Institutional and individual investors around the world are increasingly seeing commercial real estate as a key part of their portfolios. Investors seeking income, capital appreciation and, to some extent, inflation protection, continue to use commercial real estate as a means of further diversifying their assets.
REAL ESTATE INVESTING: AN OVERVIEW OF THE OPTIONS
Traditionally, direct investment in property requires a substantial capital outlay. The broader the scope of investments (i.e. by region, country, or sector), the larger the investment capital required. While full ownership affords full control over a property, the truth is that most investments end up in private equity real estate funds. Although such investments can be successful, the often lengthy investment period and long duration of such funds, prohibit liquidity with investors being unable to access their capital when they need it. It is also worth noting the absence of publicly traded, or other broad liquid, derivatives to hedge the risks associated with owning real estate. We believe that the solution to allaying several of these risks is to gain exposure to the asset class via the publicly traded shares issued by real estate investment trust (REITs) and real estate operating companies (REOCs). REITs and REOCs own and operate income-producing real estate such as office buildings, regional malls, shopping centers, distribution facilities and apartments. Investments in equities of public REITs/REOCs – as a complement or alternative to direct ownership – have been popular for many years in the US and Europe. This form of investment is now growing increasingly popular in other parts of the world.
Global REITs have historically delivered stable income from dividends, while at the same time provided diversification benefits. In our opinion, listed property companies are an efficient way for small and large investors to gain exposure to global, professionally managed, institutional-quality commercial real estate. Indirect access to real estate (via REITs/REOCs) allows this exposure to be accomplished with smaller levels of investment capital. We view REITs/REOCs as cost-efficient liquid investment vehicles offering exposure on a regional or global scale, along with diversification across property type, and often with greater tax efficiency than the direct-ownership structure. The main markets for listed property securities include the US, Japan, Hong Kong, the UK, Australia, China, Germany, Canada, the Netherlands and Singapore.
Finding a place for shari’a principles in property securities investing
While there is a long history of private real estate investments conforming to shari’a principles, accessing such investments through publicly traded property stocks is a relatively new phenomenon. Additionally, Islamic investors have frequently asked us whether an investment strategy involving property stocks can be enhanced by creating value in addition to the religious aspect.
As an investment manager of a mutual fund that invests exclusively in sustainable public real estate companies, we have formulated a portfolio investment strategy that incorporates companies adhering to both shari’a principles and to stringent environmental, social, and corporate governance guidelines. This unique approach to global real estate investing aims to, not only enhance financial results, but combine the discipline of shari’a with the discipline of sustainability – a powerful combination in our view.
Two key principles of shari’a-compliant investments are the prohibition (i) of earning interest and (ii) of investing in companies involved in non-permissible activities (such as the sale of alcohol or tobacco). Shari’a-compliant portfolios must be reviewed and certified by experts; this is typically conducted by a board of shari’a scholars. The board ensures that the portfolio’s/fund’s investments conform with Islamic principles.
Given the specialized nature of managing shari’a-compliant mandates, EII’s investment team has become adept in analyzing and monitoring securities to ensure they meet various quantitative tests. Most of these tests are associated with maximum debt ratios. Additionally, EII has nearly 10 years’ experience of managing a shari’a mandate and working with the sponsoring entity and/or shari’a advisor to review shari’a guidelines and make recommendations for enhancements, while preserving the spirit of the prohibition of earning interest. EII has also developed automated tools to track debt ratios and perform the necessary calculations to determine whether individual securities meet the client’s defined shari’a investment guidelines. For example, EII conducted the checks listed below to ensure a mandate was conforming to the client’s guidelines. This particular portfolio/fund was prohibited from owning:
- Companies whose total debt divided by the trailing 24-month average market capitalization or total assets (whichever is the greater as the denominator) is >= 33% (where: “total debt” = short-term debt + current portion of long-term debt + long-term debt);
- Companies whose sum of cash and interest-bearing securities divided by the trailing 24-month average market capitalization or total assets (whichever is the greater as the denominator) is >= 33%;
- Companies whose accounts receivables divided by the trailing 24-month average market capitalization or total assets (whichever is the greater as the denominator) is >= 33 per cent; or
- Companies involved in the following “Non
Permissible” activities:
- the manufacture and/or sale/ distribution of alcohol, tobacco, pork, music and pornographic productions;
- restaurant or hotel/motel businesses (except those that do not sell alcohol);
- operators of gambling casinos or manufacturers of gambling machines;
- operators of movie theatres and cable television companies;
- conventional financial services (i.e. non-shari’a compliant banks,
- investment funds, brokerage firms, insurance businesses or any other interest-based financial services activity); or
- the manufacture of military equipment or weaponry.
