SHARIA PRIVATE EQUITY REAL ESTATE PREFACE 

RESEARCH PREMISE AND HYPOTHESIS:

The challenge is to build a private equity real estate fund that focuses on capital markets in both the United States and the Middle East. The firm will utilize institutional investors in the United States and the Middle East along with raising pools of capital through Shari’ah compliant products in conjunction with Islamic Finance Principles. This strategy  being deployed in both geographies will create a competitive advantage, especially given the lack of liquidity and scarcity of equity and debt capital. The relative low level of awareness of the shari’ah compliant securities and market will add to the value proposition and serve to accelerate asset gathering and the competitive edge. To fully exploit the opportunity in the Middle East a partner with strong relationships will have to be acquired. There will also be a small investment required in people, office space and technology within the Middle East and the creation of an off shore entity to create a dual head structure to accommodate all institutional investors and ERISA investment authorities. The final feasibility and outcome will be determined by the liquidity and value created in U.S real estate by the liquidity provided by the institutional investors in the Middle East and Sovereign Funds abroad. Institutional Investors and the relationships on both side can be fully exploited to as the transference of assets and capital across borders occurs.

 

BACKGROUND

From 2002 to 2007 the capital markets in the Middle East have grown exponentially in terms of Shariah compliant fixed income products. The population of Muslims is 1.6 billion this represents 24% of the total world population which is 6.3 billion. Shariah compliant assets have grown 35% over the past 20 years, representing US Dollar $ 300 billion banking assets and approximately $400 billion US Dollar in Capital Markets. This makes these markets large enough to tap for substantial pools of capital although the general finance community is relatively unaware of the products or the investors. Economists world wide agree that over 1 trillion dollars a year will flow into the Middle East regardless of the price of oil for the next (20) twenty years. There are 430 million inhabitants in the Middle East including ex-patriots. Investment opportunities will be far outstripped by the demand.

 

QUESTION

Can a pool of Capital be established to purchase existing discounted real estate assets comprised of sovereign funds and institutional investors from the Middle East who have tremendous political friction impeding their ability to acquire assets? Given the existing currency values, economic state of the United Sates capital markets, illiquidity and subprime crisis-U.S. commercial real estate is trading at a discount. The combination of equity pools of capital, leverage from off shore banks and the advent of newly issued shari’ah lead to a superior ability to finance and therefore capture intrinsic value. If this is possible a sizeable yield will be reaped when the price dislocation corrects and the recession subsides. The shari’ah compliant paper will create other arbitrage opportunities since Shari’ah laws prohibit the earning of interest. I will delve into this substantial issue later.

  

APPROACH

I have researched the debt capital markets in the Middle East, the Investment banks that underwrite and/or trade the debt along with the institutional managers that purchase traditional debt securities. Further analysis of the funds that have a history of buying/ selling shari’ah compliant securities. I will specifically target the current Shari’ah compliant investors, banks, insurance companies and Sovereign funds in the region. I have begun relationships and extensive polling of the top banks and insurance firm in the region. I have also built an extensive set of relationships with the top 4 underwriters of sukuk underwriters in the region, these 4 underwriters represent 78% of the issuance of sukuks so they represent a viable distribution chain. This information will be used to determine where to place sukuks and other shari’ah structured investments inside the region by using the bankers who sell the securities as conduits. The bankers are driven to assist because they have participated in conferences that I have held in the region and are aware of our political connections. They also want to develop strong ties with our organization because they are aware that we are raising a pool of capital which will give them a new products and issues to sell. In terms of distribution, this represents a definitive way to overcome a dis-intermediated and fragmented distribution chain effectively and efficiently..

  

OUTCOME

The past year has seen the world’s debt markets enter into turmoil and lose tremendous liquidity due to loss of confidence and the inability to properly measure risk, which has resulted in stagnation on a global basis. This has dramatically affected the capital markets, stock market and real estate values. The markets in the Middle East are in stark contrast to this phenomenon , particularly those in Shariah compliant economies have been on the upswing and rapidly accelerating. Institutional Investors are faced with moribund markets and limited options and they will subsequently have a need and desire to find additional areas for investment especially in areas with significant growth and returns. Simultaneously, Shariah compliant investors will seek more products and additional robustness in products, while the underwriters and investors will cultivate and need additional participants. This will drive innovation in products due to increased demand. The by-product of that structuring of new products will be increased capital for those with knowledge and access to these investors.

