What is Diminishing Musharakah, and how does it work?

At a glance

• Musharakah means partnership. Diminishing Musharakah (also called musharakah mutanaqisah) is a partnership that reduces over time.
• Al-Mustaqbal ("the future" in Arabic) SMSF finance uses it for commercial property purchases only.
• The fund pays a dividend rate, with Principal and Dividend or Dividend Only payments.
• The fund needs a corporate trustee, and every member gives a personal guarantee: see how an SMSF can buy commercial property.

What does Musharakah mean?

Musharakah is an Arabic word for partnership. In Islamic finance, it describes an arrangement in which two or more partners contribute to an asset or venture and share in its risks and returns under an agreement.

"Diminishing" describes what happens to one partner's share. Over time, the customer buys the financier's share in instalments until the financier's share has gone and the customer holds the whole asset.

How does Diminishing Musharakah work?

In general terms, it works like this.

1. The customer and the financier both contribute towards buying the property.
2. The customer pays the financier for the use of the share the financier still holds.
3. The customer also makes payments that buy part of the financier's share, so the financier's share gets smaller.
4. When the customer has bought the whole of the financier's share, the partnership ends and the customer holds the asset outright.

Islamic finance avoids riba, which is any increase charged for lending money for money. Here, the financier's return comes from its share in a real asset.

How does Diminishing Musharakah work for SMSF commercial property?

With Al-Mustaqbal SMSF finance, your self-managed super fund (SMSF) and the financier both contribute towards a commercial property. Your fund pays a dividend on the financier's remaining contribution and buys that contribution out over time, and on the final payment legal title passes to your fund.

Super law only lets an SMSF borrow to buy property under a limited recourse borrowing arrangement. To fit those rules:

• the fund must have a corporate trustee, a company whose job is to run the fund;
• a bare trustee, a separate company holding the property in a holding trust, holds legal title for the fund from settlement;
• every fund member gives a personal guarantee, so each member could be personally liable if the fund can't make its payments;
• members get independent legal advice on the finance contracts before settlement, unless it's waived.

The fund pays a variable dividend rate. Payments are Principal and Dividend, which also buy out the financier's contribution, or Dividend Only for a period.

What can the fund buy, and what isn't available?

• Commercial property purchases only. A residential property qualifies only if it's business real property.
• No refinance of existing SMSF finance.
• No construction finance for SMSFs.
• No redraw, no card and no cash out.
• A Cash Management Account is available: the fund can hold surplus money in it to reduce the dividend payable, with no interest paid or charged.

Our Al-Mustaqbal SMSF finance page explains the features and costs.

How does Diminishing Musharakah compare with Murabaha for a business property?

They're different kinds of contract: Diminishing Musharakah is a partnership, while Murabaha is a sale at cost plus an agreed mark-up. Neither suits everyone, and the right structure depends on who is buying and why.

For self-managed super funds buying commercial property, super law requires a particular arrangement, so we use Diminishing Musharakah for Al-Mustaqbal SMSF. If you're buying business premises in your own name, a company or a trust, see our Islamic commercial finance page. Our Ijarah vs Murabaha guide compares all three structures.

What are the pros and cons for fund members?

Possible pros

• The fund can buy business premises with finance rather than only with cash it already holds.
• The return comes from a partnership in a real asset, not riba.
• A Cash Management Account can reduce the dividend payable.

Possible cons

• Every member gives a personal guarantee.
• Extra companies and deeds are needed, and there's no redraw, card, cash out or refinance.
• Approval isn't certain: every application is assessed against credit criteria.

How does an SMSF use Al-Mustaqbal SMSF finance, step by step?

1. Talk to a broker. If you don't have a broker, contact us and we can refer you to an accredited broker. Get advice on the fund from a licensed financial planner or an accountant licensed to give SMSF advice before the fund commits to anything.
2. Check that the fund has a corporate trustee and that its trust deed allows borrowing.
3. Set up the holding trust and its bare trustee company before any contract is signed.
4. Your broker lodges the application, and the financier arranges a valuation.
5. If approved, members get independent legal advice on the contracts, unless it's waived, and your solicitor coordinates settlement.

How can Riyadh Financial Services help?

Riyadh Financial Services arranges Shariah-compliant property finance through accredited mortgage brokers. Accredited brokers must act in your best interests under Australian credit law (the best interests duty), and they work across Australia, in person or online.

• Al-Mustaqbal SMSF finance for self-managed super funds buying commercial property.
• Islamic commercial finance on selected Ijaar finance for individuals, companies and trusts.
• Ijaar home finance, which uses Ijarah Muntahia Bittamleek, a lease that ends in ownership.

Our product structures are reviewed by our independent Shariah adviser. Ask us for the current Shariah certificate and what it covers. We explain how our structures work, but we don't give religious rulings, and you're always welcome to seek your own scholar's view.

Neither Riyadh Financial Services nor brokers give SMSF advice. Speak to a licensed financial planner or an accountant licensed to give SMSF advice.

Keep reading:Al-Mustaqbal SMSF finance · How an SMSF can buy commercial property with Shariah-compliant finance · Ijarah vs Murabaha