Islamic finance: Key asset classes and trends

The asset class of choice for Shari’ah-sensitive investors deploying funds into the UK has historically been real estate. This is no surprise considering the already well established and increasing global popularity of the UK real estate market. In fact, CBRE estimates that investment into the UK commercial real estate sector in 2024 increased by 20% when compared with 2023.

However, the popularity of this asset class amongst Shari’ah-sensitive investors remains even more pronounced due to its conduciveness towards meeting Shari’ah standards. For example, Islam generally prohibits investing into businesses in the conventional banking, insurance, derivatives, alcohol and weapons manufacturing sectors, as well as businesses which are saddled with or invest heavily into interest-bearing debt. As a result, Shari’ah-sensitive investors are generally unable to invest in a number of equities, bonds and structured products.

When it comes to real estate, however, the Shari’ah approach is comparatively simple. Provided that the use of the property is acceptable from an Islamic perspective, investors can benefit from the rent it generates. Consequently, Shari’ah-sensitive investors have looked to the living sector for investment opportunities and the subsector remains a market favourite to date.

The Shari’ah-sensitive investor is therefore largely responsible for fuelling demand for Shari’ah-compliant facilities, which are often used to purchase high value real estate assets and enhance returns. Islamic banks, FinTechs and even some conventional lenders have responded to this demand, resulting in a diverse Shari’ah-compliant product offering for customers with a range of financing and investment needs.

Islamic finance and the living sector

More recently, Shari’ah-sensitive investors and Islamic finance institutions have paid closer attention to two important subsectors: purpose-built student accommodation and residential property. Other subsectors of note, which fall outside of this article’s scope, include the hotel, corporate occupier, social housing and retail subsectors.

To begin with, PBSA has proven to be a resilient asset which has drawn in several investors beyond those with Shari’ah sensitivities. With the UK being a popular destination for international students and certain cities experiencing housing shortages, the need for PBSA has been constant. This explains the continued growth in this subsector and its correspondingly high returns which, according to CBRE, outmatched every other commercial property subclass in the first three quarters of 2024.

Islamic banks have capitalised on this, with the principal asset underlying several high-profile Islamic finance deals being PBSA. For example, Foot Anstey recently advised Urbium Capital on the £18.5m development facility provided by the Bank of London and the Middle East in respect of a 133-bed PBSA asset at 15 Foss Island Road, York. This was one of two PBSA-backed facilities provided by the bank to real estate private equity firm Urbium Capital, both of which in the aggregate amounted to £45m. These transactions speak to the growing confidence that investors and financiers in the Islamic finance space have in this subsector.

The second subsector of interest is residential property, where the focus has been on Shari’ah-sensitive customers looking to purchase their first home with an Islamic mortgage. This market has a long history in the UK, with its roots stretching back as far as the 1980s.

Today, it is estimated that there are around 3,000 residential and buy-to-let mortgages in the UK and that number continues to rise. Although this may seem comparatively small, only a handful of providers exist in this sector, meaning that targeted focus and investment can lead to good returns.

For example, Nomo, a brand of BLME, has carved out a niche for GCC citizens looking to purchase second homes or buy-to-let properties in the UK. This product line is supported by strong demand, with Rightmove mapping more than one in 10 enquiries regarding UK residential property to the region last year. Other providers have also taken full advantage of the growing Islamic mortgage market, a great example being Gatehouse Bank, which has grown its home finance portfolio to £1.224bn in 2023.

As an aside, Gatehouse Bank, via its subsidiary entities comprising the Gatehouse Living Group, also has a strong track record in the build-to-rent sector illustrated by the recent sale of its UK single-family rental platform to Citra Living (now rebranded as Lloyds Living) for an undisclosed sum.

At Foot Anstey, we have received more than 2,000 instructions relating to Islamic mortgages in the last few years from a wide variety of providers. We have also seen a large number of queries from non-bank institutions who have shown a keen interest in launching Islamic bridge financing products. These queries are also reflective of a developing trend of greater non-bank participation in, and demand for, this market. Examples of this include Nester, Whitehall Lending and Offa. Altogether, this shows that the Islamic home finance market remains buoyant and continues to grow at a notable pace.

Secondary market and club deal Transactions

Having now understood the massive potential that lies ahead for the Islamic finance industry in the UK, it is important to look at what market participants are doing to take it to the next level. The answer lies in the increased sophistication with which key industry players have begun to approach the question of funding and growth. This indicates a maturing Islamic finance market in the UK and a potential move towards the development of new products and subsectors.

In that regard, we have seen a growing number of secondary market transactions in the residential mortgage market, within a short space of time, which require the industry’s attention. The first of these, which we have already mentioned, is Offa’s purchase of Bank of Ireland’s 350-unit-strong Shari’ah-compliant home finance portfolio in December 2024. The second, which was announced only a few days afterwards, is Gatehouse Bank’s partnership with ColCap, which included a £100m sale of part of its existing Islamic home finance portfolio and an agreement to originate more than £550m in Shari’ah-compliant mortgages.

Not only do these transactions provide Islamic finance institutions with more liquidity, but they also allow others to diversify their portfolios and make their offering even more attractive to investors. This marks a significant step for the UK’s Islamic finance market, considering that the last major transaction of this kind, Al Rayan Bank’s Islamic mortgage-backed securitisation, took place more than seven years ago.

Another sign of greater sophistication within the industry is the rise of club deal financings, which we expect will develop into fully-fledged syndicated deals with time. In the last few years, we have acted on behalf of various banks in relation to club deal financings and of late, we have seen an increase in the number of queries we have received regarding the topic. What we have found is that Islamic banks are keen not to shy away from lucrative opportunities simply due to internal policy and risk considerations.

They have instead sought out club deals as a way to achieve mutually beneficial outcomes and so they can grant their clients access to higher value assets. A good example of this is a recent transaction concluded in December 2024 which we mentioned in passing in the first edition of this series, the £140m Paddington Citi View PBSA refinancing. This was structured as a club deal between Abu Dhabi Islamic Bank and Emirates NBD. We now understand that ADIB has been admitted to the Loan Market Association as a member, which signals further interest from the bank regarding the concept of syndication. This is a welcome development and we look forward to seeing the very first Shari’ah-compliant syndicate consisting of UK Islamic banks and/or financial institutions.

Summary

The living sector remains one of the core sectors in UK real estate that continues to capture the attention of Shari’ah-sensitive investors globally. The simplicity and neutrality of the sector’s underlying assets lends itself well to fitting within Shari’ah investment frameworks. This, alongside the UK real estate market’s long track record, has resulted in the sector’s popularity. The key subsectors of interest include PBSA and residential property, where increased investment activity has led to further demand for Islamic bridge, and development and real estate investment facilities, which Islamic financial institutions have been ready and happy to provide.

It doesn’t stop there. The Islamic finance market in the UK continues to evolve, with parties exploring more sophisticated ways of funding transactions and portfolio-wide needs, including by way of club deal financings, deal originations and outright portfolio purchases. The size and frequency of such transactions suggests that these developments are not fleeting. Instead, the numbers tell us that more is to come from the UK Islamic finance market, it is simply a matter of time.