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									                               The Official Voice of the Foreign Real Estate Industry

October 2003   Real Estate Joint Ventures with
               Islamic Investors: Understanding the
               Keys to a Successful Relationship
               Craig Friedman and Imran Ahmed, Arch Street Capital Advisors, L.L.C.

               Since the reversal of the fantastic US bull market run in the spring of 2000, real estate
               professionals have witnessed a worldwide shift in investor sentiment in favor of cash
               flowing real estate investments. This trend is best evidenced through the exponential
               increase in cross-border real estate demand and activity. Multiple sources of capital–
               institutional investors, high net worth individuals, retail investors and fund sponsors –
               including organizations which pool real estate investment capital from many individuals
               or smaller institutions are looking for real estate opportunities in the US and Europe.
                   The surge in foreign investment in US real estate has been dramatic – 2002 volume
               was up 356 percent over 2001 and indications are that 2003’s volume will be even
               greater, with year over year volume as of March 31, 2003 up 34 percent over the same
               period of 2002. Nowhere has the increase in foreign investor demand been more striking
               than in the capital influx from Middle Eastern investors. Furthermore, the increase in
               Middle Eastern investment capital for US real estate is being driven largely by Islamic
               investors- i.e., individuals or entities investing in accordance with the principles of
               Islamic law (also referred to as Shari’a). Sponsors of Islamic real estate funds have
               indicated that this increased level of investment appetite is likely to continue in the near
               term. As an asset class, Islamic investors view real estate as a vehicle that will allow them
               to earn a risk adjusted yield premium relative to the available alternatives. This outlook,
               coupled with a projected fifteen percent annual growth rate in the Islamic investment
               universe’s demand for real estate and an increasingly positive view of the dollar’s
               prospects for appreciation against the euro, make a strong case for US real estate
               owners/operators and investment professionals to take some time to understand the
               fundamentals in working with this increasingly important investor base.

                                              Arch Street Capital Advisors, L.L.C.
                                     Two Sound View Drive, Suite 100 • Greenwich, CT • 06830
                                           Phone: (203) 622-3929 • Fax: (203) 622-3931
                       September / October 2003

