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Understanding Islamic-Compliant Commercial Development and Finance

Real estate is universal. We all need buildings to live, work, and play in. But the industry of real estate differs depending on geography, law, culture, and customs. One clear example of this is how the property industry operates in many areas of the Muslim world. The process is made more complex because Islamic religious laws, called Sharia, which have many principles and rules covering commerce and finance. As the population of Muslims continues to grow and their economies develop, Islamic-compliant finance is becoming increasingly important to understand. Overcoming complexities that most Westerners don’t even know to exist can open new opportunities for Muslims and non-muslims to get more deals done together. 

Islam is the world’s fastest-growing religion. The global population of Muslims is expected to increase by roughly 70 percent, from 1.8 billion in 2015 to nearly 3 billion in 2060. By 2060, approximately 30 percent of the global population will be considered Muslim, up from 25 percent in 2015, according to Pew Research. In the United States, Muslims will replace Jews as the second most populous religious group by 2040, reaching 8.1 million American Muslims by 2050, roughly 2 percent of the population. Muslim populations in Europe are growing even faster.  Depending on migration scenarios, Muslims could represent 14 percent of the European Union’s population by 2050. Navigating Islamic-compliant commerce is critical to doing business with Muslims, whose economic importance globally and in the Western world continues to grow. 

Islam’s finance and commerce laws are a form of ethical investing. It prohibits investing in and conducting business with any enterprise that manufactures or distributes alcohol, pork products, or, in the case of certain interpretations, firearms. Gambling businesses, brokerages, and illicit types of entertainment are also forbidden. The hardest obstacle to overcome is rules forbidding the concept of riba, roughly translated as “usury.” While there is some debate about what exactly riba is and its various forms, it’s commonly understood in the $2 trillion Muslim banking industry that charging interest is forbidden. Riba makes doing business with most insurance companies and other businesses with interest-based business models impermissible. 

These rules certainly make commercial development, leasing, and financing more difficult but things can still get done with the right work-arounds. The most common form of acquisition and operating financing structure in Islamic real estate finance is the ijara, which sets up a ‘project company’ and a ‘funding company.’ The deal is set up like an auto lease, establishing a lessor-lessee relationship rather than a creditor-debtor relationship. The funding company must own the asset and be fully responsible for maintaining and insuring the property. The funding company leases the asset to the project company as lessee. The rent the project company pays is identical to the debt service from the conventional bank, providing the funds to service the debt. The process is tantamount to a reverse mortgage, paying rent instead of interest. 

Mudaraba is another important legal structure in Islamic financing, whereby the lender (rab al maal) and a borrower (mudareb) enter a profit-sharing partnership to undertake an investment. The borrower is solely responsible for managing the investment, earning a fee that is deducted from any profits for managing the investment, and the parties share in any profits according to a contractually agreed-upon ratio. This way, no entity is earning interest, but a fair price on services provided. 

The third major form of Islamic financing structure you need to know about is sukuk. This is most similar to a bond in Western finance. Since interest-paying bonds are forbidden, a sukuk sells an investor a certificate, using the funds to purchase an asset that the investor group must have a direct partial ownership stake in. Whereas a bond is a direct interest-bearing debt obligation, a sukuk involves direct asset ownership interest, making it permissible. Most importantly the sukuk cannot be speculative and must be invested into a tangible asset. 

The world of Islamic-compliant finance has developed over centuries and is far more complex than we can cover in this article. But education about this unique aspect of real estate in the Muslim word is a first step; many Westerners don’t know this is how a large portion of the world does business, closing themselves off from a growing segment of clients and customers. The good news for laymen is they don’t have to understand everything by themselves to do Islamic-compliant business. Most Muslim banks, financial institutions, and propery firms in the Islamic world employ Shari’ah scholars to help investments stay compliant. Muslim or not, individuals rarely have the expertise to determine Sharia compliant business practices themselves. If you’re considering doing any type of business with Islamic-compliant businesses, you’ll be working with Shariah compliance scholars who often make up a board at the institutions they serve. 

Right now Islamic-compliant finance remains niche, but is growing at roughly 9 percent annually, now topping over $2 trillion. In the United States, financial institutions like the American Islamic Finance House, University Bank (through its subsidiary University Islamic Financial), and the Harvard Islamic Finance Project are making headway bringing the practices into the mainstream. JP Morgan Chase has even begun working in Islamic-compliant finance. 

Institutions and commerce are built around culture and laws and religion plays a major part in both regardless of nationality or belief system. Understanding the unique aspects of each business environment is key to further accelerating the development of our economies and, hopefully, lead to more cross cultural exchanges that can help bring us all closer together.

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