(A) INTRODUCTION

Malaysia as one of the main player in the Islamic economy has always been active in establishing a
sustainable and feasible Islamic Capital Market to cater the needs of Muslims and to make sure that its
products and services are attractive to all investor regardless races or religions. Malaysia is also committed
to be a global Islamic financial and capital hub, according to the Capital Market Master Plan by the
Malaysia Securities Commission in 2001. An efficient capital market is needed to provide opportunities for
developing well-diversified portfolios and to meet investors demand according to their risk and return
preferences (Iqbal & Mirakhor, 2007).
Securities Commission has recently introduced a new investment opportunity in the Islamic Real
Estate Investment Trusts (I-REITs) to help boosting the expansion of Islamic capital market in Malaysia.
Guidelines on the Issuance of I-REITs were issued by the Securities Commission to facilitate the
development. This guideline provides Shariah guidance on the investment and business activities on IREITs and is the first guidelines on I-REITs in the global Islamic financial sector.
The Securities Commission has approved a total of 11 issues with market capitalization amounting
three billion ringgit since the introduction of REITs (Yakcop, 2007). The first Islamic REITs listed on the
Main Board of Malaysian Bourse is Al-Aqar KPJ REIT and stated as the world's first I-REITs with total
market value of RM481 million (Idris, 2006).
This paper provides insights into the issues and challenges faced by Islamic REITs in Malaysia.
The remainder of the paper proceeds as follows. The next section illuminates the definition of REITs and IREITs. Then, the structure, types and general regulatory framework of I-REITs will be stated. Next section
is the issues and challenges of I-REITs in Malaysia. A recommendation on how to curb the issues and
challenges will come next, whilst the final section contains the concluding remarks.

(B) DEFINITION
Real Estate Investment Trust (REITs) is defined as a security selling similar to a stock on the major
exchanges and invests in real estate, either using mortgages or properties. It is a trust fund that invests in
rental properties to obtain rental income and is obligated to distribute the profit as dividend to its holders. To
simplify, REITs is an investment vehicle made as a unit trust that pooled capital of many investors to
purchase and manage the fund in stable income producing real properties and real property related assets.
REITs have a low risk and have high certainty of cash flow from rentals received from lease
agreements with tenants. USA was the first country to see the development of REITs in 1960, followed by
the Netherlands in 1960 and Australia in 1971. 1 A deed of trust is executed by the parties involved in
establishing REITs. The trustee will be responsible to act on behalf of the unit holders. REITs are governed
by the deed of trust. The responsibilities and the roles of trustee and the management company are
governed by the deed of trust as well.
Islamic Real Estate Investment Trusts or I-REITs are one of the recent investment opportunity introduced in
Islamic Capital Market in Malaysia. Islamic REITs generally is a collective investment scheme which invest
their fund in listed real estate securities that own and operate real estate such as residential, commercial
and retail properties and car parks which is almost similar to conventional REIT. However, Islamic REIT
prohibits the tenant(s) from operating in non-permissible activities according to the Shariah. A real estate
investment that is Shariah compliant must ensure that the utilization of the real estate, financing of the
acquisition, investment of cash or liquidity and insurance scheme for protecting the real estate be Shariah
compliant as well.
I-REITs provide a new investment opportunity in real estate for those who are interested to invest
through Shariah compliant capital market instruments. The main objective is to generate returns on
investment. Returns are obtained through rental income plus any capital appreciation that appears from
holding the real estate assets over an investment period.

1 http://www.deutschereit.de/index.php?id=132
2

(C) STRUCTURE OF I-REITs

The parties involved in I-REITs are the manager, the trustee, the Shariah adviser and the unit-holders
controlled by a deed registered with the Securities Commission. A deed is entered into between the
manager and the trustee in I-REITs. The deed govern the manner in which the scheme is administered, the
collection and distribution of income, the rights of unit-holders, the duties and responsibilities of the
manager and trustee, the valuation and pricing units, and the protection of unit-holders interests. The
relationship between the trustee, the Shariah adviser, the unit holders and the manager in I-REITs can be
demonstrated below:

The explanations of the main parties in Malaysian I-REITs are as follows:

I.

The Unit Holders

The unit holders are those who buy the unit trust fund in I-REITs. Unit-Holders are entitled to
receive the distributions of the fund and all other rights as provided in the deed.

II.

