Kivanc Dundar in Istanbul -
Turkey’s construction sector was one of the drivers of the country’s impressive bout of economic growth that averaged 5.5% between 2002 and 2011, but the tide turned after 2011 for both for the sector and the economy as a whole as investor and consumer confidence was hit by a combination of toxic domestic and regional developments. Will the election victory for President Recep Tayyip Erdogan’s party change that?
The economic outlook was rather gloomy before the November 1 election, with inflation stubbornly high, unemployment nudging double digits, and few prospects for a strong recovery in $800bn economy any time soon. Yet there are growing hopes within the industry after the Justice and Development Party’s (AKP) sweeping victory in the election, in which President Erdogan’s party comfortably regained the parliamentary majority it had lost in June.
In theory, the AKP’s unexpected success at the polls should bring about much-desired political stability and economic policy coherence, which would feed into a better investment climate that benefits the real estate and construction sector. However, many questions remain as to whether the AKP is willing or able to deliver the long-delayed and much-needed economic reforms that will restore the kind of investor confidence that is key to reviving the country’s economic prospects.
The markets immediately welcomed the AKP victory, but investors will be in a “wait and see” mode over the medium term to see if the scenario of heightening social tensions – if the ruling party does not change its polarising ways – re-emerges.
The other challenge for the new AKP government is the expected US Federal Reserve interest rate hike. In this scenario, Turkey’s central bank would have to raise its interest rates to avoid a sharp depreciation of the currency and renewed capital flight. This will mean higher borrowing costs both for companies and consumers that could affect demand for real estate.
According to the latest GDP data from the statistics office TUIK, Turkey's construction sector in the second quarter grew by 2% from the year before, after contracting 2.8% in the previous quarter. That is a far cry from the halcyon says between 2002 and 2011, when growth in the construction sector averaged 7.5%, including an astonishing 18.3% in 2010 fuelled by large government infrastructure projects and booming demand for residential housing.
Debt-financed consumption was the main feature of Turkey’s remarkable economic growth, which in turn fuelled demand for real estate. Consumer loans exploded, rising from only TRY12.73bn in 2004 to TRY281n (€84bn) at the end of 2014 – an eye-popping 2,108% increase in ten years. Housing loans grew by a jaw-dropping 5,000% from 2004 to reach TRY141bn as of end-July.
The AKP government’s mega-infrastructure projects – such as urban transformation works, highways, the third airport in Istanbul, a third suspension bridge over the Bosphorus, new metro lines in Istanbul, the Marmaray rail tube crossing linking the European and Asian continents, the Istanbul Finance Centre, and the residential development projects the public housing administration TOKI undertook together with private companies in 81 cities – contributed to the sector’s growth. The rapid expansion of retail industry also helped the construction sector; Turkey has now 350 active shopping centres with total gross leasable area of 10.3mn square metres and more 70 malls are under construction.
But the economy, once the rising star of the emerging markets universe, began slowing after 2011, dragging down the construction sector that accounts for roughly 5% of national income with it. The industry’s growth rate dropped to 0.6% in 2012 from 11.5% in 2011, but picked up to 7.4% in 2013.
That 2013 recovery was short lived. The Gezi Park protests that rocked the country in the months from May 2013 were a sign of the political landscape becoming more volatile as the ruling AKP’s policies started to divide and polarize the 78mn nation.
The prospects of a Fed rate hike, rising geopolitical risks, the sharp depreciation of the Turkish lira, the political vacuum that emerged after the inconclusive June elections and the flare-up in violence with the Kurdish minority have all combined to depress consumer confidence and investor sentiment this year.
Consumer confidence hit its lowest level in more than six years in August with the sub-index measuring the probability of purchasing a house over the next 12 months declining by 1.3% on month after rising 1.7% in July. The construction sector confidence index dropped 0.7% on month on a seasonally adjusted basis in August, its lowest level since April.
The lira has already lost 20% of its value against the dollar this year and remains depressed. A weaker currency means rising costs for construction companies and consequently higher prices that will inevitably translate into weaker demand for houses. Moreover, if Turkey's central bank lifts its benchmark rates to defend the value of the currency and stop capital outflows in the face of the expected Fed rate hike, housing loans will become even more expensive, further depressing demand.
From a developer’s perspective, a weaker currency poses other risks. Like many private companies in Turkey, construction firms borrowed too heavily when money was cheap and plentiful in the world markets. The problem is that construction firms’ revenues are in lira, but their debts are mostly in dollars. A study by the central bank found that 56% of total debt in Turkey’s construction sector is in foreign currency.
On the positive side, cheaper currency makes local properties cheaper and thus more attractive to foreign investors. In the first seven months of the year, a total of 12,380 houses were sold to foreigners, up from 9,980 units sold to non-residents in the same period of 2014. But foreigners will keep buying Turkish properties only if the economic and especially the political situation improves in the medium term, otherwise they will avoid a country mired in political turmoil and economic gloom.
Per-capita income in Turkey has been stuck at $10,000 and stubbornly high inflation erodes households’ purchasing power. Thus, Turkey needs reforms to restructure its economy to produce more value-added to ensure more income for households so that they could spend more on real estate and save more.
People in Turkey treat real estate as a safe investment. House prices rose nearly 19% on year in July, according to data of the central bank. Buying a house as an investment is a safe bet in a country where banks pay around 10% interest on deposit accounts and annual inflation is running at 7%. This explains the 13.5% year-on-year rise in house sales in July. A total of 731,699 units were sold in the first seven months of 2015, versus 609,877 units a year ago. In the short to medium term, funding costs, directly related to the political situation and the health of the economy, will be one the key factors determining demand for real estate. But consumers will continue to take on housing loans only if the political stability is restored and the cost of housing loans starts to fall again.
Despite its current problems, Turkey still has a lot to offer and has a huge potential for construction firms to exploit. The urbanization rate in Turkey is 78% and the population growth rate is 1.4%. This means the country’s urban population will be more than 70mn in less than ten years. As the urban population grows, the country will need more infrastructure investments and more houses. Turkey’s urban regeneration projects, already underway in Istanbul, should spread to country’s other regions. Turkey is targeting 50mn foreign tourists by 2023 and the increasing tourism activity will have a positive impact on the real estate and construction industries as the country builds more hotels and better infrastructure.
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