Public and Private Real Estate: The Options and Challenges of Investing Within a Sharia Context

By Thomas Polson of Polson Real Assets. Polson Real Assets is a long-term, Halal real assets financier that invests, co-invests, and provides small balance financing for North American real estate and infrastructure projects. 

Individually investing in physical commercial real estate and efficiently operating it is nearly impossible for most Americans these days unless their personal capital or connections—whether from friends, family, or financing—are substantial. This situation leads many to consider joining private fractional ownership pools. However, for the majority, capital is instead deployed in public real estate investment trusts (REITs) directly or via funds in their brokerage and retirement accounts. A number of these American REITs have been deemed Sharia-compliant and are held by well-known Islamic funds and indexes. Particularly in sectors such as multi-family housing, assisted living, industrial zones, timber estates, and self-storage properties.

Public Real Estate

Real Estate Investment Trusts (REITs) offer numerous advantages for investors, particularly in providing exposure to physical assets and ensuring mandated income distributions, which hold significant importance within an Islamic framework. In fact, I dedicated my Islamic finance master's degree dissertation to exploring the utilization of Islamic REITs as a quasi-fixed-income alternative. To this day, I continue to regard these instruments as invaluable tools for generating recurring income. At the time of my research, my enthusiasm for the REIT use case was amplified by the scarcity of options in the American market, with only one mutual fund offering exposure to Sukuk^[i]. Fortunately, the landscape has since evolved, with several Islamic investment options now available for both income generation and capital protection.

Public REITs can also provide signals regarding the broader real estate market and the economy's trajectory. This was notably observed in multi-family REIT occupancy rates during the financial crisis of 2008/2009. Companies like Camden Property Trust (CPT), managing over 30,000 apartments at the time, experienced occupancy rates nearing full capacity a year before the crisis became widely recognized. However, robust occupancy rates do not necessarily ensure stable or rising REIT prices, particularly in times of economic uncertainty. Mid-America Apartment Communities (MAA), overseeing just over 100,000 units, currently boasts an occupancy rate of 95.5%. Despite this, its share price has declined by approximately 27% over the past twelve months. Nevertheless, its quarterly dividend has consistently increased from $0.96 to $1.47 over the past five years. In essence, multi-family REITs may serve as indicators of rising mortgage default rates and offer insight into where yield can be found if the economy begins to falter.

Sharia-compliance screening for public REITs over the last decade has primarily focused on evaluating the financial status of the listed management company and the sectors in which their real estate operates. For example, an apartment manager with a conventional debt-to-market cap ratio below 33% would typically be considered compliant by Islamic index providers. However, REITs operating in the hospitality or restaurant sectors, as well as certain types of office spaces, would not be deemed compliant, regardless of their financial metrics.

Times do change, and several leading Sharia scholars are becoming wary of American, Asian, and European REITs that have been classified as Sharia-compliant. In September 2021, Shariyah Review Bureau in Bahrain^[ii] issued an extensive private research study on this topic. They surveyed twenty-four highly respected scholars from around the world. Twenty of them from countries such as Bahrain, Saudi Arabia, The United Arab Emirates, The United Kingdom, and Malaysia came to the conclusion. "That conventional REITs should only be classified as Sharia-compliant after the vetting of contracts and documents (as well as financial information) making up the REIT, including ongoing supervision in light of Sharia principles and standards."

This is because scholarship and compliance decisions are based on the timely availability of public information and regulatory reports for listed securities. In an era where nearly everything can be discovered through Google and ChatGPT, the internal management of most REITs can appear mysterious to outsiders.

The general structure of a REIT is composed of a listed management or operating company (similar to a fund manager) and a portfolio of underlying property assets that all sit in private subsidiary entities. Thus, these concerned scholars have no way of knowing how these underlying property entities operate.

Sharia compliance in real estate mirrors the scrutiny applied to companies or investment funds. Essential factors that must comply include the business sector, revenue sources (ensuring no non-compliant tenants^[iii]), financing methods, capital management, and investor-management contractual terms. Along with lease structures, there are distinct financial risks and obligations for asset owners in Islamic finance. These should not be transferred to lessees, as seen in triple-net or absolute leases, where commercial tenants may cover property insurance, taxes, maintenance, minor repairs, and potentially structural fixes.