The Shariah Adviser

The role of Shariah Committee forms an integral part of I-REITs that is distinct to the conventional
REITs. This party is obligated to act as an adviser on all Shariah related matters. It must monitor
the workings of the Islamic fund based on Shariah standpoint and to review all transaction to
ensure that it is Shariah compliant. The Shariah committee provides references and consultations
to the manager on permitted investments.
Besides that, it also provide certificate and prepare a report to be included in the interim
and annual report in respect of the I-REITs.

III.

The Trustee
The trustee must be independent of the manager and is appointed for the unit holders. They act as
the custodian for all the assets of the I-REITs and to safeguard the interests of the unit holders. The
trustee shall ensure that the manager follows the provisions of the deed, collection and distribution
of income, proper record keeping of administrative and investment and unit-holders' transactions.
The trustee earns trustee's fees for its function in holding the assets for the benefits of the unit
holders.

IV.

The Property Manager

The manager is responsible to manage and administer the I-REITs in accordance to the objectives
and investment policy. The manager must follow the deed, the Securities Commission Act (SCA),
REITs Guidelines and Islamic REITs Guidelines in a professional and good manner to ensure high
standard of integrity in managing the I-REITs to the interest of unit holders. Other than that, the
manager ought to exercise due care, skill and to effectively employ the resources and procedures
necessary for the proper performance of the I-REITs.

(D) TYPES OF REITS

There are three types of Real Estate Investment Trusts, namely Equity REITs, Mortgage REITs and Hybrid
REITs (Allen, Madura, & Springer, 2000; Obaidullah 2005; Park, Mullineaux, & Chew, 1990). They are listed
as follows:
1. Equity REITS:
This type of REITs invest in and own properties involving wide range of activities including leasing,
development of real properties and tenant services. Equity REITs are different compared to the
other because it acquires and develops the real estate properties by managing them as part of its
portfolio rather than reselling them after they are developed. The revenues are generated directly
from their properties' rents.
2. Mortgage REITs
Mortgage REITs are involved in investment and ownership of property mortgages. Owners of real
estate received interest-based loan for mortgages using these REITs, or purchase existing
mortgages or mortgage-backed securities. Mortgage REITs hold long-term mortgages, but some
also engage in short-term construction financing (Park et al., 1990). It involves higher risk as
mortgage REITs are more sensitive to volatility in market interest rates. This is because mortgage
REITs hold mortgages whose prices move in the opposite direction of interest rates.
3. Hybrid REITs
This type of REITs are a combination of the investment strategies of equity REITs and mortgage
REITs by investing in both properties and mortgages. This means, they own and operate real
estate and offer loans to real estate owners and operators.

(E) GUIDELINES ON I-REITs IN MALAYSIA

The Securities Commission (SC) is responsible on releasing the Guidelines for Islamic Real Estate
Investment Trust on 21 November 2005 (Securities Commission, 2005a). It aims to facilitate the
development of new Islamic capital market products in Malaysia. The guideline released by SC is the first
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Islamic REITs guidelines in the world. In Malaysia, an Islamic REITs must comply with the Guidelines for
Islamic REITs and the general SC Guidelines on REITs.
Malaysias Guidelines for Islamic REITs facilitates Islamic REITs development. It made Malaysia as
the first jurisdiction in the global Islamic Financial sector, which set a global benchmark for the development
of I-REITs.2 The latest guidelines aim to provide a new investment opportunity for those who wish to invest
in real estate through Shariah compliant capital market instrument.
Islamic REITs Guidelines which was introduced by the SC allow fund managers to further diversify their
investment sources and portfolios. Besides that, it allows international investors to invest in Malaysian real
property without any needs to directly own such assets. 3
Islamic REITs are categorized into listed and non-listed I-REITs, although they are still new in Malaysia.
Investors may buy and sell they listed I-REITs like listed stocks. Investors will have to go through the same
process to invest on stock by going through a stockbroker to invest in them. Every investor must be aware
that I-REITs could be traded at premium or discount according to their respective net asset values. For
unlisted I-REITs, investors may buy or sell them like any other unit trust products through management
companies or other authorized agents.4

