Zeynep Kudatgobilik of Deutsche Bank Research -
Despite ongoing domestic political tension, vulnerabilities in the economy and continued volatility in global financial markets, Turkey remains an attractive longer-term investment market, being the second most populous country in Europe after Germany and the sixth largest European economy. It has a young and growing population of over 7m - 43% of the Turkish population is under the age of 25 and sizable migration to the country's cities is taking place. These demographic trends compare favourably against those of aging Europe. In addition, Turkey has increased its real per capita GDP in USD terms by more than 30% over the past 5 years. Naturally, growth in the economy and rising purchasing power levels have created increased demand for new housing and lifted the real estate market in general.
The Turkish economy is in much better shape than six years ago: Real GDP expanded by almost 7% per annum over the last five years. However, the Turkish economy remains vulnerable to external and domestic shocks. The domestic challenges are amplified by the global economic slowdown. GDP growth will remain between 4.0% and 4.5% for 2008 and 2009.
Favourable long-term trend intact: Strong population growth, better qualified employees, deeper integration in the global flows of goods and capital, and an ongoing process of macro- and microeconomic reforms promise an average growth rate of 5-6% per annum for the next 15 years. Retail property has benefited most from the economic upswing: Rising incomes of the increasingly urban population have helped changing the retail structure towards more western shopping formats. The still large supply pipeline is starting to bear supply-side risk for some Tier-I cities. Retail project developers will therefore have to focus on the smaller Tier-II cities, where significant pent-up demand still offers investment opportunities.
Strong growth in office space demand expected: Ongoing structural change towards more services and especially the shortage of modern office supply are the foundation for strong demand for investment in office space over the next 10 years. Not counting replacement demand we expect additional demand for modern office space in excess of 5m square metres (sqm) over the next 10 years in the largest 25 cities. !
More than 5, housing units requited in next decade: Within 10 years the number of households in Turkey could rise by 3.7m. Combined with necessary replacements Turkey needs about 500,000 new housing units each year.
Real estate finance system maturing: In 2007, a new mortgage law was passed in Turkey. This new law will enable the mortgage system to develop. The total volume of mortgage loans could reach roughly $90bn by 2015, up from almost nil in 2005.
The retail sector spearheaded the evolution of Turkey's commercial property market. Within a few years, domestic retailers expanded and consolidated to form regional and national chains. Cross-border retailers entered the market, benefiting from the country's strong economic growth, limited legal barriers to entry and attracted by high growth potential. Approximately 190 shopping centres had been built in the country by February 2008, although most shopping centre developments were delayed until 2003, due to the contraction of the Turkish economy following the economic crisis in 2001. Ever since, the retail market has been the fastest-growing sector of the Turkish real estate market. The increasing wealth, the growing population and limited existing retail stock have fuelled retail development and provided a ready space solution for cross-border retailers keen to expand in this market.
Turkey's large and young population make it appear attractive for retail investments. Turkey is one of the few markets in Europe that will experience strong growth in the key consumer group of 25-35 year olds. This has a multiplier effect on the country's market potential for retailers. First-mover advantage is critical both for retailers and shopping centre owners. If Turkey's shopping centre market follows the pattern in Europe, it may be anticipated that developments will be subject to greater planning control in the future. Gaining a significant market share at an early stage will then be a crucial success factor.
At 50 sqm of modern shopping centre space per 1,000 inhabitants, Turkey's shopping centre stock is still relatively small; far below the levels in the mature markets like Sweden, the Netherlands, France and the UK, that exceed 250 sqm per 1,000 inhabitants. The low stock, however, not only represents pent-up demand, but primarily reflects the lower wealth and spending potential in Turkey.
A more accurate benchmark of market potential, consumer spending per sqm, shows that Turkey already looks stretched in terms of its ability to absorb all the existing retail schemes, let alone the ones in the pipeline. At almost €21,000 per sqm, consumers in Turkey spend less per sqm than those in Sweden and in the Netherlands, which already have established retail markets. In addition, some of the biggest markets like Erzurum, Istanbul, Eskiehir, Ankara and Antalya, seem to have reached or even passed their saturation point - at least with regards to consumer spending per sqm.