Being in America, some of these factors cannot likely be Islamically amended due to legal constraints or the lack of service providers. For instance, Islamic insurance (Takaful) is not available here, and insurance is a requirement to receive mortgage financing. Conventional insurance can be acceptably applied and viewed as an operating expense rather than an investable asset, as is the case in Muslim-majority countries.

When we examine Public Storage, the largest self-storage REIT in America, it boasts a portfolio comprising over 2,900 facilities.^[iv] That likely includes wholly-owned, financed, and franchised properties. This REIT has been deemed Sharia-compliant by most Islamic indexes. However, scholarly financing concerns would specifically focus on identifying facilities with conventional debt-to-equity ratios exceeding permissible limits.^[v]

But scholars would also want to know what is being stored in these facilities, as it could mean that the square footage the rents are tied to, might be used for non-Halal goods. I've had this exact conversation before with a scholar who asked if there were tenancy rules against the storage of alcohol, food, tobacco, munitions, or hazardous materials (and most properties do). These are valid concerns, as there are self-storage companies that have dedicated properties and sections within properties intended for tenants such as wine collectors^[vi], businesses or retail establishments^[vii], and those with items that require climate-controlled environments.^[viii]

The challenges of accurately understanding the operations of public real estate might lead some of us to hesitate and explore other options. However, this doesn't imply that we should steer clear of REITs listed within Sharia stock screening apps or those included in Islamic indexes or funds. It's worth noting that the four scholars from Shariyah Review Bureau's survey that endorsed the legitimacy of Sharia-compliant American REITs methods are industry leaders too. They reside in Saudi Arabia, Pakistan, and the United Arab Emirates. Unfortunately, Muslim American investors have limited investment options within this sector. Thus, it's essential to carefully consider both perspectives and make your own informed decisions.

Private Real Estate

However, if the more conservative view of ensuring that properties operate, as the twenty surveyed scholars would prefer, is needed. Then Muslim Americans require a reliable mass-market private investment vehicle, that is open to retail, affluent, and high-net-worth investors. That should be focused on ensuring that all facets of commercial property financing and ownership are conducted properly.

Maintaining proper compliance from the start may make it necessary to focus on a select few sectors, possibly multi-family and single-family rental properties, which pose the least amount of Sharia-compliant tenancy risk. This strategy could involve acquiring existing properties and undertaking new developments, given the significant shortage of low-income, affordable, and moderately priced rental housing in much of America.

One of the most surprising revelations I've encountered in recent years is the availability of Sharia-compliant commercial real estate financing from various private and institutional lenders in America. What's intriguing is that many of these lenders don't actively advertise this service. Even more intriguing, I am aware of one financing arrangement that originated from the family office of a Texas billionaire. This development presents a significant shift for Islamically focused firms, freeing them from the constraints of cash-only investments that often limit portfolio growth. And for some, they could avoid having to navigate complex cross-border structures to access Islamic lenders and capital in regions like the Middle East or Southeast Asia.

We can leverage all these pertinent facts and figures to establish a comprehensive cooperative, capable of accommodating Muslim American investors from various income brackets, to establish an inclusive US Islamic housing trust with its own Sharia Supervisory Board. A nationwide initiative in this sphere is not a new concept. Consider Crescent Wealth in Australia, which operates Sharia-compliant retirement funds.^[ix] Since its launch in 2013, it has gained over 12,000 members who contribute monthly. These contributions are diversified across stocks, REITs, sukuk, and private real estate investments.

The view on wealth in Islam is that it all belongs to God and man’s purpose on Earth is to be a good steward. To increase its value for the good of the world and the betterment of future generations. Thus the time horizon for investments is very long term. With this in mind, this trust could focus on key areas of the country that have been deemed as future hubs of climate migration, such as the Northern Midwest and New England. That today may have the smallest populations, lowest crop yields, and least desirable or not enough investment opportunities. But in the future, the opposite could be true, if one can stand less profits in the near term, given the significant investment required to turn these migration zones into modernized and habitable communities.

