A Real Estate Investment Trust (REIT) is a security that can be sold like stock. Concurrently, it can be invested (either directly or indirectly) in real estate through properties and mortgages. There are varying types of REITs with the major ones being Equity REITs and Mortgage REITs. There are also Islamic REITs mainly found in countries operating under Islamic Laws. Islamic Real Estate Investment Trusts (REITs) is similar to conventional REITs in many aspects. However, the difference is that REITs operate under Islamic laws namely Shariah (Zain, Azharuddin, Nadiah, and Abdul, 2007, p. 1). They are investment schemes in the real estate sector in which tenants operate activities that are allowed by Sharia principles (Ibrahim & Ong, 2008, p. 401).
Generally, the structure of conventional and Islamic REITs are similar. The only difference is that REITss seek to ensure that Sharia Laws are observed in all aspects of the investment. The goal of investing in real estate is to generate revenue. In REITs, the source of returns is scrutinized to ensure Sharia compliance. Thus, the operations of REITs in different countries are governed by both the government and Islamic laws. This paper reviews some of the studies done on IREITs with the aim of determining their effectiveness during economic downturns. This is a significant provision when considered critically.
The preference of IREITs as investment options has increased tremendously in many countries. However, the ability of IREITs to perform better than conventional REITs is not known with certainty. In order to know the effectiveness of IREITs when compared to REIT, the similarities and differences of the two have to be known. Conventional REITs attain their shares through investment companies/trusts. This type of investment can either be in the form of purchase, management, sale or lease of real estate property. It can also, be in the form of buying of shares in companies that are publicly traded. They enable inclusion of professional management in real estate and offer diversified venture portfolio for investors. REITs are of three categories namely Equity REITs, Mortgage REITs and Hybrid REITs. Equity REITs hold and manage returns generating assets. They are usually fully functional organizations and engage in the development, administration and acquirement of commercial real estate. Mortgage REITs are majorly involved in credit extension to real estate owners. They can provide both short-term and long-term mortgage financing. It is interest-oriented funding and incorporates risk-taking. This occurs due to the fact that real estate markets are astoundingly responsive to market interest rates.
Majorly, hybrid REITs incorporate mixed features of both equity as well as mortgage REITs. This means that they possess, manage and offer mortgage loans to real estate owners and developers. In all, IREITs apply Sharia laws while conventional REITs do not. These REITs have many benefits hence popular among investors. They investors invertors with a wide range of investment options (Chan 2008, p. 10). Investors can choose from the diversity of the products portfolios offered and can also spread risk. They also provide high liquidity thus shares can be easily converted into cash (Nelling, Mahoney, Hildebrand & Goldstein 1995, p. 1). In addition, there are tax transparencies and profits that investors make are never taxed (Chan 2008, p. 10). Finally, REITs usually earn investors high dividends as the proportion to be distributed to shareholders is usually high.
However, for the IREITs, there are additional advantages. IREITs have low correlation with most common stocks traded and act as a hedge against inflation (Chan 2008, p. 10). For this reason, IREITs can withstand economic downturns when compared to conventional REITs. Additionally, they earn higher dividend incomes, especially when a tenant operates a nonpermissible activity, and there is income certainty. Rental and real estate activities prohibited by Sharia laws that govern REITs include financial services in which interest is charged, gambling and speculation, conventional insurance, and entertainment activities considered unethical under Islamic laws. Others include the manufacture of cigarettes, stockbroking, and management of hostels.
Groups engaged in transactions might be personal investors, tenants, asset managers, as well as venture companies. According to regulation requirements used in Malaysia, companies offering REIT as an investment option must commit at least 50% of their total assets to real estate. This can be either directly or indirectly. The requirements for REIT administration are different in different countries. In the US, corporations are demanded to invest at least 75% of the entire assets in real estate so as to run REIT. Korea and Singapore requires a minimum of 70% of total assets to be in real estate in order for a company to operate REIT (Chan 2008, p. 10). This shows that operating IREIT in Malaysia is affordable compared to operating REIT in other countries such as the United States.
REITs also require trustees who are custodians of investors’ assets (Chan 2008, p. 10). The trustees also safeguard the interest that investors have and all relationships are governed by a deed signed by all parties involved. Trustee deeds outline the goals of the REIT and the roles of management and the trustee. This ensures effective management of investors’ assets. In addition, REIT management requires that a property manager has to be contracted. The role of property manager is to control assets, prepare budgets and prepare financial records for all properties (Chan 2008, p. 10). These are uniform requirements across many countries and thus effects economic downturn cannot be analyzed using these aspects only.