This is a consequence of shopping centre development having mainly targeted the densely populated districts of major cities such as Istanbul, Ankara, Izmir and Antalya. These four represent roughly 60% of Turkey's total shopping centre stock, which is estimated at 3.5m sqm. Istanbul alone comprises over 30% of this stock. The city has 47 shopping centres, with a total gross leasable area (GLA) floor space of about 1.5m sqm, including Turkey's largest shopping centre, Cevahir, which opened in 2005 and offers 107,000 sqm GLA.
The development pipeline in Turkey is enormous; only second to Russia's and similar to Italy's, with approximately 2.4 million sqm to be completed until 2009. About 35 new shopping centres are under construction in Istanbul alone, with an additional 20-30 at planning stage. Roughly 80% of these projects are located on the European side, and particularly in the north west of the city. Forum Istanbul is the largest project in the country, with 165,000 sqm GLA. Also in other cities significant new buildings are expected: Ankara will see another 620,000 sqm GLA entering the market by 2010; Antalya and Izmir will house an additional 315,300 sqm GLA16 and 258,000 sqm GLA respectively over the same period. Almost all shopping centres are well designed, are high-specification schemes and medium to large in scale. They also represent some of the best schemes in Europe, especially given the ageing profile of Northern Europe's shopping centre stock.
Tier-II cities still offer opportunities
Due to saturation in some of the big Turkish cities and rapidly increasing land prices, many developers and institutional investors are forced to look beyond the biggest cities and explore secondary cities, like Mersin, Samsun, Kocaeli and Diyarbakir. Mersin for example, is a sizable city with a busy port on the Mediterranean coast of southern Turkey and an industrialised and commercially active city. It has already attracted a number of retail investment projects and houses five shopping centres, with the capacity to absorb further centres. Its retail profile is very similar to that of Athens, and its spending per sqm is higher than that of Frankfurt, Milan or Madrid - indicating significant growth potential in the medium term, especially as construction costs are well below the levels in Western Europe. Similarly, Samsun with a population of 725,000 people on the coast of the Black Sea is an important Turkish trade centre. Kocaeli, with its capital Izmit, is a giant natural harbour benefiting from its proximity to Istanbul, while Diyarbakir is the second largest city in Turkey's South-Eastern Anatolia region - behind Gaziantep - and had seen its development held back by political unrest until only recently.
Overall, retail investment has tended to target the western cities of Anatolia. This situation will likely change in the next few years, as incomes will continue to grow across the country and saturation levels in the Tier-I cities will drive investors eastwards. This will be supported by the gradual shift in economic activity towards the centre and east of Turkey, as companies are trying to reduce production costs. There are already two big shopping centres under construction in the eastern region: the large Forum Diyarbakir with 55,000 sqm of GLA and the medium-sized Forum Gaziantep (39,000 sqm of GLA).
Increasingly, Turkish shopping centres will not only function as areas for retail use, but also as meeting points for social activities and as weekend destinations, similar to the patterns across Western Europe. Then, differentiation of shopping centre concepts will be key as leisure activities offered will play a more prominent role for success. Quality of offers will be upgraded and more international luxury brands will enter the market. In addition, asset management will become more professional, i.e. greater attention will be paid to the quality of the tenant mix.
Compared to the retail sector, the office sector in Turkey is still in its infant stage. As it stands, attractive investment grade office space is primarily located in Istanbul, and even there it is limited. Since the beginning of the decade, demand for office space has been rising rapidly, with more foreign companies entering the Turkish market, and more local players expanding their businesses thanks to Turkey's economic growth.