Factors

The problem we have to solve is where are Americans going to live and thrive over the next 100+ years. These regions could see significant population growth due to steadily worsening climate conditions (and the associated economic hardships^[x]) in the Southern and Coastal States over the next twenty years. That if geographically planned out correctly could allow the trust’s sustainable communities to have long-term economic viability and more importantly, livability.

There is a strong likelihood that livability in much of America could become quite difficult by 2040 and potentially catastrophic by 2060.^[xi] Those who start preparing for these shifts now could ensure that their children and/or grandchildren are well-positioned with physical safe-havens. In addition to possibly benefitting from first-mover speculative, buy and never sell investments in safe havens. Like John Jacob Astor said on his deathbed in 1847, “Could I begin life again, knowing what I now know, and had money to invest, I would buy every foot of land on the island of Manhattan.”^[xii]

This endeavor will not only serve the broader public interest but also offer members a sustainable investment avenue generating consistent cash flow over the decades to come. Eventually, all or a portion of this trust could transition into a publicly traded and fully fledged Sharia-compliant REIT. That could then be easily bought by future Muslim investors through their brokerage and retirement accounts. But as well for those in foreign countries looking for Sharia-compliant exposure to the US housing market. Both of which are not easily attainable today.

Sample Target

Vermont is one such State that has a housing deficit and is one of these targeted climate safe-havens. It is a beautiful place that swells with city dwellers in the summer and skiers in the winter. But the hard truth is if 10,000 or even 5,000 people desperately needed to move there this year there simply would not be enough housing, schools, social services, and jobs to support them. A point in fact, even with the current deficit of 6,800 houses in the State.^[xiii] Data on REITs Across America shows that there are no residential REIT properties in Vermont.^[xiv] Because there are few if any large or modern apartment buildings that the likes of Camden Property Trust would snap up. Or build, because the few cities they have are not large enough to support several 300+ unit buildings.^[xv]

Given that outside of the Burlington metro center, the majority of Vermonters live in counties with less than 65,000 people, and most of the towns and villages in these counties have less than 8,000 residents. Rather than building in these towns that may not have the infrastructure to support lots of new residents. It may be more feasible to increase the housing supply on demand, by laying out the infrastructure now, for dozens of future sustainable ecovillages to be built over the next ten to twenty years near existing economic centers. So that Vermonters and future climate migrants will be close enough to civic, economic, education, and healthcare. Where each ecovillage will have a community center, housing grid plan, and its own renewable energy, water, sewer, waste management, and agricultural systems.

This is not a new or novel approach but rather a large-scale, planned copy of the 170-acre EcoVillage at Ithaca^[xvi] in New York, whose residents built it out over the last 33 years. Residents own their homes and participate in agriculture, education, and civic operations. The core difference would come in the ownership structure as noted above with the multi-member cooperative theme. Where each Vermont ecovillage would give residents the option to be renters, or owners in the entire village. That would also include non-resident external investor members, who may be larger or organizing benefactors. Each cooperative owns and operates the land, infrastructure, and properties. Built on demand, modular homes would arise when new residents apply to live in these communities. However, the Islamic trust would sit above all these communities to direct land purchases and development and will hold a non-dilutive minority to medium equity stake in each ecovillage.

What could these communities be called and where else around the world aside from Ithaca can we draw inspiration. That has achieved long-term and stable successes. Just by chance, the Swedish side of my family immigrated to the United States from Halland County. A region in Southwest Sweden that has long been known as an agrarian self-sufficient society. Predominantly rural in nature with pockets of industrial and technological advancement that are of great importance to the rest of the country. And thus with longtermism and sustainability in mind each “Halland Park '' could range from 50 to 500 acres in size to accommodate all the trappings of life in Vermont or other States along the Canadian border.

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About the Author:

Thomas Polson is the manager of Seattle-based Polson Real Assets (www.polson.company). A Halal, multi-member cooperative that deploys capital within US real estate, infrastructure, and commodities. He has been involved with Islamic finance since 2008, with two graduate degrees in the subject, and on-the-ground industry experience in several countries.