Sabana brings Islamic REITs to broader audience

Asiamoney, December 2010

In November, Sabana REIT achieved a number of landmarks: the largest ever Islamic real estate investment trust (REIT); the first one to be listed in Singapore; and perhaps the transaction that demonstrates beyond argument that Islamic securities can be attractive to investors who couldn’t care less about religion.

Sabana was, on the face of it, a curious deal. Singapore’s REIT market has made its name through listings from big developers like CapitaLand or Mapletree, choosing collections of quality assets and listing them with a view to careful management and expansion under their own brand name. This, on the other hand, seems a looser affiliation of 15 industrial properties, and the closest thing to sponsorship comes from Freight Links Express, which injected five of them. Management of the assets will not be contributed by a big property developer but will be through independent management controlled by the shareholders themselves.

But if that seemed rudderless, it didn’t show in the deal’s reception. It raised S$636.1 million (US$500 million) and brought in four cornerstones: Al-Salam Bank of Bahrain, Capital Investment & Brokerage of Jordan, Fidelity’s FIL Investment Management (Hong Kong), and a subsidiary of Metro Holdings called Meren.

“I think it’s a landmark deal from a number of perspectives,” says Jason Kern, managing director and head of real estate advisory for Asia Pacific at HSBC, sole financial advisor and one of the lead managers on the deal alongside UOB and Daiwa. Partly that’s because it’s a big deal by any measure; partly because of its scale as a Shariah deal; and partly because of its contribution to Singapore’s overall REIT market, cementing its place as the regional hub. But chiefly, it’s about investors. “We have truly brought a brand new set of global investors to the Singapore market through this deal,” he says. “30% of the shares went to Shariah-compliant investors who had never invested in a REIT before, much less in Singapore.” And the bulk, 70% went to non-Shariah buyers.

Perhaps the most significant name in the investor roster is Fidelity. It’s rare for Fidelity to come in as a cornerstone investor in any circumstances, but to do so in an Islamic deal is particularly striking. Fidelity declined to comment, saying it never comments on individual stock holdings or IPOs. But Kern says: “Non-Shariah investors like Fidelity saw the underlying attractiveness of the deal in terms of the size and the yield and the high quality of the assets. Those fundamental aspects were attractive enough to get them on board; for them, the Shariah-compliant nature was neutral.”

This is exactly what Islamic bankers have been saying for years, but have lacked an obvious example to point to for evidence. In Malaysia in particular, it is commonplace to claim that Islamic finance works primarily as a solid financial system producing attractive assets, regardless of whether you embrace the faith or you don’t. “In Malaysia, some of the largest providers of Islamic financial services will tell you that more than 50% of their clients are non-Muslims, some up to 70%,” says Dr Zeti Akhtar Aziz, governor of Bank Negara Malaysia. “In our sukuk market, we see many issues from non-Muslim countries, and many investors. They look at whether products or services meet their financial requirements, and whether they are competitive. So long as you can offer those two elements, Islamic finance offers tremendous benefits,” including for investors who are not drawn to it for reasons of religion.

Still, for a deal that mainly went to non-Muslims, it was interesting to note that Sabana went for a level of Shariah compliance far higher than that typically required in neighbouring Malaysia. In fact, of the Shariah book, most were from the Middle East, including Kuwait, Jordan, Bahrain, the UAE – and Saudi Arabia, by far the toughest market of them all on Shariah compliance.

This is an interesting decision. Until now, Malaysia has been the main centre for Islamic REITs. Malaysia’s Securities Commission issued its guidelines for Islamic REITs back in November 2005, and the first three REITs in the region are here. They are based on interesting assets: the first, Al-Aqar KPJ REIT, established in June 2006, is underpinned by hospitals; the next, Al-Hadharah Boustead REIT, was the first plantation REIT in the world; and the third, Axis REIT, was distinctive for having started life as a conventional REIT in 2005 before begin converted to an Islamic structure in December 2008. (Another REIT, Cambridge, began a similar conversion but abandoned it.)

Malaysia is unusual in having published guidelines for Shariah compliance in REITs, but that’s no surprise: Malaysia stands out for the clarity of its regulation and practice in Islamic finance across the board. But the part of these guidelines that leaps out is that in Malaysia, a REIT can get up to 20% of its total turnover from what it calls non-permissible activities. So, for example, if you own a shopping mall, the fact that it includes a supermarket that sells alcohol, or a newsagent selling lottery tickets, does not count you out of Shariah compliance in Malaysia provided no more than 20% of the rental income to the trust comes from those sources. Likewise if your office tenant mix includes a conventional insurer, or a bank, or a broker who deals in non-compliant shares, the same 20% rule applies. (Crucially, this has to be from mixed compliant and non-compliant activities; if your property has tenants in which everyone conducts non-permissible activities, such as a cluster of bars, then that’s not Islamic even if the rental from those activities is less than 20%.)

That’s considered rather liberal in Shariah terms, and it certainly won’t wash in the Middle East. “There are varying degrees of Shariah compliance,” says Kern. “We have gone for the most strict interpretation.” The Shariah committee Sabana put together included Mohammed Elgari, a Saudi scholar (profiled in Asiamoney in September 2006) who brought a more strict interpretation of compliance than would be common among Malaysian scholars. Doing so opened the investor base to the Middle East.

