Planned development: Urban renewal programmes plus major infrastructure projects equal significant opportunities for investment

With strong year-end results both in 2010 and 2011, Turkey’s construction sector emerged from the 2008-09 financial crisis in relatively good shape. A projected slowdown in the local economy due to European sovereign debt woes means the double-digit growth is unlikely to be repeated in the near term, but the underlying fundamentals look strong.

Turkey is a growing country, with steady migration from rural provinces to large cities, and a burgeoning middle class. This has created demand for both affordable housing as well as an expanding luxury sector, while a growing role in the international business arena has created demand for office buildings. Firms are particularly interested in the plans to replace a majority of Istanbul’s building stock because of concerns over the threat posed by earthquakes.

Moreover, the country’s infrastructural deficiencies provide significant opportunities. Many of Turkey’s construction companies have experienced huge success overseas, particularly in the Middle East and North Africa and Commonwealth of Independent States regions, but even some of these giants are being lured back into the domestic market by the infrastructure contracts now being drawn up.

PUBLIC PLAYERS: There are possible obstacles to the growth of each of the industry’s subsectors. For example, in Istanbul the potential for major urban regeneration projects will depend on key government players, particularly the Housing Development Administration (TOKİ). While TOKİ does partner with the private sector, its policies are not always clear, and there is considerable confusion about the master plan for rebuilding Istanbul. This regulatory uncertainty extends to infrastructure projects. In January 2012, for example, the tender for a third Bosphorus bridge was met with deafening silence, as none of the prequalified candidates submitted a bid. The proposed culprits were numerous – a dearth of financing, an unnecessarily large project and insufficient details from the government. What was clear was that despite great investor interest in the overall project, there was a gap in communication between public and private sectors.

Private sector participants say that a collaborative approach to the construction industry is necessary, whereby the government establishes clear plans and then invites construction firms to design and implement them. With construction providing employment for about 7.5% of the country’s workforce, Turkey cannot afford to let uncertainty and hesitation snag its ambitious development plans.

BY THE NUMBERS: In contrast to the slowdown in construction and real estate markets in the developed world, the Turkish sector emerged from the 2008-09 crisis with two years of double-digit expansion. Following contractions of 8.2% and 16.2% in 2008 and 2009, respectively, the industry bounced back with 17% growth in 2010, followed by annualised expansion of 12.7% over the first three quarters of 2011, according to data from TurkStat. The trend, however, has been decelerating steadily from a high point of 22.1% in the third quarter of 2010, reaching 10.6% a year later. Looking ahead, ISI Emerging Markets, a market research outfit, has projected 7.2% growth for the sector in 2012.

Expenditures tell a similar story. Total construction sector spending reached TL30.4bn (€12.9bn) in the third quarter of 2011, down slightly from TL31.1bn (€13.2bn) in the second quarter. This put third quarter growth, year-on-year (y-o-y), at just north of 32%, a touch higher than the previous quarter’s 29.2% expansion. While this is likely a lagging indicator that will slow during 2012 as the market cools off, a closer look at the figures reveals a moderate shift from private to public spending. Private expenditure on construction in the third quarter 2011 amounted to TL17.9bn (€7.6bn), in comparison to TL12.5bn (€5.3bn) in government spending. But the latter figure rose steadily during the preceding two quarters, from a 2010 quarterly average of TL9bn (€3.8bn). With the government focusing on a raft of new infrastructure projects – rail, roads, bridges and more – public spending may be able to provide a countercyclical boost during a soft period of growth.

Public sector spending will also preserve jobs in an industry that is an increasingly important employment provider. The construction sector employed 1.89m workers in the third quarter of 2011, a record figure. This accounted for 7.6% of total employment, also an unprecedented share. Having added 625,000 jobs since the first quarter of 2010, the sector has played an important part in bringing Turkey’s unemployment rate down from 13.7% to 8.8%.

Finally, a further headwind that the industry will face in 2012 is the steady increase in construction costs since the end of the economic crisis. According to the construction cost index compiled by TurkStat, residential construction costs increased 5.7% during the third quarter of 2011, and nearly 14.4% y-o-y. The increase included both labour and material costs, with inputs like steel and cement the primary causes.

STARTING OVER: The government is behind two major initiatives that should drive growth in the construction sector over the next 10 years. The first is an urban renewal plan, inspired by the twin challenges of poor urban areas and unsafe building practices in cities across Turkey. The past four decades have seen massive migration from rural to urban areas, particularly the “big three” of Istanbul, Ankara and Izmir. New arrivals, mostly from central and south-eastern Anatolia, have clustered in cheap housing in these cities, driving Istanbul’s population, for example, above 14m. The name gecekondu, roughly translated as “built overnight,” has come to describe the low-quality, largely illegal housing that has sprung up in these areas. Although the cities offer jobs often not available in the countryside, many migrants have found it difficult to cope with the cost of living, transport difficulties and crowdedness of urban life.

