In the Islamic finance world, real estate has generally been the perfect asset class. An investment in a commercial real estate asset is usually an equitable, tangible and certain transaction with little room for speculation, uncertainty or unjust gains – all of which are impermissible pursuant to Shari’ah law. However, whilst hotels are a familiar asset class for Islamic and Middle Eastern investors, from a Shari’ah perspective, hotel financing can give rise to certain complexities, principally due to prohibited underlying revenue streams.
Nonetheless, the Islamic finance industry is quickly gaining momentum globally and with Shari’ah-compliant assets projected to reach $3.8 trillion by 2023, we are seeing a considerable and growing interest from our Islamic finance clients in the hotels and leisure sector.
Why is investment in hotels problematic from a Shari’ah perspective?
Islamic finance transactions must comply with Shari’ah law, which is derived primarily from the holy Qur’an and Hadith (reports describing the words, teachings, actions and behaviours of the Prophet Muhammad (peace be upon him)). Shari’ah principles of Riba (the prohibition of the payment or receipt of usury or interest), Gharar and Maysir (parties to a contract must have knowledge of the contract, its objects and its implications) are now well-known precepts within Islamic finance.
Most significantly in relation to hotel financing, however, is the prohibition on dealing in products and industries that are not compliant with Shari’ah law. Broadly, businesses which involve the sale and/or promotion of alcoholic beverages, tobacco, gambling, adult entertainment or pork (or otherwise non-halal meat products) are considered haram (forbidden). This is clearly problematic when considered in the context of most hotels (particularly in the Western world) that rely on bars, restaurants, casinos and in-room mini bars for a significant portion of revenue.
How can it work?
The concept of ‘halal hotels’ has recently become popular with Muslim consumers and, at least from a Shari’ah perspective, would likely be an attractive proposition for Islamic investors and funders. Halal hotels typically serve halal food and drink, have segregated-gender recreation facilities (including women-only beaches) and entertainment tailored to Muslim families. Online travel agents such as halalbooking.com offer opportunities to structure this type of trip.
We are also seeing interest from certain of our Islamic banking clients in financing budget hotels. This is largely because such hotels do not usually have a bar or restaurant (or mini bars) and as a result do not face the same compliance issues relating to underlying revenue streams. Subject to the view of their Shari’ah scholar board, some of these funders will also invest in conventional hotels provided that income from non-halal items falls below a set threshold, typically 5% of the hotel’s total income. The condition around this widely accepted de minimis threshold is usually that any income produced from haram items is given to charity as zakat and is therefore ‘purified’. It is important to note that in practical terms, the estimation of this income to be distributed is a contentious and complex task, which requires deep knowledge of accounting and finance as well as an exceptional ability to handle Shari’ah concepts and issues.
CMS has advised Islamic banks and investors on transactions where a separate special purpose vehicle is set up to hold income which is attributed to the non-halal operations of the business, outside of the main financing structure. This is most commonly achieved using a bifurcated Commodity Murabaha structure.
Given the interest in the hotels and leisure sector from affluent Islamic investors who have the ability to deploy significant capital, the Islamic finance industry is certain to continue its development in order to cater to this rising demand.