Turkish real estate sector poised to become global leader

While much attention has been given to the promises of the Turkish banking sector and the opportunities offered by İstanbul as a finance hub, less attention has been showered on the real estate sector. Like the much-publicized resilience of the Turkish banking sector, which has remained incredibly sound -- in large part as a result of its lack of sophistication and its steering well clear of a number of highly leveraged debt instruments -- the Turkish real estate sector has been amongst the least leveraged and least negatively affected in the developed real estate markets of the world. And experts are confident that demographics and geography as well as sound economic and structural forces will ensure that all sub-sectors in the real estate market in the coming years will go on to become some of the most promising in the world.

“When we ask international investors to rank countries like Turkey, Greece, Romania, Ukraine, Russia and Azerbaijan, the majority would place Turkey as number one or two on the list,” says Alan Robertson, managing director at Jones Lang LaSalle (JLL) in İstanbul.

His reluctance to put Turkey at the top of the list stems only from the fact that Russia has “gone from boom to bust” and hit rock bottom, with prices having plummeted 50 percent below their previous highs. Robertson feels that the temporary deals to be made might lead investors to flock to take advantage of cash-strapped and leveraged Russian property owners in dire need of liquidity. But once the smoke clears, demographics, geography and sound economic fundamentals lead many experts to conclude that a bright future awaits Turkey.

“When the deals are gone,”     Robertson says, “they will be back.”

One reason the prices in İstanbul, and Turkey as a whole, have not dropped as much in recent years has been the lack of a developed financing system for mortgages; this only came into effect last year and was just starting to get on its feet when the crisis broke -- and with interest rates hovering around 15 percent per annum (right before the crisis they dipped down below 12 percent), financing real estate was not a cheap option -- especially with the 25-30 year amortizations common in developed markets.

In sum, when the crisis began strangling investors across the globe, causing real estate owners to rush to sell their property and plunging prices down for bargain hunters, the Turkish land holder, who owned property free and clear could afford to hold on and wait for prices to recover. As such there has been little movement in the real estate sector. “We call this stagnation,” says Kerim Cin, managing partner at Colliers International in İstanbul. “There is a clear mismatch between what owners will sell at and what buyers will pay.”

“We cannot attach a precise figure on how far the market has declined,” says Idil Hamzadi, research manager at JLL. “There have not been any [significant] transactions in the market since the end of 2007.”

One way to gauge real estate values is to look at rental prices. As sale prices stagnate and rental prices drop, yields (the total gross yearly rent of a property divided by its value) are down by as much as 30 percent. “The prime yield for office space is said to be around 8 percent. But prime capital values have declined by 30 percent. When commercial property rates are generally determined by rents, this creates problems for valuations, further scaring away investors,” says Robertson.

Most analysts, however, believe that this is just a temporary trend. “When bargains are gone [in countries such as Russia], investors will come back to Turkey,” Robertson said, quickly driving prices back up to pre-crisis levels.

Residential, retail or office -- which     will lead the recovery?

Not all agree which real estate submarket will lead the recovery and whether or not all will be able to reach these pre-crisis levels. Robertson, for instance, believes that it will be the office market that will be leading the recovery in the real estate sector: “Grade A office space in İstanbul is tiny compared to any other city that is anything like the size of İstanbul,” he said, noting that many multinationals are now occupying poor space despite their desire to occupy better quality office areas.

Indeed, according to officials at JLL, even now, at the height of the crisis, vacancy rates for grade A office space stand at only about 5 percent of full stock. And office space that is over 5,000 square feet is virtually nonexistent, creating increasing problems for multinational companies who are losing a great deal of time and energy with costs associated with occupying sub-optimal locations.

When the recession ends, “the existing [grade A] office supply will not be sufficient. That's why we are telling our office developers to come in and develop speculative offices,” Robertson said. “We expect to see a full recovery by 2011 -- maybe the second half of 2010.”

The enthusiasm, however, at least appears to be dampened by the fact that very few developers have been willing to begin building in anticipation of a recovery. Insiders who are close to many real estate deal-makers that Sunday's Zaman spoke with pointed out an Eczacıbaşı (one of the leading Turkish holding companies) project under construction in the Levent district as being the only speculative project being developed at present in the central business district -- the area which stretches from Beşiktaş to Maslak on the European side and which presently accounts for 80 percent of the Turkish A-class office space.

But not everyone was as optimistic as Robertson on the speed of recovery from the crisis. The absence of financing, while influential in preventing a dramatic crash in the real estate market, according to some, will also be influential in preventing a swift recovery.

“I think this [inability to obtain financing] is the main factor that affects the Turkish commercial market,” said Cin. “Developers can't find money. Investors can't buy assets because they can't find acquisition finance. Homebuyers can't find home loans.”

Put differently, “there will be less demand and less supply,” Cin said, referring to the larger commercial deals. “There will be a lack of supply because developers are not building and a lack of demand because investors not buying.”

And this was largely why he felt it would be the residential market that would be the first to recover. Cin had a hunch that home loans will probably put the real estate market back on the road to recovery. “With lower interest rates, there will be increased movement in the residential sector.”

Ediz Giray, owner of A Plus Consultancy, a company that has been counseling real estate construction companies on matters relating to feasibility studies, financing, and the like, since 1997, noted that “sales for the A+ and B income segments have almost stopped.” Despite residential real estate prices having tripled in some areas over the past five years, Giray argues that prices are not the cause of the problem. “Prices are not high. Companies are selling on tight margins,” he said. The problem, according to him, was rather the unreasonably high interest rates, which, up until a few months ago ran at about 24 percent per annum. With rates falling dramatically over the past months this trend may be reversed.