The economic and social conditions experienced by Turkey’s urban poor are compounded by another danger, namely the threat of earthquakes. With two major seismic zones – the North Anatolian and East Anatolian fault lines – Turkey has experienced seven earthquakes of magnitude 7.0 or higher since 1939. The most recent quake struck in October 2011 in the city of Van, killing nearly 600, following a 1999 earthquake in Izmit that led to more than 17,000 deaths. Given seismologists’ warnings that the next disaster could hit Istanbul itself, and within the next 20 years, government officials are taking the threat very seriously. Indeed, on October 28, 2011, Turkish Prime Minister Recep Tayyip Erdoğan announced, “We will demolish all illegal buildings and will rebuild them.” Statistics for illegal construction are scarce, but it is estimated that roughly half of Turkey’s 19m buildings are illegal. Renewing them will be a massive undertaking for the government, but it also offers significant opportunities to construction companies.

The details of the government’s plans for earthquake-proofing Istanbul are emerging. Erdoğan Bayraktar, the minister of environment and urban planning, announced in March 2012 that the first renewal projects would begin with four districts in Istanbul, with groundbreaking slated for April or May. The districts of Zeytinburnu and Avcılar, on the city’s European side, and Ümraniye and Pendik on the Anatolian side, have been highlighted for their vulnerability to earthquakes. Municipalities wishing to take part in the renewal project must submit reports to the ministry, and as of March 2012, 110 districts had done so.

The campaign depends on a law that was making its way through parliament in March 2012, having been approved in sub-committee. According to Hakan Yener, coordinator at the Urban Land Institute Turkey, the new law would make it easier for private developers to negotiate with residents of unsafe buildings.

Yener told OBG that the threshold required for developers to evict the residents of a building and knock it down would be lowered to two-thirds, whereas previously even one person’s refusal could negate the redevelopment project. If the remaining one-third cannot find affordable housing after being evicted, the government would step in with financial help. Beyond Istanbul, the provinces shortlisted for transformation, according to Bayraktar, include Balıkesir, Bursa, Izmir, Aydın, Burdur, Mersin, Eskişehir, Adı yaman, Giresun, Erzincan, Bitlis and Diyarbakır. The estimated cost of these projects will be substantial: $400bn for the whole country, with Istanbul accounting for $100bn of this total figure.

OUT WITH THE OLD: Urban renewal of a different sort, meanwhile, is already proceeding. Under Law 5366 (“Law for the Protection of Deteriorated Historic and Cultural Heritage through Renewal and Re-use”), private developers can bid to demolish and replace dilapidated neighbourhoods in historic areas of Istanbul. Renewal has already commenced in two districts: Tarlabaş›, in the Taksim district, and Sulukule in Fatih. These areas, which are mainly poor and inhabited by marginalised peoples, are being razed and replaced by mixed-use developments that will incorporate hotels, shopping centres and luxury residential units.

These major transformations of the city’s built environment are not proceeding without controversy. Considerable attention is being paid to TOKİ, which is responsible for overseeing most urban renewal projects, including finding new housing for displaced residents. Critics of the plans say that the relocation options being offered are located in peripheral areas of the city, sometimes two hours’ commute from the central districts. Moreover, even at the reduced prices offered to residents, many of them cannot afford the rents being charged in these apartments.

In addition, developers and construction companies are concerned that the process of urban renewal itself may be a bumpy one, due to confusion between the public and private sectors. According to Yener of the Urban Land Institute Turkey, the lack of a master plan for Istanbul means that entrepreneurs are redeveloping some regions without including adequate social facilities, such as parks and sports areas. Moreover, zoning and permitting difficulties make involvement in renewal programmes quite risky, given that developments can be cancelled well into the planning stages of a project, according to Yener.

CONNECTING THE DOTS: While contractors that focus on residential and commercial development are excited by the prospect of urban renewal opportunities, industrial and infrastructure companies are looking at the major transportation projects in the pipeline. According to Şule Kılıç, the head of financial advisory at UniCredit Securities, which has served as the financial advisor for several major transportation projects in Turkey, the country will need $100bn in transport investment over the next five years, and up to $120bn-140bn over 10 years. Planned investments range from roads and bridges to railways and ports.

The need for the country to invest in infrastructure is clear. With its growth in recent years, Istanbul’s population now far exceeds the capacity of its transport network, for example. Meanwhile, the booming economy and growing exports necessitates expansion and upgrades to the country’s ports. Some projects are under way already: the much-hyped Marmaray tunnel under the Bosphorus, for example, began in 2004 and is expected to be completed in 2015. The $3bn project is being funded by three multilateral financial institutions, while Japanese contractor Taisei and a joint venture of two Turkish companies, Gama and Nurol are heading up the construction.