    The Preference for Joint Ventures              objectives and constraints. The
    Islamic investors have frequently chosen       following sections outline potential
    to invest in joint ventures along side         issues that may arise in a joint venture
    established real estate owners/operators,      relationship and ways that some of
    rather than owning 100 percent of real         these issues may be mitigated.
    estate assets. There are many
    advantages to the foreign investor in          Permitted Tenancies
    pursuing this strategy:                        Perhaps the most fundamental aspect
        1. the investor gets the opportunity to    of a Shari’a compliant real estate
           leverage the experience and             investment is that the owned property
           contacts of a local operator’s          or properties must be leased to tenants
           management team, operating              that are not engaged in prohibited
           infrastructure and knowledge base;      activities. These activities include
        2. the investor may require its joint      banking, mortgage lending and
           venture partner to make a               consumer lending (including brokerage
           meaningful equity co-investment,        firms that extend credit to clients);
           assuring an alignment of interests      insurance; manufacturing and
           (a) between owners and (b)              distributing alcoholic beverages
           between ownership and property          (including restaurants and retailers
           management;                             that serve/sell alcohol); producing and
        3. the investor can avoid adding to its    distributing pork related products
           overhead burden for                     (including restaurants and retailers
           administration of the investments       that serve/sell pork); manufacturing of
           by relying on its joint venture         firearms and munitions; purveyors of
           partner’s personnel to carry out        pornography and profanity; gambling
           the monitoring, reporting and           and gaming; and tobacco and related
           other administrative functions; and     products.
        4. partnering with a well-known                 While this list may seem limiting at
           operator may provide the investor       first, there are asset classes which
           with name-brand recognition that        readily satisfy these tenancy restrictions
           immediately increases its own           - multifamily and self-storage are two
           credibility in the international real   examples. Other asset classes can also
           estate arena and augments the           satisfy the tenancy tests, provided that
           likelihood of success for any retail    care is taken in tenant screening. These
           syndication of its investment.          include industrial, office, and retail
                                                   properties with non-prohibited uses. A
    For the US real estate owners/                 simple rule for minimizing the potential
    operators there are also many benefits         for conflicts, as it relates to leasing
    to a joint venture with an Islamic             vacant space, is to focus on properties
    investor, however, there needs to be a         with a single Shari’a-compliant tenant,
    concerted effort by both parties to            or very few such tenants, with lease
    clearly understand each others’                terms that exceed the anticipated life of
the venture. By minimizing the                   “SPV”), which is owned and controlled by
anticipated lease rollover, the                  a corporate service company. The SPV is
partnership can avoid the tension that           the borrower under the financing, and as a
can be created when the operating                lessor (the “Lessor”), leases the Property to
partner brings a non-compliant tenant            a newly formed entity, which is owned by
(e.g., a highly rated financial institution)     the Islamic investor and its joint venture
to its Islamic partner to fill a vacant          partner, together (the “Lessee”) pursuant
space in a joint venture property. Clear         to a lease co-terminus with the financing
communication regarding the tenancy              (the “Lease”).
limitations adopted by a particular                  By virtue of the Lease, the Lessee
Islamic investor, at the earliest                becomes the economic owner of the
opportunity, will also assist in avoiding        Property, and is acknowledged as such in
misunderstanding or frustration later on.        the lease documentation. The Lease
                                                 requires that the Lessee make an initial
Financing                                        payment under the Lease, equal to a
After finding a property that meets              percentage of the acquisition price not
Shari’a standards, the next most                 funded by third party financing, which
important concern in forming a                   allows the SPV to pay a portion of the
compliant real estate joint venture is to        purchase price and serves as the initial
structure financing that satisfies Islamic       equity in the Property. The Lease provides
principles. A prospective partner with an        for on-going monthly lease payments in
Islamic investor must bear in mind that          amounts equal to the interest payments
such an investor cannot borrow funds             associated with the financing and other
through conventional means or pay                negotiated expenses of the SPV, which
interest to a conventional lender. There         payments are pledged to the financing
exists, however, a widely accepted body          provider. Under the Lease, the Lessee
of Islamic Finance that can readily              receives a call option and the SPV receives
create for the joint venture partners the        a put option with respect to the Property, at
same financing attributes (in terms of           an acquisition price equal to the
loan to value, financing cost, loan              outstanding financing amount. The put right
assumability, etc.) that can be achieved         may be exercised by the SPV at the
through a conventional financing.                maturity of the financing or upon an event
    The most common Islamic Finance              of default. The Lease, including the Lessee’s
structure utilized in the context of property    purchase option thereunder, is subject and
financing is the “Ijara” or Lease structure.     subordinate to a first mortgage lien on the
In an effort to gain the benefits of             Property. The SPV collaterally consigns to
conventional leverage while adhering to the      the financing provider all of the collateral
prohibition on interest, the title to the real   that has been assigned to it by the Lessee as
property (the “Property”) to be acquired by      security for the Lessee’s obligations under
an Islamic investor in a joint venture           the Lease, including an assignment of the
relationship is held by an orphan entity or      underlying end user leases and rents.
special purpose ownership vehicle (the           Additionally, the SPV assigns its put right
                        September / October 2003

