Real estate is the safest investment source concerning Islamic financing and halal investment. Islam already has a law that defines the importance of dealing with tangible assets and their preference. Real estate has got this one advantage and shariah support. You rent out your house or property, the tenant pays rent as per schedule. There is no sharia rule breaking here.
The landlord is receiving the rent in return for the right given to tenants to stay and occupy his property. In another case, any person buys a property and after a while sells it for a profit. It is a business deal. So, there is no interest, speculation, concealment, fraud, or excessive uncertainty involved. Tenants, landlords, buyers, and sellers are fully aware of all the terms and conditions.
Exceptions of Islamic Real Estate Financing
There are some exceptional scenarios in Islamic real estate financing. Sometimes we don’t know the source of real estate collective income. Such as earning through a mall might include some non-sharia-compliant investment or conventional businesses like Chinese restaurants using pork, or alcohol, conventional bank branches, casinos, and many other conventional and controversial businesses. Now what to do in this situation? Unlike residential properties, commercial projects can be a tricky subject to be fully eligible for shariah-compliant rules.
So, Islamic scholars have decided that the income from the forbidden business activity should be below 5 percent. That 5 percent will be donated to any charitable organization to cleanse the income before the profit distribution to the investors. But if the amount is very low and insignificant then there is room for the investors to add the amount to the whole profit.
Using Islamic Finance to Finance Real Estate
Four main Islamic financing structures are used to finance real estate projects.
- Commodity Murabaha Structure
- Ijara Lease Structure
Commodity Murabaha Structure
Commodity Murabaha Structure involves financing a commercial property. In this case, the financier buys a property from a supplier on an immediate basis. Sells the property to the customer but receives the payment in installments and includes the markup. On the other hand, customer directly sells the commodity in the open market. Commodity Murabaha is similar to the traditional Murabaha. The only difference is that the customer immediately introduces the property into the market.
Here we are talking about real estate property. For instance, the financier buys a house for price X from a supplier and pays the amount in a lump sum. The financier then sells the commodity to another customer by adding its profit (X+P)=Y. Y is now the price offered to the customer. They both agree to do the transaction and the customer will pay the amount in installments and this amount also includes the markup.
Now the customer is allowed to sell the house again in the market at price X as the market prices do not change much. After that, he will pay the security to the financier out of the amount he received. The security is paid to make the future payments guaranteed and in case of breach of the Murabaha Commodity Agreement. It is also kept to avoid breach of the Agreement’s other rules or conditions.
Also Read: Who Should Not Invest in Real Estate?
Ijara Lease Structure
Ijara lease has generally many types but here we are discussing the real estate residential property Ijara lease. It is the case the financier acquires the property by purchasing it on a lump sum basis. He then gives it to the customer/tenant at a premium lease. The tenants monthly pay the lease just like a rent payment. They also have the right to buy the residential property in a lump sum during the agreement after paying the bullet amount, which will be equivalent to the purchasing price financier had already paid.
After paying all the lease installments or bullet price the property rights will be transferred to the tenant. Just like commodity Murabaha, the Ijara lease may also contain any conditions, obligations, and terms. In case of breach of the agreement or terms, the financier has the right to forfeit the lease, terminate the agreement, and possession transfer. These conditions motivate the lessee to pay the due payments carefully.
Mudaraba is the most commonly used method in sharia-compliant investments. In real estate, we term it as a limited partnership where one person provides the funds to buy and regulate the property and the other one (Mudarib) provides professional real estate management services. The mudarib can also be a fund manager and he hires someone else (a professional real estate manager) to provide the real estate duties. Sharia boards have strictly prohibited Mudarib’s capital contribution.
Only the other partner (Rabb-ul-Maal) is liable to pay the amount. They both then share the profit according to the terms. The mudarib takes the profit in form of his fee and the Rabb-u-Maal treats it as his profit share. The profit might be the rent or any other property selling price.
Unlike Mudaraba, The Musharaka system in real estate is based on partnership financing and joint venture. All the partners bring the capital to buy a real estate property and share the duties and responsibilities as per the agreement. Here the profit and loss distribution is defined straight to the point and the partners are not allowed to go beyond these;
- Profit can be allocated by assuming the capital contribution and the amount of participation in the partnership and business management.
- The profit cannot be paid to a specific partner in favor or for a specific reason nor paid in the lump sum to any partner.
- In case of loss, the loss bearing is to be distributed as per capital contribution by each partner.
- A partner is not liable to pay the liability of any other partner and no one is liable to take anyone’s guarantee.
You might have already heard of the Islamic terms Murabaha, Ijara, Mudaraba, and Musharaka. It is a great fact for the Muslim concerned realtors and real estate investors that the real estate industry matches the best shariah-compliant rules and standards. These standards are now frequently applied in Europe to eliminate the rights exploitation of any party. It is recommended to invest in real estate if you are a Muslim and want to earn halal and long-term profits and it is also a source of an immediate roof on your head in case of emergency.