SPONSORED ARTICLE: Turkish delight

With proximity to both Western and Eastern markets and a fast-improving business climate, Turkey has become an increasingly popular destination for regional and global businesses and investors alike. Indeed, the country has come a long way during the past decade, a reality reflected in both its social and economic landscape.
 
Following a rather turbulent political past, which historically cast a shadow over its economic achievements, the Turkish political system achieved long-needed stability and efficiency with the appointment of the AK Party in 2002. Meanwhile, the country continues to be one of the fastest-growing economies in the world with increasing per capita income levels, an expanding middle class and a young, steadily-growing population.  

While these positive developments are strengthening Turkey’s macroeconomic position, there remain substantial acquisition and development opportunities in the domestic real estate market, which is relatively underpenetrated by the institutional investment community. That is because, despite significant growth via investments by local and international investors over the past decade, the market still is underserved by institutional-quality products in many sectors. 

In that respect, Turkey is especially attractive for opportunistic real estate fund managers looking for higher risk-adjusted returns and those that can effectively manage the general volatility of emerging markets. Indeed, both ULI and PwC have ranked Istanbul as one of the top investment markets in Europe for the past three consecutive years.  
Growing with increased stability

Following extended hyperinflationary periods and the deep economic crisis of 2001, Turkey embarked on a clean start in the early 2000s, which led to significant achievements on the macroeconomic and political fronts. Turkey’s continuing EU accession process has led to implementation of numerous economic and regulatory reforms resulting in increased transparency, enhanced competition and efficiency in its economy, which has created an increasingly favorable foreign investment environment. The country’s growth story is further supported by its recent promotion to investment-grade status, which enhanced the positive perception of Turkey’s stability.

Turkey is one of the largest global economies with 2012 GDP of $786 billion and a projected annual mid-term growth rate of around 4 percent, outpacing neighbouring EU countries that are projected to grow just 1 percent on average over the next several years. Driving the economic growth and increased real estate demand, Turkey benefits from a young and growing population, which is the second largest in Europe and approximately half of which is under the age of 30. 

Turkey’s banking and financial sectors, which historically were perceived to be the main weaknesses of the country, have been completely transformed into one of the most stable financial systems in Europe. This was underscored by the sector’s robust performance throughout the recent global crisis, with banks maintaining average capital adequacy ratios of around 18 percent and reasonable nonperforming loan levels of around 3 percent. 

An underpenetrated market

The Turkish real estate market started its current development phase during the early 2000s, parallel to the macroeconomic restructuring of the country. While there was a highly localized market with few major developments in the pre-2000 era, a large uptick was observed during the five-year period from 2003 until 2008, which was interrupted only by the global financial crisis. 

During this period, the real estate landscape shifted significantly with heavy investments from major international firms such as ECE Projektmanagement, Corio and Multi Corporation, primarily in the retail sector. Other segments such as hospitality, office, logistics and residential remained for the most part dominated by local investors largely due to the scarcity of institutional-quality acquisition opportunities. While most international investors were wary of going into development, local investors with such expertise were able to benefit from the attractive prospects in these sectors, taking advantage of the significantly lower construction costs in the Turkish market compared to major international markets.

Today, the landscape of the Turkish real estate market continues its transformation via several ongoing projects initiated by the government. Urban regeneration projects continue to be one of the key topics on the government’s agenda with a goal to rehabilitate problematic urban spaces, which resulted due to rapid urbanization and uncontrolled growth. Major infrastructure projects undertaken mainly in Istanbul are anticipated to positively influence real estate investments throughout the city. Furthermore, private investors have initiated mega mixed-use development projects in Istanbul such as the Zorlu Center, Mall of Istanbul and Emaar Square projects, which stand to benefit from increasing demand. 

As the positive perception of Turkey’s stability for investments grows, more international capital is expected to be invested in Turkish real estate. Despite the mixed global macroeconomic backdrop, the Turkish real estate market continues its steady performance supported by domestic and international demand drivers and through multiple new large-scale public and private projects being implemented. The confidence of international investors in the market has been displayed by recent sizeable direct investments by The Blackstone Group and the Government of Singapore Investment Corporation in the retail sector.  

Distinct opportunities 

Istanbul’s popularity as a tourist destination has been growing significantly, with increasing foreign arrivals leading to strong RevPAR increases. Between 2000 and 2012, foreign tourist arrivals to Turkey increased at a compounded annual growth rate of around 10 percent, which has led to strong interest in the country from international hospitality operators. The medium- and long-term prospects for tourism in Istanbul and other major Turkish cities remain positive.

Meanwhile, declining mortgage rates, robust underlying demographics and strong economic growth is expected to reflect favorably on residential sales. Demand for housing in Turkey is projected to outpace supply supported by rising household incomes, ongoing urbanization and re-urbanization rates. Furthermore, a significant portion of the existing housing stock is in need of replacement due to age, substandard construction quality and earthquake risks. 

The student accommodation market also is underserved. A lack of quality offerings in the market, coupled with a rapidly expanding student population, has created investment opportunities. Being the leading student destination in Turkey, the Istanbul market is comparable in size to London, with demand from around 320,000 students being met with only around 50,000 beds in modern schemes. 

The office market is ripe for further investments too. Despite an increasing office supply, vacancy rates have been stable and office rents resilient as there is a growing need for high-quality office space in line with economic expansion and global and regional businesses choosing Istanbul as their hub. Strong occupier demand for prime office assets, combined with limited available space in existing prime stock, has led to an investor-friendly climate in the central business districts. It is anticipated that the office segment will gain pace and achieve notable investment share over the medium term.

The retail sector continues to hold the largest exposure of foreign investors in the Turkish real estate market, with meaningful acquisition activity. Although the market increasingly is becoming more competitive and retailers have a more disciplined approach to their expansion plans, strong retail centers in premium locations offering sustainable rent and turnover levels continue to attract significant local and international retailer demand.

Market traits

On the other side of the coin, Turkey is not an easy market to navigate. This is especially true for international investors relatively unfamiliar to the high volatility on both the economic and political fronts, which could result in potentially strong market swings.  

For example, the second quarter of 2013 was a turbulent period for the Turkish market.  Protests erupted at the end of May over Taksim Gezi Park, which spiralled into two weeks of anti-government protests across many cities in Turkey. The issue was later resolved following the government’s willingness to halt the development and put it through legal channels. This eased the tensions in the market and, by late June, things were largely back to normal.   
From an opportunistic perspective, the combination of global market volatility and perceived uncertainty in local markets has led to reduced investment levels from domestic players, thereby creating interesting acquisition prospects for those investors with access to capital and proprietary deal flow. While Istanbul remains Turkey’s most prominent city and continues to dominate the country’s real estate market, other major cities such as Ankara, Izmir and Antalya also attract substantial investment.

After the initial global sell-off following the US Federal Reserve’s comments over the summer, international investors are expected to re-assess the risk-reward potential of emerging markets. As a result, Turkey could benefit from future capital flows given its strong market fundamentals, growing economy, sound banking system and strong fiscal position when compared with the medium-term growth prospects for Europe and other Western markets. 

About the Author:
Frank RoccoGrande is a senior managing director and partner at BLG Capital, where he is responsible for management of the firm’s real estate funds management business. He can be reached at +90 212 381 2293 or via email at froccogrande@blgcapital.com.

About the Firm:
BLG Capital is an independently managed, vertically-integrated private equity real estate firm focused on investments in real estate and companies with underlying real estate assets in Turkey and adjacent geographies. The firm’s principal focus is on hospitality, student accommodation, office buildings, mixed-use properties and high-end residential projects.