   

PROCESS:

 

1.)    Analysis of the Capital Markets and Debt Markets along with the Sukuk market, various Shari’ah instruments, underwriters and investors. I will take an in depth look at volume, volatility and valuation practices. The study will also include an intricate analysis of the underlying assets as well. The focus on the components will help to fully display and outline the true value of Sukuks and how to properly value them.

2.)    The dissertation will also include an economic discussion of the proposition, detailed analysis of the existing market and a dissertation on the potential roadblocks and obstacles for growth and liquidity. There will be a marketing plan, executive summary, business plan and investment thesis included.

3.)    The last portion will have a summary and conclusion based on the findings, examination of the market. I will also include very specific recommendations for gaining Institutional investors in the west to participate by outlining all the potential issues and upside to reduce the initial resistance to change and get their full involvement to expand the market.

   

I will use strategy methods to develop the best and most profitable approach along with valuation techniques to properly value the opportunity and business.

  BODY 

Why a Private Equity Real Estate Fund vehicle?

 

The first question we have to address is why use a Private Equity Real Estate structure as a way to exploit these trends instead of another investment or financial services entity such as a Hedge fund. Hedge funds are exclusive, professionally managed investment vehicles for institutions and the ultra-wealthy that generate market superior returns using various investment strategies such as: Equity Hedge (long/short), Convertible Arbitrage, Option Arbitrage, Statistical Arbitrage, Fixed Income, Distressed Debt and Event driven. The Managers of the fund receive performanced based fee (usually 20% of profits) and a fund management fee (usually1% to 3% of assets). There are various strict laws on how they can be promoted and these precious few are highly regulated causing the ones that can generate returns to be promoted very exclusively.

 

When the exclusivity veneer is peeled away, most investors find that the fund opportunity is usually closed to new investors and usually very difficult for the lay person to understand and fully comprehend all of the risks. Compounding these issues is the investments frequently are tax inefficient, have limited capacity liquidity and require large investment minimums that are typically in the USD $1 to $5 million range.

 

These factors have made hedge funds an inaccessible vehicle for the general populace to their detriment because hedge funds have been the greatest sources of alpha generation for the bulk of this decade. The bulk of these returns were created by using lots of leverage and risk—these two factors when combined with general inaccessibility of a number of securities and trades to the lay public caused institutional investors and high net worth investors to flock to the hedge funds because of their desire to obtain the superior returns. The same institutional investors and high net worth individuals that were previous investors, began to focus on gathering more of the capacity of the performing funds. This has had a direct effect on the hedge fund industry creating the greater size and larger number of hedge funds to serve these investors. Having said that, given the ever increasing size and abundance of hedge funds-- the opportunities to generate substantial returns have reduced tremendously, along with them so has the ability to allocate capital—given the reduction in opportunities. This in turn creates a vicious cycle that reduces the return rate on overall capital for the firm therefore reducing the opportunities to provide superior returns. Consequently, the opportunity to raise capital to deploy is affected as well greatly reducing the firm’s viability and prospects in the future.

 

Three other factors helping to greatly reduce US Hedge Funds ability to generate superior returns have been the advent of superior trading technology and access to the general public along with the proliferation of market data to accompany this high speed trading. This has caused a number of people to create hedge funds both functional and dysfunctional which help to crowd the playing field and the trades available.

 

The third and most deadly factor has been that of leverage, which was initially the source and wellspring of the ability to create the outsized returns. As technology democratized trading by reducing the cost and access to information—more and more entrants entered the field employing leverage making it more difficult to find alpha generating opportunities. There are currently over 7000 hedge funds in the world and they have over USD $2 trillion in assets.

 Global Market Comparison 

The Middle East markets are widely appealing to Fixed Income institutional Investors due to shifting currency preferences the benefits of geographic diversification and access to issuers not found in the US domestic markets. These markets will give them access to the Sovereign Issuers, supra national Issuers and the Corporate Issuers with the region. As the credit markets and liquidity in the US has reduced more cross-border M&A deals there has been a fundamental shift in global debt issuance which used to be dominated by the U.S

 

Creation of a fund in the Middle East allows Fixed Income Institutional Investors access to issuers and transactions that they would not have exposure or investment accessibility to enter. By investing in globally they are able to make investments in sectors and create a compound layer of diversification while simultaneously broadening their reach. This process and influx of new investors is good for the middle east because it creates greater demand and participation in their financial markets which ultimately increases demand and liquidity. US Institutional Investors and Non US Institutional Investors will be drawn to the opportunities present in the regions capital markets because returns elsewhere are significantly less robust and the capital markets activity with shari’ah compliant structure has a low correlation to US domestic investments. These factors will serve to broaden bond issuance and purchase as the differences in Monetary Policy regimes generates (3) three potential sources of returns: 1)Enhanced Yield vs Domestic Bond Markets and, 2) Potential for Capital Gains through increase of the asset’s valuation, 3) access to infrequent issuers and their fixed income offerings.