Making a REIT Islamically compliant is not particularly complicated. Chiefly, it’s about avoiding tenants or sources of income from no-no areas like defence, alcohol, gambling, porn or conventional financial services. In practice, this makes industrial portfolios easier to consider than, say, retail or office property which is always going to have a wide range of contributory tenant mixes. “Generally, industrial property would be a lot easier than commercial assets,” says Tan Jeh Wuan, managing director of the Islamic Bank of Asia in Singapore, although he does point out that defence assets – like military barracks – can be trickier to handle.

In many cases it’s unavoidable to have some income that is indirectly non-compliant, so the practice is simply to cleanse that income – generally by giving it to charity so it never features in the income stream. “The work required is nothing other than getting that respected Shariah board put in place, having scholars do due diligence on the rent, and then looking at individual tenants to make sure the leases are not for businesses that constitute a violation like alcohol or tobacco.” Retaining the Shariah board represents something of a compliance cost, but Kern puts it at about US$100,000 a year.

Leverage is also an issue, and this is a continuously grey area in Islamic finance. Naturally, the Quran did not get into precise percentages of acceptable leverage, so it has been left to scholars and the market to decide what degree of (compliant) borrowing would represent undue risk to the point of becoming speculation, which is prohibited.

“The purest view of an Islamic REIT would be that 100% of the financing is done in an Islamic way, in which case the ratio is not an issue,” says Tan at IBA. “At the other extreme, the Dow Jones Islamic Index has created some accepted minimum standards of leverage for Islamic investors to buy equities. In between this and pure REITs come a whole range of standards, and it depends how Islamic investors look at these standards relative to their internal requirements.” As a rule of thumb, indices like the Dow Jones Islamic index consider 30% leverage a ceiling for any stock to be considered; in Sabana’s case, it starts out with leverage of 26.5%, compared to an average for the REIT sector generally in Singapore of over 30%.

The fact that industrial REITs are an obvious area for further Islamic growth stands Singapore in good stead, because it is already a haven for industrial REITs – in fact, they are the largest cluster. Moreover, they tend to be backed by very big names: Mapletree, which has a logistics REIT, is backed by one of Singapore’s sovereign wealth funds, Temasek; and Global Logistics Properties, the industrial property company which came within a whisker of being Singapore’s largest ever IPO earlier this year, is backed by the other, Government of Singapore Investment Corporation. GLP is not a REIT but is considered likely to spin one off in due course. CapitaLand, the biggest of all REIT developers, is better known for its retail REITs but is also a candidate.

Asiamoney asked all three groups, who responded with varying degrees of practised ambiguity. “We are always exploring and seeking new opportunities in the market,” says Jonathan Kuah at CapitaLand. “However, at this juncture we do not have any immediate plans.” At Mapletree, Lily Ler, who speaks for the MapletreeLog logistics REIT, was less open to the idea. “To be in compliance with the Shariah investment principles will mean imposition of restrictions and conditions on the logistics players, which would not be welcomed unless they are able to impose similar conditions on their principals,” she says. “Until our customers are ready to accept such terms, we do not think it is practical to make MapletreeLog Shariah compliant in the immediate foreseeable future” – although that’s not the same as saying that new REITs might not consider the approach.

Bankers are certainly talking to groups like this. “We are seeing a lot of interest following the Sabana REIT,” says Tan at IBA. Interestingly, he says that many of these inquiries come from companies in the GCC considering an Islamic REIT in Singapore. “The advantage is, it opens up the investor base. In a normal REIT conventional investors can of course participate, but in an Islamic REIT both conventional and Islamic can do so.”

Raja Teh Maimunah, head of Islamic market development at Bursa Malaysia, also suggests we may see REITs from the GCC appear in Asia – though naturally, she’s expecting them to come to Kuala Lumpur. “Companies in the Middle East are not as familiar with what the REIT structure does, but real estate is close to their heart,” she says. “The Asian REIT market could possibly address some of the challenges with the regard to the returns investors are seeking in the GCC from their real estate investments. Some listed REITs in Malaysia start out with a yield of 7 to 8% at IPO. That’s virtually unheard of in the GCC.”

Another sign of interest in the GCC is that prior to the financial crisis, the Islamic International Financial Market – a Bahrain-based multilateral backed chiefly by Middle Eastern countries, which seeks to standardise markets and products in Islamic finance – was looking at issuing guidelines and templates for Islamic REITs. Changes in the market through the financial crisis caused it to look at other things instead, and the bulk of its work since then has been on standard templates for hedging mechanisms in order to bring that element of Islamic finance into line with International Swaps and Derivatives Association (ISDA) structures. “But it’s possible we will return to Islamic REITS if the industry requires it,” says Ijlal Alvi, CEO, in Bahrain.

If GCC property developers are considering REIT listings in Asia, then Singapore may be able to make a useful point of distinction. Malaysia is clearly the regional centre for Islamic finance, and has a track record going back the better part of 20 years in its capital markets now. But if Singapore can use the Sabana example to suggest that levels of Islamic stringency are typically higher there, it’s possible it could steal a march. “It is essential for the Islamic REITs that are coming up in Singapore to be able to set a relatively high level of Shariah compliance standards so that they meet GCC requirements,” says Tan. “We want to maintain those high standards so that investors can look at an Islamic REIT listing in Singapore as, by general consensus, meeting the GCC standards.”

Still, the fact that there are REITs with more liberal interpretations of compliance in Malaysia does not mean it would not provide a willing audience for stricter structures too. In the end, these deals will stand or fall on what they offer to investors, and more than anything, that’s just about providing a decent deal. “Sabana REIT offered very good commercial returns,” says Tan. “That is what attracted conventional investors: if it makes sense, they come in.”