, payment of interest – are in direct opposition with the core principles of Islamic finance.
How Is Islamic Finance Used To Finance Real Estate?
Murabaha is a transaction in which the seller candidly reveals to the buyer the cost of the underlying commodity (as originally incurred by the seller), on the agreement that a specific amount of profit (mark-up) will be added thereto.
In this sense, murabaha is not an interest-bearing loan; it is, rather, a sale of a commodity for cash/deferred price.
Murabaha accounts for quite a large percentage of Islamic banks’ business (60-70% of all financing transactions are conducted through murabaha).
Tawarruq or Commodity Murabaha
Also known as a reverse or commodity murabaha. An Islamic finance technique used to provide working capital in compliance with Shariah.
In a Tawarruq transaction, a buyer (borrower) buys an asset (typically a freely tradeable commodity such as platinum or copper but can also be a property) on credit from a lender on a deferred payment basis and then immediately resells the asset on the spot market for cash to a third party.
Following this transaction, the:
- Borrower has the required funds.
- Borrower has an obligation to pay to the lender the original purchase price of the asset (usually the cost of the asset plus a profit element).
- Lender has made a profit on the transaction.
Ijara with Diminishing Musharaka
The principle of ijara with diminishing musharaka can be used for home-buying services.
It is essentially a co-ownership agreement.
This means that both parties own the property together, with separate stakes. So, each repayment – which is part rent and part capital (and part charges) – is used to purchase the bank’s shares in the property over time.
As the buyer’s stake grows, the bank’s stake shrinks. This reduces the amount of rent the buyer has to pay for use of the bank’s share of the property.
Istisna is a Shariah mode of financing broadly used by Islamic banks and financial institutions to finance the construction of buildings, residential blocks, houses and related units, as well as the manufacturing of aircrafts and vessels etc.
The Arabic word “Istisna” means “asking someone to make”.
It is defined as a sale contract between the seller and the buyer for the sale of an asset described in the sale contract and transacted before it is made.
To fulfil their obligation, the seller can either manufacture/construct themselves or have it manufactured/constructed by someone else to deliver it to the buyer on the date described in the sale contract.
The buyer can pay the sale price in a lump sum at the time of contract-signing or in instalments later in the manufacturing/construction process.