Investors have been attracted to its economic growth potential and demographics. But Turkey's investment story is not straightforward, as Lynn Strongin Dodds writes

Five years ago institutional investors and real estate companies poured into Turkey searching for opportunities on the back of a growing economy, strong demographics and rising consumer spending. Fast forward to today and deals are thin on the ground with activity expected to remain muted for the rest of the year. The unresolved euro-zone crisis is partly to blame, but a mismatch of expectations between buyers and sellers has also played a significant part.

"There have not been that many transactions over the past two years and it has been difficult to find projects that make sense on a risk-adjusted basis compared to the opportunities that Peakside is seeing in other markets such as Germany and emerged central Europe," says Zeynep Fetvaci, Peakside Capital's head of business development. "However, we definitely do believe in the long-term macroeconomic story and there is strong potential for the institutional real estate market in the future."

İdil Hamzadi, associate director, capital markets, Jones Lang LaSalle (JLL), Turkey agrees, adding: "We are definitely seeing stronger investor interest, but the number of suitable assets is limited, with aggressive pricing by local vendors. The prime yield both in retail and office remains at 7%, although this is not backed by a transaction. Sovereign wealth as well as private equity funds and international developers are interested and are looking at some opportunities in the market. We believe one or two deals will be completed during the remainder of the year."

Joe Valente, head of research and strategy for European real estate at JP Morgan Asset Management, notes that the over-inflated prices are down to the structural nature of the Turkish real estate market. "There is a significant amount of domestic capital with Turkish companies and families holding real estate for wealth preservation," he says. "There is little distress and banks are not under any pressure to sell. For international investors, although there are high rates of growth, other more mature markets offer better value, which is why there have been so few transactions."

According to industry figures there was around €1bn of transactions last year compared with the €3-4bn that flowed through during the halcyon years of 2006 and 2007. Retail was the most popular and five years ago there was an influx of international players such as Dutch groups Corio and Redevco, German-based ECE and Union Investments and UK Prime Development. Forward purchases/funding and development projects dominated the scene as foreign investors were keen to undertake development and leasing risk.

Activity screeched to a halt after the financial crisis and some investors - such as US developer Hines which entered the market in 2008 looking for joint venture opportunities - pulled out at the beginning of 2011. Others such as Tishman Speyer are still hoping to close a transaction. One of the main problems in the retail sector is that demand for high quality prime high streets and shopping centres outstrips supply. This is especially the case in Istanbul, the country's largest city with a population of more than 14 million people, where there are only three high street locations and one shopping centre at the high end of the spectrum.

Investors are also nervous due to the spluttering economy. High inflation and interest rates as well as a large current account deficit is taking its toll, and although the International Monetary Fund has revised its gross domestic product outlook to 2.3% from 0.4% earlier in the year, it is still in sharp contrast to last year's buoyant 8.3% growth.

Market participants, though, are bullish about the sector's long-term prospects due to the refurbishment of older properties, as well as a strong development pipeline. According to a report by JLL, roughly 66 centres with a total gross leasable area (GLA) of 2,096,000 sqm is expected to come on line by the end of 2013, leading to a total of 9,726,500sqm in 368 centres across the country.

In addition, research undertaken by CBRE shows that Turkey has joined what it calls the "super league" of shopping locations, with 39 of the top 100 world brands having entered the market. Vastned Retail, part of the Dutch-based Vastned property group is hoping to target the mid to top end but is only focusing on a select group of high streets. This past year, the €2.1bn pan-European fund allocated €100m for the acquisition of a building on Abdi Ipekci Caddesi Street which is located in the upmarket Nisantasi shopping area on the European side of Istanbul, home to luxury brands such as Hermes, Prada and Louis Vuitton. The total property is slated to be redeveloped and will comprise close to 2,000sqm GLA with the expected rent level coming in at €1.4m pa.

Our strategy is to focus only on quality high-street shops and a limited number of other streets in Istanbul," says Taco de Groot, CEO of Vastned. "With the latest acquisition, we are now present in three prime high streets in the heart of Istanbul. We are not looking at shopping centres because we think there is better value with high-street shops. For us, it's all about quality and not size. It will be a step-by-step process and we are looking to invest €250m in Istanbul venues for premium shopping."

Istanbul also has the most developed office market in the country. The city is a hub for many multi-national companies due to its geographical position. However, unlike the retail sector, local players dominate the development arena and while interest has been strong over the past two years, the number of institutional assets is limited. This means that grade-A assets with a single owner and multiple tenants are confined to a small number of buildings in Istanbul, according to Hamzad. "This is why investors are looking into development opportunities."

Currently, there is 682,000sqm of office space under construction but the total grade-A office space in Istanbul is projected to reach 3.57m sqm by the end of 2013 with 44% of this new supply being located in the central business district. Projects expected to be completed this year include the multi-use Trump Towers and Buyaka Project as well as the Tekfen Kagithane Ofis Park outside the central business district.

Emre Akcakmak, a senior analyst at independent asset manager East Capital, says: "Overall we are optimistic about the real estate market in Turkey because of the long-term structural growth story. The economy may be slowing but the country has a demographic advantage with the average age of the population being 28. This means new babies, marriages and urbanisation which are good for the economy and the building of offices, shopping centres in Istanbul and other cities."

Another trigger, according to Valente, would be the upgrading of Turkish bonds to investment grade. "It was talked about before last summer but it would be a major plus in that it would absorb a bit more international capital once financial markets normalise," he says. "However, with the current situation it is difficult to know when this will happen."

There is no doubt that Greece's possible exit is casting a shadow over the entire region but the rating agencies have also said that a potential upgrade also depends upon a further strengthening of fiscal fundamentals, such as the government whittling down the country's large current account deficit and tackling the high inflation rates.