In Istanbul, the business and financial services sectors form the major source of demand, with letting activity being mainly concentrated on the European side, where more office space exists. The city's modern Central Business District (CBD) is stretched on a 'strip' on the European side that crosses two separate boroughs and includes the areas of Levent, Esentepe, Zincirlikuyu and Maslak. The high quality office buildings (Class-A) are mainly found in Levent and Maslak. Maslak is expected to receive additional office occupier interest now that the metro line extension is underway. The office buildings on the Asian side are mainly of a lesser quality (Class-B) but there is a considerable pipeline of prime office buildings in the short to medium term that should help increase occupier demand. Altunizade is one of the main office locations on the Asian side, together with Kozyatagi, that is benefiting from its proximity to the D-100 highway.
The office vacancy rate has been decreasing throughout all business districts of Istanbul in the last few years. This is particularly the case on the European side, where it is virtually zero for modern office stock in the areas of Levent and Maslak. There is more variation on the Asian side, with vacancy rates of 5% to 15% in 2007 depending on location. Limited supply and strong occupier demand have put strong upward pressure on prime office rents, which have risen by more than 60% over the past three years. Although the price differential between the two continents holds firmly, rents have grown strongly in all business districts of Istanbul, reaching $40 per sqm a month in Levent and close to $20 per sqm a month on the Asian side.
Medium-term outlook for Turkey's office market
Going forward, the upward pressure on rents is likely to continue, albeit at a moderate pace. The shortage of available land, coupled with very high land prices restricts further office space developments, particularly in the CBD. Moreover, the current financial and economic slowdown means that fewer new enterprises will seek to enter the Turkish market in the next 24 months. The current supply pipeline will then limit rental growth. The significant rent differentials within Istanbul together with the economic slowdown will force some office occupiers to relocate to new, emerging locations on the Asian side. Within the core CBD area, where land supply is restricted, we expect to see more refurbishments. The government's latest pro- posal to move Turkey's Central Bank headquarters to Istanbul will positively impact the city's office market. The government-dominated office market in Ankara would suffer from the move with rising vacancy rates in the coming years.
In the longer run, the service sector is expected to continue expanding faster than the overall economy, ie. the share of the service sector in overall employment will increase. Our baseline scenario for regional office employment does not forecast any big shifts in the regional distribution of the industries. Based on population size and the concentration of services, Istanbul is and will remain by far the largest office market in the country, with the market's importance as a gateway between Europe and Asia continuing to increase. Still, a rapid increase in office employment is anticipated throughout the country at rates that compare favourably with those in major western European cities (ie. average annual growth for seven primary German cities was 0.8% from 1995 to 2005).
Besides Istanbul, Antalya, Ankara, Kocaeli and Izmir are expected to generate fast growth in office demand. Izmir, in particular, has already started to experience significant office development with the New City Centre project. The scheme has actually moved the city's former centre of Alsancak-Konak area, where land has become scarce and expensive, to a new city centre, where better quality office stock can now be found. According to Colliers, an additional 330,000 sqm of new office space is expected in Izmir by 2010, changing the face of the city. The Izmir project is an example of planned development and further reinforces the Turkish govern- ment's intention to be more flexible compared to other Western European countries when it comes to the expansion of its cities' planning system. Residential Key drivers for the development of residential markets in Turkey are: – Rising incomes, – population growth, intra-Turkish migration and continued urbanisation, – the need for new development and upgrading of unlicensed, sub- standard buildings, ie. in order to meet higher construction standards following the 1999 earthquake and – the new mortgage law passed in 2007.
We expect the overall trend of declining household size to persist. This is supported by an analysis of a panel of 38 countries over time: by the year 2027 on average 3.8 people will live in a Turkish household - still significantly more than in west European households today. Furthermore, we have assumed a slowdown in migration as push and pull factors for moving are weakening. This stems from the likely narrowing of relative income differentials between regions and diseconomies of agglomeration like rising cost of living and mounting traffic problems that cannot be solved quickly enough through infrastructure investments.
Overall, the growth rate of the household numbers is outstripping the population increase. Our forecast model predicts that household growth will be strongest in already more densely populated regions with smaller average household sizes. What is striking, due to outward migration, a few regions may actually experience falling house- hold numbers over an extended period of time.
