Europe’s rising giant: Istanbul

Exciting demographics have propelled Turkey up the league of investment appeal in spite of a shortage of stock and nagging political uncertainties, as Paul Strohm discovers

In May of this year, the London-based international property investment, development and asset management company St Martins completed the financing of its acquisition of Europe's largest shopping centre, Cevahir mall in Istanbul.
Like the shopping centre itself the size of the deal was spectacular. But perhaps as significant is the indication of the growing institutional acceptability of real estate investment in Turkey.

St Martins has placed considerable faith in the country in making the investment. But it was not alone. The financing it has arranged to fund the acquisition, US$515.5m (€384m) in a mix of dollars and euros, was believed to be the biggest real estate loan ever put in place for Turkish real estate and involved a syndicate of 11 banks, with Citibank, Eurohypo and HSBC in the lead.

Over the past few years investors have become increasingly aware of the potential of Turkey. Turkey's economic growth rate has fluctuated between 5.8% and 8.9% since 2001, and inflation has fallen from a peak 68.5% in 2001 to a more manageable if still high 9.65% by the end of 2006, with a target of 4% for 2007.

But it is the longer-term potential of Turkey's demographics that has attracted the attention of foreign investors. In global terms Turkey is the 17th largest economy, with the 17th largest population at 74.4m. Negotiations to join the EU began in October 2005 and the alignment of the economy and social structure is progressing, albeit slowly. When compared with its European neighbours, Turkey's is the 9th largest economy and has the second largest population. Turkey's projected population growth rate between 2000 and 2050 is 43% against the European rate of 10.3%. By 2050 it will have the largest population in Europe. It already has one of the youngest populations with an average age of 27 years compared with the EU's 43 years.
Foreign direct investment in Turkey has already increased dramatically - from $1.4bn in 2002 to $19.8bn in 2006. Of this latter figure $2.9bn, or 15%, was accounted for by investment in the real estate sector.

Tristram Frost, partner in international investment at commercial property consultant King Sturge, says: "In my view, Turkey's European entry might well be gilding the lily. In the medium term, proving it has its inflation and currency under control is more important. That will have a big impact on returns and currency exposure. Overall there is more interest in Turkey. Property developers are looking and the institutions will follow on the back of that, whether they do it on their own or in joint ventures with other western investors."

Apart from St Martins, other European investors to dip their toes into the warm waters of the Turkish market include Netherlands-based property companies Corio, Multi Development Corporation and VastNed.

However, according to Firuz Soyuer of property consultant DTZ Pamir & Soyuer, currently there are no pension funds investing directly in Turkey's real estate market.
The shortage of investment grade stock is one reason why property companies and developers dominate the foreign presence in Turkey.

King Sturge has a number of clients looking at Turkey but the most difficult thing is finding the right sort of product. "Istanbul is a huge city with extremes of quality," Frost adds. "Returns have got to be aligned to match risk and return but are not always available."

With so little investment grade property available one solution is for funds to create their own investments through joint ventures, says Soyuer. "Pure investment in the market is probably a couple of years away, by which time there will be enough investment grade stock in the market," he says.

Soyuer expects that German funds will lead the way, followed by the Netherlands and the UK. In the longer term he also expects US funds to join the rush although he points out that their first stop tends to be the UK. There is interest too from the Gulf states but development is the primary interest of companies there rather than pure investment. Sama Dubai, part of Dubai Holding has, for example, recently bought a 40,000 m2 site for $800m and is planning a mixed use project driven by its residential content.

Large scale foreign investment in Turkish real estate has been focused on retail property. Soyuer explains that this is partly because in other categories - office, industrial, logistics etc - there is little investment grade stock available. Certainly there is little available in the sort of lot sizes that are needed by investors. Soyuer points out that there is only 2m m2 of Grade A office space in Istanbul.

However, many investors prefer the comfort of the broader retail base, the more direct link to the consumer market that is inherent in retail property and the presence of familiar brands in many of the centres.

One UK fund manager that has been looking at Istanbul is Henderson Global Investors. Darren Downs, part of the real estate acquisition team, said that he has looked at retail property opportunities in the city on behalf of Henderson's shopping centre fund and also for Warburg Henderson.