2 Nik Ruslin Nik Jaafar, "Complying with the SCs Islamic REITs Guidelines", slide
presented in Workshop on Islamic Real Estate Investment Trust, 12th August 2006,
IBFIM, Kuala Lumpur, p. 12.
3 http://www.sc.eom.my/ (press release on 21st November 2005).
4 Malaysian ICM, Quarterly Bulletin of Securities Commission, May 2006, v. 1, no. 1,
pp. 4-5.
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(F) ISSUES AND CHALLENGES OF I-REITS IN MALAYSIA

The development of I-REITs in Malaysia has been improving especially with the introduction of the
Guidelines for Islamic REITs. Conventional and Islamic REITs are the same in terms of structural
requirements such as valuation, trustee, management companies and property manager. The difference
can be seen on the Shariah compliant assessment conducted by a Shariah committee or advisors whom is
responsible to oversee the operation of I-REITs to ensure compliance with Shariah principles.
There are some specific aspects of Shariah compliant assessment process outlined by Securities
Commission in the Guidelines for Islamic REITs. These several aspects have brought up some issues that
need to be monitored. The following are some of the issues related to the compliance assessment process.

1) Non-Permissible Rental Activities

The main incomes for investors are generated from rental. Thus, it is vital to ensure that these
rentals are derived from halal or permissible sources. The list of non-permissible rental activities
was classified by the Shariah Advisory Council (SAC) of Securities Commission to give awareness
to future investors. The list includes gambling, manufacture of sale of non-halal products,
conventional insurance, manufacture or sale of tobacco-based products, stockbroking or share
trading in non-Shariah compliant securities, services based on interest, and hotels and resorts.
Investors must refrain themselves from investing in REITs that use those listed non-permissible
rental activities. In the event where there is no ruling about the permissibility of a certain rental
activities, the Shariah committee or advisor may use their discretion to determine its permissibility.

2) Rental from Tenant who Operates Mixed Activities

The Shariah advisors must perform compliance assessment with additional consideration, if there
is a case of tenant who operates mixed activities. Mixed activities here can be defined as one
where its core activities are permitted by Shariah, but some other activities containing small extent
of prohibited elements still exist. In the event that the tenant operates mixed activities, the fund
manager of an I-REITS must perform additional due-diligence task to ensure that the proportion of
rental from the operations of non-permissible activities to the total turnover of the I-REITs in the
current financial year should not exceed certain benchmarks.
This means, the fund manager should obtain the total rental from non-permissible activities
from the property that it wants to acquire, and then compare the total rental from non-permissible
activities to the total turnover of the I-REITs. This is done to calculate the percentage of rental from
non-permissible activities.
Shariah Advisory Council (SAC) of the Securities Commission has determined the
percentage amount to be 20% for the criteria on rental from non-permissible activities. The Shariah
adviser shall advise the fund manager not to invest in the real estate, in the event of exceeding
percentage.5
For example, if the total rental from non-permissible activities is RM132, 000 and the total
turnover of the I-REIT for that financial year is RM620, 000, then, the percentage of rental from
non-permissible activities is 21.29% which is more than the 20% benchmark. Therefore, the
Shariah adviser has (Amin, February 2014) the power to advise the I-REITs fund manager to avoid
investing in the real estate.

3) Ratio Calculation of Rental from Tenants Who Operate Mixed Activities

5 Guidelines for Islamic Real-Estate Investment Trusts (issued on 21st November

2005)
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If the tenant operates mixed activities involving the usage of space, and the Shariah non-compliant
rental amount cannot be known and identified, the calculation can be made based on the ratio of
the area used for non-permissible activities to the total area occupied. The basis for determining
the ratio of rental from non-permissible activities to total percentage paid by the tenant is the
percentage.
For instance, in a supermarket, the rental for non-permissible activities such as the selling
of non-halal food and beverages can be based on the ratio of area occupied for non-permissible
activities to the total area occupied. If the supermarket leases 8,000 square feet and 1,000 square
feet is allocated for the sale of non-halal food and beverages, then the ratio is 12.5%. This ratio is
still permissible because it is still within the acceptable benchmark of 20% of the total turnover of
the Islamic REITs.
If the rental for supermarket is RM100,000 monthly, then the rental from non-permissible
activities is 12.5% of the total rental paid by the supermarket. The total of rental from nonpermissible activities is RM12, 500 monthly. This amount can be donated to charity to purify the
collection.
The calculation method for service based activities is based on the ijtihad of the Shariah
adviser of the I-REITs. An example of a service-based activity is packaging of goods that are nonpermissible.

