Wednesday, December 12, 2007

Talk about a test case!

I have to say one thing from the outset: having worked on exactly one Sharia-compliant real estate loan (almost ten years ago), I am by no means an expert on these type of deals. But they do fascinate me. The whole prohibition on interest but allowance of profit elements, and all the other magic lawyers do to try to provide the security of without running afoul of Islamic law is very interesting.

Obviously, I was intrigued by the story in today's Journal about how a foreclosure might work in such a deal. This is apparently treading new ground. According to the story:

Islamic financial investments avoid the use of interest by being structured as leases on the property. Thus, instead of interest, the investor receives rent directly from the property. The amount of the rent is pegged to an amount a traditional investor would have received in interest.

In theory, the foreclosure of a Sharia-compliant investment shouldn't pose major problems for lenders. The lease that serves as the Sharia-compliant investment vehicle is subordinate to the underlying mortgage. So when a lender forecloses on the mortgage, the lease is canceled.

But what will happen in practice? It should be just like foreclosing on a leveraged lease, or maybe a mezz loan or UCC sale. I guess we'll have to keep an eye open.


Lisa Michelle Galley: said...

I am familar with a few Sharia-compliant deals from a prior life. Never got into any issues, but during those deals I heard people muttering "hope this all works out alright" more than a few times.

David Stejkowski said...

Lisa, I always wondered what lenders thought. The one time I did it I have to admit that was in my mind too. The thing is that these deals never seem to go south, at least not publicly. And just because they say it works in theory means nothing in practice.