    to the financing provider as further security   investors are not in a position to sign
    for the financing.                              financing term sheets and commitment
         Today, the Lease structure and its         letters; however, they are able to sign a
    variants are widely accepted by a host of       letter of acknowledgement to the
    institutions including Fannie Mae, Freddie      potential partner assuming the obligation
    Mac, portfolio and securitization lenders,      for their pro-rata share of any transaction
    insurance companies and dedicated               related expenses in the context of the
    mezzanine lenders as a bona-fide means          Ijara agreement. Likewise, Islamic
    of property financing, and have been            investors cannot be party to non-recourse
    endorsed by the major credit rating             carve out obligations associated with the
    agencies. While there had been an initial       financing; the direct burden of these
    inclination to charge a structural premium      obligations is on the joint venture partner
    for the financing, a growing awareness          who can, under certain circumstances, be
    and increased competition within the            indemnified or otherwise compensated.
    financial community has resulted in the         Additionally, the prohibition on interest
    incremental costs being limited to              necessitates the use of either non-interest
    minimal additional legal documentation          bearing accounts for all joint venture
    and entity formation expenses. Despite a        related activity or the investment in
    widespread acceptance of the Lease              Shari’a compliant Murabahah Funds,
    structure, it is important to note that         which are short term liquidity
    putting an Islamic financing in place with      management vehicles utilized by Islamic
    an institution familiar with the structure is   investors, now being offered through the
    significantly less cumbersome than              Islamic finance subsidiaries of certain
    pursuing such a transaction with an             global financial institutions.
    institution unfamiliar with the concept.
    Likewise, assuming an existing financing        USA Patriot Act and OFAC Lists
    in the context of an acquisition is             Due to the enactment of Title III of the
    generally an arduous process, particularly      Uniting and Strengthening America by
    in cases where lenders and servicers do         Providing Appropriate Tools Required
    not have prior exposure to the Ijara            to Intercept and Obstruct Terrorism
    structure and experience in dealing with        (“USA Patriot Act”) on October 26,
    Islamic investors.                              2001, and money laundering lists
         From the perspective of a US real          maintained by the Office of Foreign
    estate owner/operator looking to enter          Assets Control (“OFAC”) of the United
    into a joint venture relationship with an       States Department of the Treasury,
    Islamic investor, there are additional          foreign investors in general, and Islamic
    implications pertaining to the financing        investors in particular, have come under
    that are important to understand in an          increased scrutiny when conducting
    effort to avoid later issues. An example is     business in the US. Though a majority of
    the Islamic investor’s need to distance         Islamic investors conduct their US based
    itself from traditional borrowing in light      investment activity through holding
    of the prohibition on interest. Islamic         companies incorporated in tax efficient
jurisdictions such as the Cayman Islands,   subject to several levels of external
US based joint venture partners and         scrutiny and oversight: (1) stock
financing providers have an affirmative     exchange regulators, (2) auditors
know-your-customer (“KYC”)                  (frequently Big 4); (3) equity analysts;
obligation, which extends beyond the        (4) credit committees at its leading
holding companies to the ultimate           lending relationships; and (5) in many
beneficial ownership. This obligation is    cases, credit rating agencies.
further complicated by the fact that a           Despite these benefits, a US REIT
number of Islamic investors syndicate       partner will need to provide an Islamic
their investments either prior to, or       investor with comfort on several important
shortly after, closing a transaction.       issues, unique to public real estate
    Fortunately, both potential joint       companies, relating primarily to
venture partners and financing providers    compatibility and alignment of interests. In
can mitigate related concerns by            particular, the US partner should carefully
conducting business with reputable          review with the Islamic investor its
Islamic investors supervised by             previous experience in joint venture
regulatory agencies that have established   relationships with capital partners. In
procedures for due diligence that are       addition to discussing this experience from
comparable to the requirements of the       an economic perspective (how actual
USA Patriot Act. Generally, US              returns compared to projections, etc.) the
partners, financing providers and the       US public company partner should
rating agencies will accept certification   provide examples of how it may have
attesting to the initial and on-going       altered a business practice or company
compliance with the USA Patriot Act         custom to accommodate the specific needs
and OFAC lists from a regulated Islamic     of its partner – in this way demonstrating
institution as the placement agent and      its flexibility in meeting the Islamic
responsible intermediary for an             investor’s somewhat unique requirements.
investment syndicated to multiple                Also important to address is the
Islamic investors. This certification       REIT’s ability to satisfy the Islamic
satisfies the intent of the USA Patriot     investor’s holding period requirements.
Act and reduces what might otherwise        Generally speaking, funds formed by
become a prohibitive burden on the          Islamic Fund sponsors have a finite life
Islamic investor, its US partner and the    of between five and seven years, with a
financing provider.                         strong expectation that the Fund’s
                                            affairs will be wound up and investors’
Public Company Partners                     capital will be returned within that
Islamic investors frequently seek joint     stated time period. REITs, on the other
venture relationships with US public        hand, can face several important
company (i.e., REIT) partners. Having a     impediments to sale that an Islamic
public joint venture partner provides the   investor will need to receive comfort on:
investor with the additional benefit of     1) REITs go through periods (like
doing business with an entity that is       recent quarters) where reinvestment
                      September / October 2003