 

This offering will be very appealing to the institutional investor givn the existing US Debt/Deficit situation where the USD $ 8.5 trillion Federal Debt looms forbodingly while the spectre of the imbalance challenge with the EURO make diversification a sound and profitable course of action.

 Middle East -Islamic Finance & Shariah Compliant Structures

The Middle East has been experiencing geometric growth and is a hotbed for outside investments from investors outside of the region. Aside from the typical diversification benefits the area is particularly well positioned for any economic downturn, with the added bonus of the stocks from the region having very little correlation to U.S. markets. These companies aren’t covered by the traditional analysts so there is very little reporting. These companies focus on the sundry items that companies in the West focus on delivering to their clients—these companies more often than not aren’t the oil and gas companies which for the most part are  owned by the State and/or Ruling Family consequently making them inaccessible as investments. This created an opportunity for the banks and finance companies to create solutions and innovate the Islamic finance industry—they were quick to seize upon the opportunity and now Islamic finance and shari’ah compliant structures are arising as a fresh new asset class to fixed income institutional investors due to their markets evolution and rapid rate of expansion. Shari’ah compliant assets have risen to USD $500B in 2007—giving them a growth of over %10 over the last 10 years.* Due to this rapid growth demand inside the Middle East and outside of it has accelerated greatly, quickening the pace of supply of these instruments. The European banks have been quick to establish units to capitalize on this trend (while U.S. banks have been reticent to enter the arena on an institutional basis). With the emergence of this outside institutional interest in Europe and the wholesale opportunity with it—investment banks and structured finance bankers have developed new islamic finance products to address both the demand and the increased liquidity which has created more diversification in product. This has created both corporate and consumer finance products such as mutual funds, trade funds, shari’a compliant “credit cards”, takaful (insurance) and sukuks. We will examine the Sukuk proposition in depth later on in this study.

 

Since there has been an explosion of products Islamic banks have benefited by a CAGR of 8% in a 5 year span causing them to grow much faster than conventional banks. This growth has been buoyed by 1) the diversification and continued robustness of products, 2) acceleration of asset volume growth and 3) an ever increasing base of customers. This last point is extremely important point because the banks garner a disproportionate share of deposit growth given the Shari’a compliance laws. Furthermore they operate in protected markets which give them distinct regulatory advantages. These factors have helped to create financial ratios for the Islamic banks that are often on par with some of the top performing conventional banks in the world. Given their high ROE/Growth combinations the question of their

valuations being sustainable is at the forefront after considering their 1)intricate and complex systems, 2)lack of short term liquidity tools and finally, 3) their lack of scale in comparison to international standards such as BASEL II. It is here that the Islamic banks will run into competition from international banks who are watching the returns in their arena.

 

On an institutional basis, Islamic funds within the Global Financial Services Institutions is more than USD $1.3 trillion with the Islamic Financial market estimated to be USD $400B with an AGR 12%-15%.  

 Sukuk

What exactly is a Sukuk?

 

A Sukuk is a Shari’a compliant security that entitles the holder to ownership interest to the securities underlying asset. The determination of the security is called a Fatwa and is determined by Shari’a scholars and Islamic Holy men from principles outlined in the Holy Koran. The defining principle is that it is a negotiated instrument that does not allow for interest, called Riba on a loan. Interest is strictly forbidden in Islamic law. Returns are allowed so the Sukuk works a lot like a bond in principal and is often referred to as an Islamic Bond. In some ways it is like a no interest bond that has a convertible equity stake in the underlying asset. In actuality the Sukuk is entitled to returns generated by the asset. One other very important factor with Sukuks, is that in accordance with Islamic law there has to be an underlying asset associated with the Sukuk—it cannot be a derivative or notional item such as interest rate risk. The underlying thing of value for all Sukuks is an actual asset.

 

Sukuk issuance has been one of the most demonstrative scalars of measurement in outlining the dynamic growth of Islamic Finance techniques in capital markets. Sukuk issuance has grown in line with the innovation and acceleration of the Islamic Finance industry and has been powered by the USD $1.3 trillion in Islamic funds in global institutions.