Indeed a number of dynamics at this end of the field are poised to stimulate demand again. For one, the Housing Development Administration of Turkey (TOKİ) has plans to build thousands of low-income houses this year, bringing the total number of houses that they have built up to 400,000. Specifically, earlier in the year, the Finance Ministry and the Environment and Forestry Ministry jointly prepared a bill that was submitted to Parliament paving the way to turn the many thousands of illegal settlements that have been built on forestland, or 2-B land as it is called, across Turkey into legal residences meeting safety regulations.

Giray was hopeful that this would have a positive impact on the real estate sector as the flood of land available for private ownership would not only drive down prices (thus stimulating the construction market) but also spur considerable movement in the now stagnant construction market.

There are precedents to residential real estate acting as the spearhead to recovery: After the crisis in 2000-2001 real estate values dropped by as much as 50 percent but recovered sharply in 2004. “I don't think prices will recover as fast [as they did in 2004], because the drop has not been as high,” Cin said, “but they will recover.”

“Institutional finance will not come online in the midterm. It will be unlikely to see this until 2011 at the earliest,” Cin feels. In his view, a recovery in the real estate sector will come down to a recovery in the lending markets. Banks are believed by many to lead the recovery, although the jury is still out about lending.

Turkey to become a logistics hub

Logistics-related real estate is also seen by many analysts as being a very promising sector for Turkey in the medium to long term as well. Robertson says that it is three to four years behind office in terms of its evolution and therefore offers great promise -- especially with Turkey's geographical importance along an east-west and north-south logistical axis.

Indeed, the main drivers of the economy have been retail and manufacturing, and both have been affected badly. But when the economy begins to recover, these sectors will increasingly resume their pursuit of new strategic areas:

“The sector [logistics] is going to boom,” Hamzadi told Sunday's Zaman. In addition to established centers like İstanbul, İzmit and İzmir, secondary markets such as Mersin, Trabzon and Sinop would soon explode, she said. An increasing number of international companies who have come to notice the geographical importance of Turkey in regional and global logistics have also realized the potential to upgrade and expand the logistics infrastructure.

Prologis, the Fortune 500 company which has over 44 million square meters of industrial space around the world, has recently announced their intention to invest in Turkey.

“All three types of commercial real estate offer big opportunities for investors,” Hamzadi confidently stated. “Turkey is a huge country; it has a huge young and expanding middle class; its [gross domestic product] GDP is growing, and an increasing number of multinational companies are being set up in Turkey. The demand side is going up.”

Retail to lead charge in real estate

Some posit that the retail sector will be the real estate sub-sector that will lead the charge. According to Herman Kok, associate director of research and concepts at Multi-Development, the reason is simple, “If you grow in population -- you need more places to shop.” He says that there is particular promise for high-quality modern retail outlets in good locations as “the traditional bazaar is replaced with modern retail.”

But not all agree. Cin says that it is not fair to compare developed retail markets in Western countries with Turkey. Kok, however, says the comparisons hold water: In Central and Eastern Europe (countries with comparable socioeconomic and income levels) the density of high-quality shopping areas is double and triple that of Turkey.

“Organized retail [supermarkets and brand-name retailers] accounts for about 40 percent of trade in Turkey. In Central Europe it is 80 percent.” Kok describes this as a “process of modernization,” which he said Central and Eastern Europe experienced in the 1990s and which Turkey has just been experiencing over the past five or six years.

But Kok remained skeptical of the same boom in the less than optimal retail market. “There was a boom in retail and it was about time for a correction,” he said, especially in the less optimal shopping areas with retailers likely to be acting much more selectively than in the past.

This view is shared by others. “Prior to the recession, the [square meters of retail] were over-rented,” Cin said, noting that rents were high compared to the revenues being made. “When there was a correction on the demand side, sales dropped and rents became even more expensive,” he explained. When all is said and done, rents have now dropped by upwards of 50 percent -- mainly through incentives -- which, although they do not affect the gross yields on property, certainly affect the “net yields.”

“Most landlords refused to change contracts,” said one source who is an executive manager in a large modern shopping center in Anatolia and who did not wish to be identified. Land values are directly tied to rents, and therefore no landowner was willing to implement decreases in rent.” Tenants, for the most part, were forced to accept these short-term measures because their problem was immediate cash -- something that these incentives assisted with. He was not hopeful that there would be any recovery in the near future.

Despite his optimism Cin felt the sector might suffer again next year when landlords do away with the incentives. And although he felt that the sector would recover quickly, he did not feel that pre-crisis rents would return for the next several years at least. The main cause was that most landlords have either borrowed money to realize large projects in the last couple of years, and or they got into forward sales agreements with investors.

Kok does not see an immediate increase in prices in retail -- especially rents (which exert considerable influence on commercial real estate values) -- as the sector had been “over-bought” and “over-rented” in the years leading up to the real estate crisis.

The boom in retail real estate prices and the growing consumer power of the Turkish consumer led to international companies rushing into the market and causing a rapid expansion in the retail sector. “They [retailers] did not want to give up their market share to rivals,” explains Hamzadi, who said they began opening branches in every mall around the country without necessarily assessing the feasibility of the project. “Now they will be more selective,” says Kok.