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Rental rate as an alternative pricing for Islamic home financing: An empirical investigation on the UK Market

Rosylin Mohd Yusof (Islamic Business School, Universiti Utara Malaysia, Sintok, Malaysia)
Mejda Bahlous (Department of Business, Rochester Institute of Technology, Dubai, UAE)
Roszaini Haniffa (Herriot-Watt University, Edinburgh, UK)

International Journal of Housing Markets and Analysis

ISSN: 1753-8270

Publication date: 3 October 2016

Abstract

Purpose

This paper aims to contribute to the banking and housing market literature by proposing an alternative measure of rate of return for Islamic banks that is based on the rental rate of the property. This alternative Islamic mortgage pricing mechanism could be adopted by Islamic banks as a replacement for mortgage rates if it is found to be independent from any form of interest rates as required by Islamic law.

Design/methodology/approach

By investigating the short run and long run dynamics between rental price index (RPI) and the proposed Islamic Rental Rate (RR-I) and, three selected macroeconomic indicators in the UK via autoregressive distributed lag model, the authors examine the link between RPI, RR-I and the real economy.

Findings

The findings provide evidence that while RPI in the UK is significantly related to three leading macroeconomic variables, namely, gross domestic product (GDP), real effective exchange rate and interest rates measures, while RR-I is only impacted by changes in GDP. More importantly, the authors show that there is no short or long run dynamics between the rental rate and any form of interest rates.

Research limitations/implications

This paper did not attempt to investigate the impact of the physical attributes of the rental property to formalize the model describing the relationship between RPI and RR-I. Also, other macroeconomic factors like household income growth, risk, house value growth rate and taxation could be included in future models.

Practical implications

As Rental Rate is not linked to the macroeconomic determinants, it is therefore more stable, resilient and sustainable and, at the same time, making the financing less risky for both parties, as they are less susceptible to economic vulnerabilities.

Social implications

Some calculations incorporating the proposed RR-I can also be extended to the pricing of products based on other contracts such as Tawarruq, Bai Bithaman Ajil or even Murabahah for a fairer and just pricing to both the banks and customers.

Originality/value

The results suggest that Islamic banks should consider incorporating the proposed rental rate (RR-I) when pricing their home financing products, as this will lead to less dependence on interest rates for benchmarking. In addition, using the proposed rental rate (RR-I) reduces the exposure to the subjective evaluation by property valuators and speculative macroeconomic elements.

Keywords

  • Islamic home financing
  • Autoregressive distributed lag model
  • Impulse responses functions
  • Musharakah Mutanaqisah
  • Rental price
  • Residential rental index
  • C22
  • R210
  • E580
  • E1

Acknowledgements

The authors wish to express great appreciation to the International Research and Training Institute (IRTI), Islamic Development bank, Jeddah for funding this study. The authors acknowledge with thanks to those who have contributed towards successful completion of this project.

Citation

Mohd Yusof, R., Bahlous, M. and Haniffa, R. (2016), "Rental rate as an alternative pricing for Islamic home financing: An empirical investigation on the UK Market", International Journal of Housing Markets and Analysis, Vol. 9 No. 4, pp. 601-626. https://doi.org/10.1108/IJHMA-10-2015-0063

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Emerald Group Publishing Limited

Copyright © 2016, Emerald Group Publishing Limited

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