 

The Islamic bond market has grown at an exponential rate with issuance over USD $50 billion in 2007--Islamic Capital markets have the potential to reach several Trillion USD there estimated growth is between 15%-20% on an annual basis. The main driver of this phenomenon has been the rapid build out of infrastructure in the Middle East. The issuance of Sukuks has been exponential since 2003 doubling every year.

 

Given the combination of the multi-billion USD Infrastructure projects,  we can well expect this trend to continue and with the Surplus continuing for the next 5 years due to oil demand and price. There currently are over one hundred Islamic Funds and they manage over USD $9.5 billion. One of the larger challenges for this market is that there is no developed secondary market so liquidity is impeded.

 

The following  factors will help to drive the Sukuk market and create more liquidity..

Sukuks have been listed in both London and Luxembourg. The Dubai International Financial Exchange currently leads all exchanges with over USD $13 Billion listings in Sukuks.The United Kingdom has created special tax legislation and reforms to support the distribution of these securities to citizenry in the UK on a tax free basis.

 

These factors and general macro economic trends for the investment area indicate that there will be greater liquidity in the future. Even with that being the case there are still risks associated with the liquidity of the market. In spite of this interest and the issuance the secondary market has very few market makers and is relatively illiquid. There are also issues concerning uniformity of products and securities necessary to determine which are the most valuable when compared against other Sukuks with different maturations. The challenge and overarching bet is that there will be greater liquidity in the future given existing trends, increased consolidation of exchanges and increased demand for shari’a compliant products in the Middle East as the confluens of capital and dearth of investment areas is exacerbated by the excess cash and low capacity. The conspicuous absence of a yield curve does not aid the investment process when coupled with the lack of uniformity in regulating and determining viability. There will also be a need for the development of sort term sukuk money market instruments which demand and the investment bankers will accelerate. These are common issues for an emerging asset class. The last factor in liquidity is the reason why the issuance will greatly increase. Most buyers of Sukuks are buy and hold players  due to the dearth of available appropriate products—this pent up demand will help to continue driving innovation and issuance because it is tied to the macro-economic  factor of 1 trillion dollars a year going into a region that only has 430 million inhabitants. The basic economic law of low supply and high demand will drive innovation, issuance and price. The capital flows will continue for the next 20 years regardless of the price of oil. This factor will be the single largest driver of new issuance.  As the dis-intermediation of this market is eroded by increased institutional investors (buyers) the supply of products from the issuers (borrowers) will be made more robust by the banks and investment bankers (providers). The distribution will accelerate through the listed exchanges creating more transparency, pricing and liquidity. This is usually followed by analyst coverage over the region and issuers which greatly aids in creating transparency and pricing, this is what is needed to create more liquidity. Once this occurs- knowledge, transparency and proper pricing of the instruments—makers makers will come in and greatly enhance the liquidity in the market on an ongoing basis.

 INVESTMENT THESIS Investment Objectives CMG  will restrict its activities to asset-backed transactions whereby either legal or beneficial ownership of the asset held on behalf of the Fund.  Capital Management Group Investments is a private equity real estate company, which raises equity capital for dedicated program of investing into opportunistic real estate investments.  The capital is raised primarily in blind pool limited partnerships.  Those investment programs are further distinguished in that they will not be “core” or “core-plus” investment strategies.  These investments will be private equity, opportunistic and/or value added strategies.  The fund will not seek to own the assets into perpetuity but to eventually exit them to realize a capital gain and generate an internal rate of return for the fund and its investors. There will also be an opportunity to gather capital from the U.S. Institutional plan sponsors to invest in the region given our existing client relationships with the 20 largest institutional investors-this will be explored later in depth and paired with a strategic plan.  The fund will raise capital from institutional investors, banks, insurance companies and high net worth individuals from the United States and Middle East and leverage its existing institutional clients, contacts and relationships. This connectivity and convexity of relationships will fuel this proprietary deal flow and create insight and inside deal tracks, that CMG will use to deliver  superior returns for its’ investors The other investment objectives of the CMG Middle East Event Driven Fund include generating for its investors regular income that is targeted at producing superior returns. t. Investment Strategy  CMG Investments mission is to maximize returns while limiting liabilities for our clients. CMG Investments is well positioned given the current global economic climate and its subsequent flow of capital from the Middle East and Europe to the United States to generate superior returns for our clients through our proprietary, relationship driven deal flow. CMG’s overall investment strategy is based on exploiting the arbitrage opportunity between current discounted real estate assets by leveraging the highly valued currencies from other regions in the world.  Along with employing Islamic Shariah compliant equity structures to increase capital availabity for acquisitions and leverages. CMG seeks situations in which investments can be made at an attractive cost basis and one which value can be enhanced through intensive operational and financial management.  CMG will source investments by teaming up with JV partners with excellent access to off market transaction flow.  The firm seeks to add value with proven local partners, through aggressive asset management. CMG Investments approach is to focus on bottom up investment analysis while considering the global macro-economic environment, the direction of investment capital, business cycles and real estate market values. We believe that a highly attractive real estate environment is available to investors by using proven real estate expertise, strong high-level relationship base and extensive network. This creates a highly competitive firm with all of the advantages necessary to successfully invest, manage and exit investments  The Fund’s Investment Committee will establish investment policies and periodically monitor all investments. If, during the life of the fund, the Board of Directors consider it beneficial to Shareholders in the Fund for the investment strategy to be revised whilst staying strictly within the initial strategy then a formal decision to do so shall be made and Shareholders subsequently informed.  Investors and Marketing Strategy 

