The African real estate market has experienced significant growth in recent years, driven by urbanization, a growing middle-class population and increased foreign investment. However, for Muslim investors who seek to adhere to Islamic finance principles, traditional real estate investment methods may not align with their values. In response to this need, Islamic finance instruments for real estate investments have emerged as a viable and ethical alternative. This article explores these instruments, their availability in Africa, and the challenges faced in their adoption.
Islamic Finance Principles
Islamic finance is guided by Sharia principles, which prohibit interest (Riba), excessive uncertainty (Gharar), and investments in activities considered forbidden (Haram), such as alcohol, gambling, and pork. Instead, Islamic finance promotes ethical conduct, risk-sharing, and asset-backed transactions, making it a unique and socially responsible financial system.
Structuring of Islamic property finance transactions
According to Sharia (Islamic Law), the ideal business transaction is based on partnership (Musharakah), where each participant shares in the risks and rewards of a venture. Islamic property finance transactions also embody these beliefs. Although there are various ways to organize an Islamic property finance transaction, the most popular ones used for property transactions are:
- Murabaha: Murabaha is a method whereby an asset is bought by the bank and then immediately sold to the buyer at an increased price on a deferred payment basis. It is sometimes referred to as cost-plus financing. The increased purchase price is to be paid in fixed-term instalments, as agreed upon by the bank and the buyer. The payments are secured by a court order granting the bank a charge on the property
- Commodity Murabaha: Commodity Murabaha is an alternate structure frequently employed by banks in practice but less preferred by Sharia experts. This entails exchanging a commodity for debt that can later be backed by property. This plan is quite versatile because it may be applied to a purchase, a refinance, or even unsecured financing. Multiple trades can be made to get a variable rate
- Ijarah and Diminishing Musharakah: Ijarah means ‘to give something on rent’. A customer can use property or equipment owned by an Islamic bank for a certain period at a pre-determined cost under the concept of Ijarah. Ijarah is quite similar to a lease, and the assets covered by the Ijarah finance can be used for vehicles, houses, buildings, plants, or machinery.
To make this process more Shariah-compliant, the bank must transfer a share in the property to the buyer as each contribution to capital is paid. This concept is known as ‘Diminishing Musharakah’.
- Istisna: An Istisna contract is a purchase agreement for the future delivery of an asset that will be built or constructed in compliance with a specified specification. To put it simply, the bank will first sign into a development arrangement with the developer and then a back-to-back deal with the client, charging a profit element and allowing for postponed payment.
Benefits of Islamic finance instruments
- Ethical and Sharia-Compliant: Islamic finance instruments adhere to strict ethical and Sharia principles, making them suitable for investors seeking to align their investments with their values
- Risk-Sharing: Many Islamic finance structures promote risk-sharing among parties, reducing the burden on individual investors in case of losses
- Asset-Backed: Islamic finance instruments are typically asset-backed, ensuring that investments are linked to tangible assets, such as real estate properties, which enhances security
- Socially Responsible: Islamic finance encourages investments in sectors that positively impact society, such as affordable housing and sustainable development
Current scenario of Islamic finance instruments in Africa
Africa is home to a significant share of the global Muslim population. In 2019, about 16% of the world’s Muslims resided in Sub-Saharan Africa, while another 20% lived in the Middle East and North Africa (MENA) region.
Africa, with its vast Muslim population and its infrastructure development needs, offers a promising opportunity for the growth of Islamic finance.
However, liquidity problems, slow development of new products, regulatory issues and competition from bigger conventional banks pose challenges to the development of Islamic finance in the continent.
Conclusion
Islamic finance instruments for real estate investment hold significant potential in Africa, offering investors a socially responsible and ethical avenue to participate in the region’s burgeoning real estate market. By adhering to Islamic principles, these instruments can attract diverse investors while promoting sustainable and inclusive development. Given the significant Muslim population in Africa, the prospects for its growth in the region remain promising.
While challenges exist, concerted efforts by governments and market participants can help realize the full potential of Islamic finance in African real estate, contributing to economic growth and social development in the continent.