4. Instruments used in Deposit, Financing and Investment in Islamic REITs

All forms of deposit, financing and investment must comply with the Shariah principles under the
Islamic REITs and subject to the approval from the SAC of the SC and/or the Shariah
committee/Shariah adviser and in accordance with the funds deed. For instance, in financing the
acquisition of real estate, Islamic REITs fund manager is responsible to ensure that riba-based
instrument is not used which would affect the Islamicity of the Islamic REITs operation and
transaction.
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In the Malaysian context, the I-REITs are permitted, subject to the provisions of the REITs
Guidelines, I-REITs Guidelines, Shariah requirements, the funds objective and as approved by the
SAC of the Securities Commission and/or Shariah committee/ Shariah adviser, to invest in the
following:
a) Real estate
b) Asset-backed securities
c) Liquid assets
d) Single purpose companies (unlisted companies whose principal assets comprise real
estate)
e) Non-real-estate-related assets (listed shares issued by non-property companies)
f) Real estate-related assets (include units of other real-estate investment trusts, listed
securities of and issued by property companies, listed or unlisted debt securities of and
issued by property companies and mortgage-backed securities)
g) Any other investment not covered by paragraphs (a) to (f) above, but specified as a
permissible investment in the REITs Guidelines or as otherwise permitted by the Securities
Commission from time to time.

CHALLENGES OF I-REITs
Islamic REITs in Malaysia have only been introduced recently. As it is still new, there are a few challenges
that I-REITs have to face under the current economic climate. These issues arise due to the unique
characteristics surrounding I-REITs to comply with the Shariah principles requirements. To cater the need
for the growth of I-REITs in Islamic capital market industry, these challenges must be resolved.
Nazah, Mohamed and Nurrachmi (2012) listed lack of standardization in Shariah, limitation of
investment universe and lack of investment index for pricing to be the challenges faced by the I-REITs in
Malaysia. Standardization in Shariah arises as a challenge because some Shariah frameworks are unclear.
Other than that, limitation of investment universe is also a concern in the operation of I-REITs because they
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are limited to products that are Shariah compliant only. Lack of investment index for pricing is a result of
less trained Islamic finance professional.
Meanwhile, Albaker (2007) listed some other issues and challenges for I-REITS. These issues and
challenges include the standardization of Islamic REITS, lack of developed secondary market for Islamic
products and the properties where mixed activities are carried out. Lack of developed secondary market for
Islamic products caused investors to be less interested in investing in I-REITs. The status of properties
where mixed activities are carried out becomes a challenge because it might become permissible or nonpermissible according to Shariah rulings. Other than those three challenges, Islamic REITs also face
challenge in term of the ruling. The rules for I-REITs are unclear especially for overseas investors in real
estates.
Some actions must be taken to overcome the challenges listed above. If no actions are taken, the
operation of I-REITs in Malaysia will not be effective to allow Malaysia to become a main player in the
Islamic capital market of the world.

(G) RECOMMENDATION
There are many initiatives that can be taken to ensure that I-REITs in Malaysia become one of the biggest
contributors in terms of return in the country's Islamic capital market. One of it is by ensuring that conducive
environment and sufficient regulatory, legal and taxation framework to entice the property owner, investor
and others to participate actively in the asset class. The regulatory framework introduced by the Securities
Commission is one of the initiatives taken to provide suitable environment to the investors.
Besides that, a clear and transparent Shariah framework must be introduced in the operation of IREITs to ensure that standardization in Shariah can be achieved. A transparent Shariah framework is
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expected to allow investors to gain more confidence by the investment in the I-REITs. Without these
criteria, it will be very difficult for the investor to differentiate between conventional Real Estate Investment
Trust and the Islamic Real Estate Investment Trust. Audited published account, financial statement and
financial information must be shared to allow for transparency in I-REITs.
To deal with the limitation of investment universe in the I-REITS, diversification of the products
should be implemented. Diversification of products will reduce the risk of investment in the I-REITs.
Investing in only one type of property will increase the risk of the investment in case of a financial crisis.
Other than that, quality management of the I-REITs will be helpful to the operation of I-REITs in Malaysia.
Quality management should be implemented by having an independent management, strong management
team, effective Shariah governance and result-oriented manager.
Exemption from double stamp duties may also be beneficial to attract potential investors to invest
in Islamic REITs in Malaysia. Double stamp duties are a drawback to the investors as this will only cause
them to pay more in the investment they participate in. More Islamic Finance professional should be trained
to ensure that I-REITs in Malaysia will be effective and efficient.
Awareness campaign should also be carried out to introduce I-REITs concept in Malaysia. Road
shows, seminars, exhibition can be done to increase the awareness of Malaysia to invest in the products
despite their races or religion. The campaign should target the non-Muslim as Islamic financial products
and services are not limited to the Muslims only. The participation of non-Muslim will increase the fund in
the investment trust to invest in various types of property.