INSTITUTIONAL INVESTORS

 

The Middle East Sovereign funds hold tremendous wealth and are in need of diversification. The relative areas to invest in their homelands are small in scale and contrast greatly with the size of their wealth. There GCC region has a tremendous surplus  this will continue to generate prodigious sums of investment capital.

 

REGIONAL BANKS

 

The local banks are perfect for enhanced retail distribution. They have clusters of clients and they are willing to share that information and client type with you. They will also collectively gather their clients for presentations—the structure I have set up is a SPV that has the Private Client contact as the sole contact for the fund and the person responsible for individual contact. The PC contact is the person that you forward all reporting to and who handles all requests.

 

8 Regional Banks that participated are participating this time.

  

INSURANCE COMPANIES

 

Insurance companies in the Middle East operate the same as here in the US except the investing of premiums in Shari’ah compliant vehicles. Several Insurance and Re-insurance CIO’s were present at the last conference and 2 are speaking at the Oct 29^th conference. I also have a complete list of over 300 Insurance companies in the region, this information database includes the direct numbers, cel phones, fax numbers and email for the CEO’s and COO’s.

 

WEALTHY FAMILIES

 

The members of the Royal family and other Sheikh’s and Sheikha’s that attend are looking for US Investments. They attend seeking knowledge and partnerships and are usually very open to conversation and readily hand out business cards when approached. To the extent that you are friendly and hand them a card they are very ready to talk. All the cards have a mobile number on them and all cards have PO Boxes since all mail is delivered to the post office and not the buildings. Middle East denizens do not generally respond to email but they like faxes and they will text like crazy!

  Private Investors The CMG Middle East Event Driven Fund enables private investors for the first time to participate in a diversified pool of Islamic assets comprising predominately sukuk transactions. Although this approach is innovative for the Islamic investor market has been, of course, long established as a main pillar for non-Muslim investors through the very large universe of bond funds. Until recent years there have not been sufficient sukuk transactions in the market to create an appropriately diversified asset portfolio for a fund. And, further hindering the market for this type of investment product, the sukuk that have been issued have been taken and held by large institutions so that the assets were unavailable for the average private investor. The CMG Event Driven Fund opens the world of full Sharia-compliant Islamic bond investing to the realm of all investors. Institutional Asset Managers CMG Middle East Event Driven Fund brings the principles of modern portfolio theory to the sukuk market. Until now the approach to buying sukuk for many institutional portfolios has been to take individual assets onto a balance sheet in a piecemeal fashion.
Each asset has been bought as it became available by the issuer, with discreet analytical work being applied to every transaction prior to purchase. In other words, individual risks have been taken on individual sukuk issues and analyzed accordingly. The CMG Middle East Event Driven Fund introduces a lower risk approach to the Islamic and Sharia-compliant fixed income markets. Investing in the CMG Middle East Event Driven Fund provides institutions with the benefits of a diversified asset pool that generates a single income stream, thus removing the burden of numerous individual credit analyses by the investor on an annual basis as well as the administrative task of allocating multiple cash inflows. Investing in the CMG Middle East Event Driven Fund spreads risk across a well-diversified portfolio of assets, making for more efficient asset management. 

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