The Reconstruction Act 19857 passed in 1985 requires a building construction licence from either the municipality or the province for all buildings. With the application title deeds, architectural and structural drawings need to be submitted. Construction should commence within two years from the permit issuance or the permit needs to be renewed. Within five years from the date of the permit constructions has to be completed. Permit to use the construction (utilisation permit). At the end of construction, the owner is obliged to obtain a permit to use the building. This permit from the governorship and the municipality is granted if the building complies with the construction permit. Legally, electricity, water and sewerage connections are only provided to buildings with a utilisation permit.
According to the most recent building census of 2000, there was no overall shortage of housing in Turkey, given that there was a total of 16.2m housing units and 15.1m households. The regional differences in the ratio of housing units available to households are stunning. In Istanbul, 33% more housing units than households were counted, in Izmir the excess was 24% and in Ankara 10%, whereas in some of the northern provinces some 30% to 40% more households than dwelling units are reported.
For several reasons this does not mean that residential markets even in regions with "excess" supply are unattractive to investors. First, the building census figures encompass all dwellings regardless their facilities and quality. In the survey more than 8% of buildings in Turkey were described as either in need of serious repair or in ruins and planned to be demolished. Second, only one-third of all housing units in Turkey had a building and an utilisation license in 2000, which is formally required to obtain a connection to utilities. In the larger cities this ratio tends to be even worse as incoming migrants typically look for low-cost housing. In Istanbul, for example, only 19% of all buildings had the appropriate licences. A large share of the unlicensed buildings are officially considered to be substandard, not meeting safety and/or other regulations.
This implies that a considerable part of the housing stock needs to be renewed. In the 8th Five Year Plan (2001-2005) the State Planning Organization (SPO) estimated the need for renewal and new settlement at 7.9m units for the years from 1990 to 2005, ie. almost 530,000 units per year. Over this period 6.2m construction permits and 3.6m utilisation licences were issued. Construction permits are used to start building but occupancy permits are not always applied for due to deviations from the original plans in the actual construction. Many of these new structures end up as so called "squatter housing". Data for the last five years show that regulated urbanisation and licensed housing also recently could not keep up with demand and the stock of "illegal" buildings is still expanding.
The official statistics identify three types of investors in residential buildings, namely private investors, construction cooperatives, and public bodies. In the recent past, the shares of construction co- operatives in a rising market was declining, whereas private investors show strong growth and the increase in public activity more or less compensates for the falling activity of construction cooperatives. Only 7% of all dwelling units built in 2006 and 2007 were single-family houses, while the remainder consisted of buildings with two or more dwelling units. This clearly results from the urbanisation trend: land is scarce in cities and multi-family homes represent the economic response to this scarcity.
Unfortunately the paucity of comprehensive and reliable price data does not permit more than a rough expert-based indication of affordability trends. According to our respondents in Turkey, houses have become more difficult to afford due to the higher cost of credit and the recent moderation in real income growth. The top 20% income-strata can more easily purchase a home, but only a reduction in the cost of credit and an extension of maturity would enable a larger share of the population to exercise demand in the official and licensed real estate markets. Against this backdrop the high home ownership ratio in real estate of almost 70% can only be explained by the traditional financing with savings of the extended family, the high preference for housing as an inflation hedge in storing wealth and the large share of unofficial construction. For our housing demand forecast we assume a slowdown in illegal construction activities, the escape valve for pressure in the housing market used extensively in the past. This is the result of the in- creased scarcity of suitable land for building in cities, improved monitoring of building and zoning rules and the indirect linkage of access to financing with the adherence to building regulations. In addition, we expect a large number of housing units to become obsolete, assuming that 1% of the building stock needs to be renewed annually. Many buildings do not meet required standards and on top of this user preferences have changed with rising in- comes.28 Furthermore, owner-occupied housing is likely to be more affected by the tightening of unlicensed housing construction than the development of residential properties for rent. An increased willingness to rent may develop as ownership will become relatively more expensive.
Based on our forecast of the number of households we expect that 5.3m (+3.7m households, +1.6m replacements) new housing units will be needed between 2007 and 2017. Another 500,000 additional housing units will be needed each year from 2018 to 2027. Rising interest rates and a weaker economy will weigh on housing affordability, thereby limiting house price growth (in real terms) for the next two years. The overall long-term outlook, however, remains intact, especially for good-quality housing units in city locations.