Downs is adopting a cautious approach, however, and says that with the amount of retail property activity underway the recent descent of yields to 6% makes him nervous. "The going yield for shopping centres does not reflect the inherent risk," he says.
There is too much foreign competition in Istanbul itself, according to Downs. His enthusiasm for Istanbul has been further dampened by the recent unrest that occurred concerning the selection of a new president. "The political crisis and protests in the streets as well as the threat of a military coup make me nervous," he says.

And there are signs that the rewards may not match the risks. Downs says that the people making the most out of Istanbul real estate are the hedge funds who will back a local representative to assemble a site. If a site can be put together this will be sold to a developer.

"The hedge funds are taking the least risk and the institutions are taking the most risk because there are so many centres being planned," he adds.

Mike Rodda, Cushman & Wakefield partner in the firm's cross-border team, counterbalances the view of potential oversupply. He acknowledges that there is a large amount of western European investment capital ready to be spent in Istanbul but adds that, unusually, there is a simultaneous and comparable enthusiasm from the international retailers. Names such as Inditex and Media Markt have requirements in the city.

Rodda also points out that while there is already a lot of shopping space in Istanbul, little is of international standard. "International retailers demand international quality design and management. If centres without these attributes are stripped out of the list, retailers currently have a choice of two centres," he says.

"Even if you ignore this, bear in mind that 20m people live in Istanbul," Rodda adds.
Downs's reservations do not extend to other Turkish locations. Turkey has 20 cities with populations exceeding 1m and Downs is looking in more detail at opportunities in places such as the capital, Ankara, and Izmir on the country's west coast.
"The same reasons for investing apply - demographic and GDP growth - but there is also a lack of retail space outside Istanbul."

Inside chance

The lack of supply in Turkey was something that US-based investor GE Real Estate has taken into its own hands.

In November last year GE Real Estate Europe and Dogus Holding AS acquired a 50.98% stake in the publicly listed real estate investment trust, Garanti Gayrimenkul Yatirim Ortaklisi AS (Garanti REIT) for the Turkish lira equivalent of about US$ 98.07m.

The deal was GE Real Estate's first investment in Turkey.

Garanti REIT was established in 1997 and invests in commercial real estate assets and development projects in the retail and residential sectors. When GE acquired its stake, Garanti REIT owned six investment assets located in Istanbul and Antalya in Turkey, as well as properties in Bucharest, Romania. The largest asset in the portfolio is Dogus Power Center, a retail development in the heart of Istanbul comprising a 63,000m2 (678,000ft2) shopping centre with seven anchor tenants.

Karim Habra, GE's managing director for central Europe, explains that the REIT is a developer with a staff of around 25 and the idea was, since there is so little space to acquire in Turkey, for GE to get involved in development via the REIT.

By these means GE will be capable of tackling a range of project sizes, whether it is €25m or €100m, but it will focus on shopping centres and mixed-use schemes. Several projects are already being considered and Habra says that an announcement will be made soon about a project that is a mix of shopping, residential and office space. "There is not as much investment grade stock as in central Europe but we are looking at built assets going forward."

One reason why there are not enough investment quality buildings is the age and inefficiency of much of the existing stock. "On the shopping side there are some good shopping centres but not many. However, the number will increase," says Habra.
Looking at the number of square metres per capita reveals that Turkey is extremely underdeveloped, according to Habra. Although the average GLA per 1,000 persons in Turkey is still far below the  European average, it reached 32m2 in 2006, according to DTZ Pamir & Soyuer. If only 19 of the larger cities are considered, the average GLA is still only 58m2 per 1,000 persons.

Habra says that there are opportunities in the residential sector too. Disposable incomes have increased and more people are now willing to buy apartments, a trend which is in part driven by the obsolete nature of the housing stock.

Habra says that Turkey is not free of risk but growth potential is a compensating factor.
One key risk is currency fluctuation. Forthcoming membership of the EU and more particularly of the euro may, in the longer term, remove this variable from the equation. However, Habra says his company is not counting on EU membership. It is, however, counting on the growth of Turkey as a country- "it is a big country with huge potential". If it does enter the EU that would be the icing on the cake, says Habra.