There are limited studies on the performance of Islamic REITs. REITs have developed for a long time in western nations like the United States and Britain. They have operated for decades and have offered steady incomes and investment opportunities for individuals. Most investors in REITs have long-term goals and prefer large investment portfolios. However, developing countries, such as Malaysia, have not developed REITs as investment options compared to developed nations. According to Newell, Ting & Acheampong (2002, p. 109), Malaysia was the first country to develop Sharia compliant REITs. The property markets in these countries are not well developed and thus REITs is immensely attractive.
The business environment of developing countries is competitive, and thus REITs are attractive. Malaysia developed guidelines for IREITs and formed property trust funds (PTFs). The guidelines are Sharia compliant, and this attracted a lot of Muslim investors. However, studies have indicated that non-Sharia compliant REITs perform better than Sharia compliant REITs. Most researches have focused on the development of Islamic REITs and workability of Islamic REITs. Some studies have suggested that Islamic REITs provide wider portfolio diversification advantage and lower risks compared to conventional REITs (Chyi & Ting 2009, p. 208). In a study carried out to determine the effect of global financial crisis on REITs in Malaysia and other countries, analysis basis was on risk and return performance on market value. The study found that the global financial crisis negatively affected both property and stock markets in all countries under study (Hamzah, Rozali & Tahir 2010, p. 62).
Almost all REITs and IREITs in Malaysia reported negative results in investments. The average monthly returns that real estate companies in Malaysia posted were low and had a high risk compared to common stocks (Ong, Teh, Soh & Yan, 2012, p. 73). The REITs in Malaysia recovered faster after the global financial crisis. A study by Hamzah, Rozali & Tahir (2010, p. 62), found that during the global financial crisis, most of the REITs in Malaysia performed dismally. This is a critical provision when considered comprehensively with respect to REITs and its applicability in the financial markets.
There are suggestions that poor performance of REITs, both conventional and Islamic, could be due to the short time of development that they have had. Most invertors in developing countries are skeptical and cannot take the risk of increasing investment portfolios. Investors perceive REITs in Malaysia unfavorably, and this could be a reason for poor performance of both Islamic REITs and conventional REITs (Zain Azra’I, Azharuddin & Nadiah 2007, p. 1). Many investors in Malaysia do not have adequate knowledge on REITS, and this leads to low demand and low rates of participation. In general, only a few comprehensive studies that seek to ascertain whether Islamic Real Estate Investment Trust performs better than the conventional Real Estate Investment Trust has been done. The topic needs more research to determine the influence of Islamic laws on REITS.
References
Chan, S 2008, ‘Reit basics’, Malaysian Business Journal, vol. 1 no 1. pp. 10-17.
Chyi, L & Ting, K 2009, ‘The role of Malaysian securitised real estate in a mixed-asset portfolio’, Journal of Financial Management of Property and Construction, vol. 14, no. 3, pp. 208-230.
Hamzah, A., Rozali, M & Tahir, I 2010, ‘Empirical Investigation on the Performance of the Malaysian Real Estate Investment Trusts in Pre-Crisis, During Crisis and Post-Crisis Period’, International Journal of Economics and Finance, vol. 2, no. 2, pp. 62-69.
Ibrahim, M & Ong, S 2008, ‘Shariah Compliance in Real Estate Investment’, Journal of Real Estate Portfolio Management, vol. 14, no. 4, pp. 401-414.
Nelling, E., Mahoney, J., Hildebrand, T & Goldstein, M 1995, Real Estate Investment Trusts, Small Stocks and Bid-ask Spreads, Bloomington Press, Bloomington.
Newell, G., Ting, K & Acheampong, P 2002, ‘Listed property trusts in Malaysia’, Journal of Real Estate Literature, vol. 10, no. 1, pp. 109-118.
Ong, T., Teh, B., Soh, C & Yan, Y 2012, ‘Malaysian Real Estate Investment Trusts: A Performance and Comparative Analysis’, International Journal of Economics and Finance, vol. 4, no. 5, pp. 73-84.
Zain Azra’I, A., Azharuddin A & Nadiah, A 2007, “Islamic REITs in Malaysia: Practical Issues”, Asialaw Journals, vol. 1 no 1, pp. 1-10.