Additionally, this mandate was prohibited from owning the following instruments or any derivatives of them:
- futures;
- options;
- swaps;
- preferred shares;
- short sales; and
- other instruments whose components involve the payment or receipt of interest.
As part of the process of monitoring the debt, leverage, cash and accounts receivable ratios for the holdings in the portfolio, EII also compiled a monthly report and identified any of the securities in the portfolio that had fallen out of shari’a compliance. The complete list of compliant holdings, as well as any non-compliant securities, were provided to the client and its shari’a advisor for regular review. Securities that were out of compliance for two consecutive months were sold out of the portfolio (they could qualify for re-inclusion at a later date should the company move back into compliance).
It is always worth bearing in mind that funds that adhere to Islamic Investment Guidelines may perform less well than those with a similar investment objective, but that do not conform to these religious principles.
OUR EXPERTISE IN SUSTAINABLE INVESTING
EII has been managing the EII Global Sustainable Property Fund since 2012. The Fund will only consider securities that meet certain environmental, ethical and social criteria before qualifying for investment.
The Fund shall invest in equities and equity-equivalent securities from issuers that cooperate in the implementation of environmentally friendly and sustainable development, meet minimum standards for human rights, support the cause of reasonable working conditions and value the principles of good governance. Special attention is also paid to a large number of exclusionary criteria. Essentially, these criteria exclude the sectors of alcohol, nuclear energy, gambling, green genetic engineering, pornography, weapons and tobacco as well as violations of labor and human rights, promotion of child labor, the conducting of animal research and controversial environmental and business practices. The fund management of the EII Global Sustainable Property Fund is supported in their selection process by oekom research AG, one of the world’s leading independent rating agencies for sustainable investments. Oekom conducts in-depth research on all of the companies it monitors prior to assigning each company a sustainability rating. It is particularly dedicated to maintaining the quality, independence and transparency of the companies/securities evaluation process. Securities must meet a minimum rating to qualify for inclusion in the fund. Oekom provides ratings updates quarterly, and if a security no longer meets the minimum rating it is sold out of the fund.
EII’s history of managing real estate equity securities according to Islamic law dates back to 2006. Our ability to identify securities that conform to sustainable investment principles while also adhering to shari’a guidelines, may add value for investors interested in gaining exposure to shari’a-compliant real estate.
MORE ABOUT EII
EII Capital Management, Inc. (“EII”) is an independent employee-owned investment management firm engaged in structuring and managing portfolios invested in regional and global real estate securities and US direct real estate. The firm was founded in 1983 to invest foreign capital in the US across asset lines. The original mandates included equity, fixed income and private real estate. From these combined efforts the firm discovered the attraction of securitized real estate as an alternative means of acquiring real estate assets and developed a portfolio management service specifically in this sector. As an innovator and leader in the management of listed- property securities, EII received its first US REIT mandate in 1987 and began managing real estate securities portfolios for US institutions in 1993. The firm extended its offering globally, to include European and Asian real estate securities management in 2000 and has been running global portfolios – comprised of North America, Asia and European property securities – since 2001. EII started managing global real estate security Shari’a-compliant mandate in 2006 for a Saudi Arabian entity and, in 2012, the firm launched a Global Sustainable Property Fund.
Our objective in managing global real estate securities portfolios is to achieve total returns consistent with global real estate while providing liquidity and flexibility of public markets. EII’s investment management philosophy centers on the belief that superior risk-adjusted returns can best be achieved by investing in, what we consider to be, a portfolio of high-quality real estate companies capable of sustainable and predictable long-term cash flow growth. Our global strategy is opportunistic and focused on investing in real estate opportunities that in our opinion, offer relatively attractive total return potential.
As with any private real estate allocation, the foundation of our portfolios will be exposure to those companies we believe to be higher-quality, “Core” real estate around the globe. However, we actively seek to buy that real estate at pricing that is discounted because the market has not yet recognized what we see developing in the underlying fundamentals. We are comfortable investing in companies that generate additional value through development. Whether “Core” or “Tactical,” we believe our portfolio investment ideas offer exposure to a mix of focused real estate investment opportunities/trends that are compelling on the basis of the underlying fundamentals and valuation. We actively seek out under-valued companies which we believe are well-managed and well-positioned to capitalize on those trends.
