Big boost to real estate

By Kabeer Yousuf — MUSCAT — The Islamic finance has a plethora of benefits to the various sectors of the economy and also accelerates the revival of the domestic real estate sector, according to experts in real estate. Experts unanimously opine that the decision to licence the operations of Islamic banking in the Sultanate has opened up windows of opportunities for the banking sector.

The successful launch of Bank Nizwa, an exclusive Islamic bank, and the opening of Islamic banking operations windows by conventional banks is evidence that the banks plan to capitalise on the opportunities presented by the new industry and meeting the increasing demand for Sharia-compliant finance.

“As far as the Sultanate is concerned, Islamic finance has the potential to, among other things, helps the revival of the domestic real estate sector. This impending resurgence will help investor confidence in the local market, but also accelerates national economic growth,” says Philip Paul, Head of Agency, Cluttons Oman.

He said that over the past two decades Islamic finance has burgeoned into a $1 trillion global industry that has served as a vital source of funding for real estate projects and other developments. Several modes of Islamic financing have been developed based on the primary tenet of Islamic financial intermediation that mandates the sharing of risk between the lender and the borrower.

“Islamic banks have focused on real estate because it fits with Islamic principles, which require an underlying physical asset in all transactions. Many other investment classes are also off-bounds due to prohibition on gambling and interest. "Some institutions have relied heavily on real estate as the primary business model, investing in real estate, developing real estate and lending to activity around real estate. The real estate investment and finance products could involve purchase of land, buying and selling, build and sell, build and lease, and redevelopment," Philip told the Observer.
He pointed that there have been challenges to Islamic banking due to slump in real estate sector in the region. However, advocates say the system has built-in protection when compared with the conventional financial institutions as excessive risk taking is banned.
In addition to the market risks there are areas such as competencies and expertise to supervise risks effectively.
“Islamic commercial banks have been conservative in lending and collateral valuations. Investors are being very cautious and asset prices are going down, so it is more challenging.
"The challenges are in identifying the quality of asset, asset price risk, rate of return risk, displaced commercial risk and equity investment risk."
Nevertheless, the bank’s exposure for Islamic banks typically takes the form of a profit sharing contract; whereby the Islamic bank puts its own money at risk in the form, effectively, of an equity stake. The bank’s exposure depends on both the skill and honesty of its partner.
“This potent mix of high risk and moral hazard is an area which needs greater scrutiny, in fact. As the real estate assets which banks are financing continue to be owned by their clients, much Islamic bank exposure to real estate risk may not appear on the sector’s balance sheets," Philip said.