(H) PROSPECT OF I-REITs IN MALAYSIA

Islamic REITs have a very encouraging future in Malaysia. The incentives from the Malaysian government
and the tax transparency are believed to be helping the growth of Islamic REITs in Malaysia. The Prime
Minister and Ministry of Finance have announced various incentives in 2007 Budget to promote Malaysia
as an Islamic financial center (Treasury Malaysia, 2006). The announcement has contributed on resolving
the uncompetitive business environment due to high taxation regime which caused foreign investors to be
discouraged from entering the Malaysian capital market before.

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The tax incentives prior to 2007 Budget Proposals can be categorized into two, namely the
enhancement of tax transparency system and reduction of investors tax. If REITs distributes at least 90%
of income to investors, it will be fully exempted from paying its income tax on its taxable income under the
tax transparency system. If the distribution is less than 90%, the undistributed chargeable income of the
REITs will have to pay income tax at the prevailing tax rates (Treasury Malaysia, 2006). The incentives aim
to encourage REITs manager to distribute at least 90% of its income to investors to give them the certainty
of income and to ensure high yields from their investments in REITs.
Dividends received by local and foreign individual investors and local unit trusts from listed REITs
will withhold tax of 15% meanwhile 20% reduction in tax will be given to foreign institutional investors
(including a pension fund, collective investment scheme or such a person approved by the Minister of
Finance) based on the new tax proposals (Badawi, 2006; Treasury Malaysia, 2006). The competitiveness
of Malaysian REIT market is expected to be enhanced by the tax incentives proposed in the National
Budget 2007.
The high-quality assets offered through Islamic REITs in Malaysia can generate a stable stream of
cash flow backed by a steady portfolio of tenants. According to Rating Agency of Malaysia (RAM), good
quality assets will command sustainable resale values through economic cycles. This will ensure timely
repayment of financial obligations through refinancing and/or disposal of assets. RAM assess the type of
assets involved and the location, accessibility, age and condition (Ean, 2007).

(I) CONCLUSION
The introduction of I-REITs in Malaysia is deemed as one of the most significant initiatives to increase the
product base of Islamic capital market in Malaysia. I-REITs in Malaysia are potentially bright to become an
alternative for investment which can be accepted globally. This can definitely be achieved by resolving the
issues and challenges surrounding the operation of I-REITs. I-REITs may help in enhancing Malaysia's
competitiveness in the Islamic capital market by attracting global Islamic investors wishing to diversify their
investment portfolio to invest in this country.
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Investors in Malaysia especially, are provided with a new Shariah compliant investment option with
the introduction of Islamic REITs. The stable returns of I-REITs attract many to start investing to comply with
God's law, and to get the benefit of steady rental yields of real estates and other properties. Due to the
generation of revenue from rental payments, the I-REITs are able to receive stable cash flow. Besides that,
I-REITs also allow investors with less capital to purchase real estate on their own to enter the real estate
market via participation and investment in units of the Islamic REITs.
The Islamic capital market in Malaysia is hoped to be expanding with the emergence of Islamic
REITs. To be truly successful, Malaysian Islamic REITs must be appealing enough to the international
investing community. Various tax incentives and regulatory framework introduced by the Malaysian
authorities are taken as the step to allow this country to become the world's Islamic financial and capital
hub.

(J) REFERENCES
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Journal of Real Estate Finance and Economics,21(2), 141-152
Ali, Salman Syed. (2005). Islamic Capital Market Products: Developments and Challenges. Jeddah: Islamic
Research and Training Institute.
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http://www.klse.com.my?website/bm/listed_companies/ipos/prospectus/index.jsp
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Treasury Malaysia. (2006). Budget 2007. Kuala Lumpur: Ministry of Finance, Malaysia
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http://www.deutschereit.de/index.php?id=132
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