Industrial and logistics
Following the expansion of the EU and the deeper integration of goods and capital markets across the continent, demand for logistics properties is set to shift towards Eastern Europe. Low labour costs, a favourable geographical location and high growth potential, all point to an increasing demand for the industrial sector in Turkey. However, poor infrastructure is still a major handicap to Turkey's industrial market. The country's transport is heavily dependent on roads with over 90% of freight carried on roads. As part of its bid to join the EU, the Turkish government appears determined to shift the balance between different modes of transport and has also designated 'Organised Industrial Zones' (OIZ) in order to reduce congestion and pollution in the suburbs of major cities. However, further infrastructure development remains crucial for the industrial market's long-term prospects.
In the past, container transport has been limited but transport volumes are increasing rapidly as a result of Bulgaria's and Romania's recent pick-up in economic growth. The Black Sea area has witnessed strong growth in sea traffic in the last few years, driving the development and expansion of ports in a number of countries on its shores. Turkey benefits from numerous container ports located along the 1,450 km coastline of the Black Sea. In 2006, its ports handled almost 850,000 twenty-foot equivalent units (TEU), while several larger ports around its other coasts handled another 645,000 TEU. Privatisation of the ports has been a high priority for the Turkish government, trying to increase seaport capacity.
Rail and air transport are also on the rise in Turkey. In 2007, Istanbul Ataturk Airport was among the top 20 fastest-growing airports in Europe (no. 13), having recorded an almost 9% increase in cargo volumes on the previous year's levels. In addition, the Kars-Tbilisi railway project currently under construction, which will connect Georgia and Turkey, will improve Turkey's position as a transport hub for Central Asia, too.
Turkey is still in an embryonic state in terms of its industrial property sector, with much of its existing stock being of poor quality. Within Turkey, Istanbul is the most developed industrial market in the country, Ankara, Izmir and Mersin are also established industrial locations. Demand in Istanbul has been driven by local companies but international organisations are becoming increasingly prominent as the manufacturing and retail warehousing sectors expand. Many international players such as UPS, DHL and TNT have been active in the market for years by either establishing their own subsidiaries or forming joint ventures with local partners.
Industrial site availability is limited in Istanbul's vicinity, and there is a severe shortage of modern space. Still, the development pipeline remains muted, with the majority of occupiers opting for 'build-to- suit' space and speculative development staying low. According to Colliers, vacancy around Istanbul stands at around 6-7%, which has been driving up rents. Industrial rents in Istanbul experienced the highest growth among key European centres in the period 2003 to 2007. Despite this impressive growth of on average 18.5% p.a. over that period, industrial rent levels are still low at €57 per sqm/y even compared to Eastern European markets like Warsaw or Sofia, but higher than Prague, Budapest or even Berlin.
In Istanbul, the main industrial areas are located along the Trans European Motorway (TEM) and the E-5 highway, and around the Sabina GÃ¶kÃ§en airport, which is planned as a logistics base for air freight. The Asian side of the city is particularly popular as a ware- housing location due to its land availability and lower rents, with Gebze, Sekerpinar and Tuzla attracting most tenants. Going forward, the expansion of the retail sector will be a crucial factor for the industrial sector, and will undoubtedly increase the demand for retail warehousing. Larger companies will be more likely to outsource their logistics operations as competition in the market increases. According to DTZ and CB Richard Ellis, the expanding retail and manufacturing sectors have put pressure on the quality of warehouse space. As a result, the industrial stock in Istanbul alone is forecast to increase by 25% over the next 12 months. In addition, the areas surrounding major container ports (like Istanbul, Izmir and Mersin) and airports (such as Antalya, Izmir, Adana, Trabzon and of course Istanbul) should also develop into key logistics locations as firms search for land with good transport connections. However, risks that could hamper the development of the sector are linked to rising land prices and the dependence on road transportation.
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