Also in progress is the 421-km Gebze-Izmir motorway, which will significantly reduce the travel time from Istanbul to Turkey’s third-largest city with a bridge over the Izmit Gulf. The $6.3bn undertaking is being led by Italy’s Astaldi, along with four Turkish firms. The project will be funded on a build-operate-transfer (BOT) basis, which involves a 22-year concession to collect tolls on the bridge and highways.

ON THE HORIZON: There are even more projects in the pre-construction and pre-tender phase. Highlights include the Eurasia car tunnel under the Bosphorus, with a BOT contract signed in February 2011 by four Korean companies, along with the Turkish rail and tunnel specialist, Yapı Merkezi. In the rail sector, meanwhile, Turkey plans to construct 6000 km of high-speed rail across the country by the republic’s 100th anniversary in 2023. The Ankara-Eskişehir line is the first operational segment, and the extension of the line to Istanbul is ongoing. Meanwhile, 2012 has seen tenders for a high-speed line from Ankara to Sivas, in central Anatolia, and there are plans for an international line connecting Turkey to the Gulf states. This project is being financed out of state funds, aided by a $30bn loan from China.

Finally, the port sector is ramping up, most notably at the Çandarlı port, which seeks to be one of the world’s 10 largest ports. Infrastructure works at Ç andarlı are being done via conventional public funding, with a TL230m (€97.8m) contract awarded to a joint venture of Limak and Kolin İnşaat. However, the superstructure will be built through a BOT contract that includes a long-term concession, costing up to $4.5bn.

The most controversial recent project, however, has been the third bridge over the Bosphorus, which is being packaged with 414 km of highway as part of the solution to Istanbul’s transport challenges. The BOT tender was originally scheduled for August 2011, and then postponed until January 2012 at the request of several companies that planned to bid. Even at that later date, however, the tender received no bids.

The failure to attract bids likely reflected not so much a lack of investment interest as discomfort with the size and specifications of the project. As Burak Berki, a senior associate in research at İş Yat›r›m, told OBG, “I think that the banks were not so willing to finance such a complex programme given the environmental concerns.” Moreover, the government’s strategy of packaging attractive and unattractive assets – the bridges and the roads, respectively – into one tender decreased interest in bidding. Finally, the proposed location, well north of the city’s most congested areas, raised concerns that traffic over the bridge would not be sufficient.

Since the failure of the tender, the transport minister, Binali Yıldırım, has indicated that the government intends to proceed with the bridge’s construction. Following investor advice, however, it has cut the project down to size, reducing the tender to the bridge itself and 90 km of surrounding highway. The remaining roads would be built by the state itself. The government has also added traffic guarantees of 100,000 vehicles per month, which would be paid regardless of actual vehicle count, and eventually increased this figure to 133,000. Traffic guarantees are a standard feature of infrastructure projects, as they decrease risks for the BOT investor, according to Kılıç of UniCredit.

At the end of May 2012, the government announced that a consortium of Turkey’s İçtaş İnşaat and Italy’s Astaldi won the tender for part of the Northern Marmara highway project, including the third Bosphorus bridge. According to its proposal, the consortium will complete the project in just under 10 years and three months. The first section, running from Odayeri to Paşaköy, will be completed in 36 months at a cost of TL4.5bn (€1.91bn), Yıldırım announced. The bridge is expected to open by the end of 2015 and will also be linked up with the country’s rail system, he added.

POWERING UP: If its infrastructure projects were not ambitious enough, several items on the government’s to-do list hold even more promise for the construction sector. Turkey’s energy sector is undergoing an ambitious expansion, with 793 power plants under construction at the moment. A record 150 licences were expected to be approved in 2011, and the projects currently in the pipeline would expand installed power capacity by more than 75%, to 93,595 MW. Particularly prominent are the hydroelectric dams included in the South-east Anatolia Project, which the government has touted as necessary for the region’s development. Turkey is also avidly pursuing its nuclear ambitions, with a nuclear power plant scheduled for commissioning in 2019 in the southern city of Mersin. State-owned RusAtom will construct the plant and supply the uranium. With these energy projects, as with a number of major government initiatives, there have been concerns that the state is pursuing development at the expense of the environment and local history and culture. The giant Ilisu Dam will flood historic sites and displace local residents, while public scepticism of nuclear power is high in the wake of Japan’s Fukushima disaster.