    opportunities are scarce and REITs          negotiations with a major tenant, a lender
    resist selling properties to avoid          on a refinancing, a new joint venture
    potential earnings dilution; 2) REIT        acquisition or an asset disposition. While
    partners may not be anxious to dispose      it is true that time zone differences and
    of assets that they believe are “core” to   physical distance can be inconvenient,
    their presence in a market or which         advanced planning and consideration
    justify the existence of a regional or      from both parties should prevent serious
    local office; and 3) REIT partners may      conflicts. Successful partnerships
    be hesitant to sell when doing so will      generally foresee tenant leasing issues
    likely require giving up lucrative          and refinancing opportunities well in
    property management and leasing             advance and can establish guidelines that
    contracts on the assets. Assurances of a    allow the operating partner to conduct
    REIT management team’s willingness to       business on behalf of the joint venture,
    periodically evaluate sales of joint        with minimal day-to-day input from the
    venture assets, coupled with a              capital partner. Similarly, negotiations
    demonstrated history of pruning the         over an asset disposition can be left to the
    REIT’s own portfolio, can be helpful in     operating partner so long as the joint
    assuaging investor concerns. Frequently,    venture has spent time in advance
    however, a well-defined exit mechanism,     agreeing upon an acceptable form of
    controlled by the investor, is the only     contract, establishing a range of pricing
    way to satisfy investor concerns. A         and timing for sale that is satisfactory to
    compromise position on control over         the partners.
    timing of sales may involve providing
    the REIT partner with an acquisition        Similar strategies have proven effective
    window towards the end of the joint         as it relates to acquisitions in which the
    venture’s intended life. During this        operating partner is charged with
    window, the REIT may have a                 responsibility for sourcing acquisitions
    preemptive right to acquire the joint       that fall within certain pre-established
    venture assets subject to investor          criteria. The operating partner provides
    protections in the form of market value     the capital partner with periodic updates
    and minimum return threshold tests.         in the form of an acquisition pipeline
                                                report that discusses in detail the size,
    Bridging the Time Zone Gap                  material terms and timing of
    US owners of real estate often voice        transactions being pursued and provides
    concern regarding the ability of a joint    the capital partner with feedback on
    venture partner located 14 hours away by    transactions that were either lost or
    plane and between seven and eight hours     abandoned prior to consummation.
    apart in time zones, to be sufficiently     These reports provide a good framework
    responsive on partnership matters. Most     for weekly or semi-weekly discussion
    frequently, this responsiveness issue is    (depending upon how active the
    relevant when addressing the resolution     acquisition program is) so that each
    of major decisions – e.g., active           party feels informed and knowledgeable
about the opinions and preferences of the other. The ability to respond quickly to
partnership issues is greatly enhanced by physical and time zone proximity. It is
frequently comforting to the US partner to know that there is an investor
representative within the country available for face to face meetings with financing
providers, property sellers, brokers, lawyers, accountants, etc. as business needs may

To be successful, a joint venture relationship between an Islamic investor and a US
real estate owner must be based on a deep and thoughtful understanding of each
partner’s needs. Both parties to the transaction should develop a general
understanding of the counterparties’ practices in order to establish a framework in
which the partnership can effectively operate. US owners that are considering
joining with an Islamic investor would benefit from spending some time
considering the issues identified in this article. ★

The authors would like to thank Isam Salah and Scott Arnold of King & Spalding,
LLP, Harvey Uris of Skadden, Arps, Slate, Meagher, and Flom, and Jennifer Keith of
Arch Street Capital Advisors, L.L.C., for their insights and assistance in the writing of
this article.

                    September / October 2003

    Craig Friedman
    Craig Friedman is a Partner at Arch Street Capital Advisors, L.L.C.,
    a real estate advisory and asset management firm based in
    Greenwich, Connecticut, specializing in advising Middle Eastern
    investors with their US and European real estate investment
    strategies. Mr. Friedman has over ten years of real estate investment
    advisory and capital markets experience. Prior to co-founding Arch
    Street Capital Advisors, L.L.C., Mr. Friedman was a senior originator with Deutsche
    Bank’s real estate investment banking group, having started and being responsible for
    the firms’ global real estate joint venture advisory business. Mr. Friedman has been a
    repeat guest lecturer at New York University’s Masters Degree in Real Estate
    Program. Mr. Friedman holds a BS from Binghamton University and a JD from
    Fordham University.

    Imran Ahmed
    Imran Ahmed is a Partner at Arch Street Capital Advisors, L.L.C., a
    real estate advisory and asset management firm based in Greenwich,
    Connecticut, specializing in advising Middle Eastern investors with
    their US and European real estate investment strategies. Mr. Ahmed
    has been involved with real estate industry for over ten years, with
    experience in real estate investment advisory, finance, development,
    construction and design. Prior to co-founding Arch Street Capital Advisors, L.L.C., Mr.
    Ahmed was a senior member of the real estate investment banking group at Deutsche
    Bank, having been involved with more than $10 billion of real estate advisory and
    capital markets transactions with a particular focus on real estate related structured
    financial products. Mr. Ahmed holds a BS and BA from Cornell University, a MA from
    Massachusetts Institute of Technology and a MBA from Harvard Business School.

                              Association of Foreign Investors in Real Estate
                      1300 Pennsylvania Avenue, NW • Washington DC 20004 • USA
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