To ensure they can compete head-to-head with conventional lenders, Sharia-compliant financiers face the challenge of increasing market awareness. Natale Giostra explains

The principles governing Islamic finance were established more than 1,400 years ago; however, the modern application only goes back five decades. More recently, the market for Sharia-compliant finance has accelerated, as both developed economies and newly developing economies have begun to embrace its ethical principles, resulting in a new-found popularity. Now, with 10 of the world’s 25 fastest growing markets in Muslim-majority countries, and a potential market of more than 2bn people, industry forecasts estimate that Islamic investments might grow beyond $2trn by 2015. 

As an increasing number of European jurisdictions seek to attract Sharia-compliant assets, Islamic finance has enjoyed impressive growth. 

Indeed, conventional borrowers in the real estate market in particular are turning to Sharia-compliant finance providers to fulfil financing needs. While this is enabling Islamic financiers to add to their list of clients, the majority of whom explicitly require Sharia-compliant financing, the knowledge of Islamic finance in the conventional lending space is still limited. 

In this context, participants in the real estate market are still developing their knowledge of Sharia finance and what features of a property it addresses. 

Sharia-compliant finance is a form of ethical funding, that prohibits investment in, or the conduct of, businesses whose core activities include:
• The manufacture or distribution of alcoholic or pork products;
• Significant involvement in gaming (gambling, including casinos), brokerage, interest-based banking or impermissible insurance;
• Certain types of entertainment (satire and pornography); or
• Impermissible amounts of interest-based indebtedness or usury.

When directed at the real estate sector, it may seem as though these prohibitions narrow the type of financeable properties down, however, real estate assets are becoming diverse and a large amount comply with the exclusions and fit for Sharia-compliance. As an example, these exclusions simply mean that single-tenant properties such as pubs, cinemas and banks’ headquarters are not permissible; other assets like hotels are financeable as long as they do not have alcoholic beverages in the rooms’ mini-bars or other non-compliant operations. 

To ensure an asset is compliant, a Sharia Board is appointed, either externally or in-house, to review the asset. This is a panel of scholars that approves proposed new investments and also reviews the operations of the company or asset to ensure that its activities will be conducted in an ethical manner in accordance with the principles of Sharia. This can be a complex process as different scholars will hold sway depending on the jurisdiction and, as is often the case with a young and growing industry, the rules and regulations are flexible with multiple differences of opinion, requiring a skilled hand to navigate. 

Even with the above restrictions, most of the assets traded in the real estate market are Sharia. As a result, excluding properties let primarily to banks, insurance companies and luxury hotels, Sharia financiers are only missing a few opportunities in comparison to conventional lenders. This is also ensured by the fact that Sharia-finance expertise are the responsibility of the financier only; the obligor/finance seeker does not need nor is expected to have a developed understanding of Islamic finance, enabling it to be used by the conventional lending market.  

The industry is seeing increased demand for Sharia-compliant financiers as conventional real estate borrowers begin to recognise them as a class of nimble, responsive investors who are truly property fundamentals-orientated and understand sponsors’ key objectives and underlying business plans. As a result, Sharia finance providers have seen their presence in the conventional lending space grow over recent years, as equity sponsors differentiate between conventional and Sharia-compliant financiers less and less. 

This has been the case in the European real estate market, which has seen an impressive increase in funding through Sharia-compliant banks in a market that is competitive.  

The size of the market for equity sponsors who are specifically looking for a Sharia-compliant partner is too small for Sharia finance providers to rely on alone, but it represents a market far less crowded and competitive. With Sharia-compliant financiers’ ability to cater to both conventional and Sharia-compliant obligors, many have chosen to build their footprint in the conventional lending space and are competing effectively against conventional outlets. In light of this, when focusing on the market outlook for real estate finance, Sharia-compliant financiers tend to focus their attention on the conventional space. 

However, to ensure they can compete with conventional lenders head-to-head, Sharia-compliant financiers face the challenge of increasing market awareness that conventional borrowers can use Sharia-compliant financiers as a true alternative. The lack of awareness and education of Sharia-compliant finance is a market imperfection. Once borrowers understand they do not have to be looking explicitly for Sharia-compliant partners or be experts in Sharia, more successful partnerships will be created between Islamic financiers and conventional borrowers. 

The growth of the Islamic finance real estate market in proportion to the conventional will continue to increase as Sharia investors are no longer known for financing residential developments but also for providing competitive senior and mezzanine investment finance in the UK and across Continental Europe – as is the case now. The UK has willingly led this movement, becoming the hub for Islamic finance in the western world through its innovative initiatives and in-built advantage; English law is the governing law of international Islamic finance transactions as it is favoured by most parties for its ability to allow flexibility and certainty to those involved.

Natale Giostra - head of real estate finance at Gatehouse Bank

Natale Giostra is head of real estate finance at Gatehouse Bank