THINKING BIG: These same feelings – excitement mixed with doubt – apply to Prime Minister Erdoğan’s self-described “crazy project”: an “Istanbul Canal” that would divide the city in two and divert freighter traffic from the Bosphorus. Little has been decided at this stage of the project, which was announced to much fanfare in 2011. The plan’s goals attract sympathy as well, as the flow of ships through the Bosphorus is considered dangerous and an oil spill could precipitate an environmental and public health disaster. But the sheer logistics of a divided Istanbul – not to mention the funding required – have led many analysts to dismiss the project at this stage as a pipe dream.

Finally, Istanbul’s bid to host the 2020 Summer Olympics, if successful, would spur a major construction boom across the city. Istanbul is not new to Olympics intrigue, or heartbreak: its bids for the 2000, 2004, 2008 and 2012 games all failed. One upshot of these years of anticipation is that the city’s sports infrastructure is surprisingly advanced. Still, opportunities would be plentiful; Erdoğan announced recently the construction of 18 new stadiums, and an Olympic Village would be required. The International Olympic Committee will announce the shortlist in May 2012 and the final decision will be made by September of the same year. In the meantime, the investment in sporting infrastructure has had ancillary benefits. Istanbul was labelled a European Capital of Sport for 2012, and the city hosted the IAAF World Indoor Championships for track and field in March 2012.

LEVELLING UP: Turkish construction companies have not traditionally worked as engineering, procurement, and construction (EPC) contractors on major infrastructure projects, which is due to both technical and financial capabilities. On the financial side, major international contractors often provide internal funding for some or all of a project, an option unavailable to the smaller Turkish companies. In addition, financing often comes from foreign development finance institutions. These lenders are generally interested in financing projects led by a contractor from their home country. Of course, foreign construction firms sub-contract most or all of the work to Turkish companies.

Still, as revealed in a research note from TEPAV, an Ankara-based think tank, the average size of Turkey’s construction firms lags that of even developing countries. Turkey had 31 of the top 225 international contractors by turnover in 2011, the second-highest total behind China, according to the Engineering News Record. But these companies together generated only 3.8% of the overall turnover of the ENR-225. China is a leading example of a country that has excelled in both numbers and value-added, with 50 countries on the ENR-225 accounting for 15% of the list’s turnover. And while Turkey will likely never achieve China’s scale, TEPAV pointed to deficiencies in the design capabilities of Turkish firms that may be holding them back from performing more valueadded work. Moreover, consolidation could help them achieve economies of scale. If they are able to increase their financial capabilities, they may win some EPC contracts. TEPAV points out that the work done by domestic contractors in Turkey’s near abroad is vital to developing the technical capabilities required for more sophisticated jobs. In 2010, according to the Turkish Contractors Association, Turkish firms were actively working in 48 countries, accounting for 517 projects worth $20.3bn. The benefits of working abroad include not only lower competition but also a chance to gain experience in major projects, often in leading roles (see analysis).

Despite this trend, unrest in the Middle East and mega-projects in Turkey are drawing contractors back home. “We are following opportunistic projects in Turkey, which has a lot of potential,” said Tolga Mut, business development manager at STFA Construction Group. Domestically, Turkish contractors continue to focus on specialty niches where competition is lower. Examples include TAV Construction in airports, Yapı Merkezi in rail and STFA in marine construction. However, UniCredit’s Kılıç predicts contractors may be “moving into new roles” as they gain experience.

OUTLOOK: Despite the market’s current softness, therefore, plenty of opportunities are available across the spectrum, from residential and commercial development to major infrastructural works. A study from the Real Estate Investing Partners Association shows that the housing demand between 2011 and 2015 will total 2.9m units, of which 500,000 will be built by TOKİ. That leaves 2.4m to be provided by the private sector. “With Turkey’s population continuing to rise, demand for residences is permanently growing,” Selim Koray, the chairman of Koray Construction, told OBG. “City centres, in particular, are seeing an even higher rate of growth, which is characteristic of a trend observed around the globe.” Meanwhile, Istanbul’s growing reputation as a regional financial centre has drawn the attention of contractors specialising in office buildings and high-rises. According to Ali Pusat, the general manager for development of Koray Construction, the planned development of the Istanbul Finance Centre in the district of Ataşehir will boost the sector.

The potential of Turkey, and in particular Istanbul, is strong enough that companies are willing to tolerate occasionally byzantine permitting and planning regulations. Still, investors will look to see that the government executes its development plans – whether urban renewal or infrastructure development – with transparency and in coordination with the private sector. “For the next 10-20 years, Istanbul will be like a big construction site. But we have to plan this development carefully, or else Istanbul will lose its reputation as a global city,” Yener of the Urban Land Institute Turkey told OBG. What construction companies, real estate developers and government planners accomplish over the next 10 years will serve as the foundation upon which the new Turkey will be built.