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The Alchemy Volume V

The Bowl of the Alchemist First of all I would like to personally thank our veteran readers, followers and friends, for showing such an interest on the issue date of The Alchemy. As we used to issue our report on a quarterly basis, some of our friends started to call, e-mail & ask about the reason of delay, or the integrity of our mailing list. Yet in fact, this is another conscious delay, in order to have enough time interval to establish and prove the main theme of this year, “misunderstanding”.

Since the first issue of The Alchemy, we have been trying to present Turkish economy and real estate markets more clearly, as we are aware that it is sometimes not possible to understand what is going on here by a look from abroad. We are not denying that such objectivity has its own merits, but as we have always stated, The Alchemy has to be subjective in some sense, as it reflects our views and comments on the markets. We are not raw data providers; our cutting edge lies on commenting and analysing the data, rather than collecting and issuing it. By being on the field and in the negotiations, we have the luxury to see the real market from inside and this is what is needed to understand a market like Turkey, a very sui generis one.

Hence the theme, “misunderstanding”. During the pages of this issue, you will see how reputable institutions changed their forecasts drastically to negative first and then to positive, observing that the reality is not overlapping with their forecasts, although they have been warned by local institutions, counterparties and rivals. We are not in a position to accuse anyone yet we believe that “forecasting should have a weight and responsibility”, being an ex-analyst for quite a long time.

Our veteran readers know our background in investment banking. A junior trader is first thought “not to trade on data, but on facts & analysis”. Yet we observe that even the international giants “traded” on data, upgrading their expectations once the quarterly dataset is released by the TSI. This is the main reason of our delay, proving by examples and dates that Turkey is often misinterpreted, sometimes with our fault involved as well. I wish you all a happy reading…

Dr. Kıvanç ERMAN Mergen Consulting

The Alchemy by Mergen Consulting Vol. V ~ 2 ~

Politics

As known and expected by the followers of the Turkish market, we will be facing a presidential election in August, where the President will be directly elected by the people, rather than the MPs.

MHP & CHP decided to move together and agreed on an umbrella candidate, Mr. Ekmeleddin İhsanoğlu, who is well known in the international intellectual Islamic arena, as he has served as the General Secretary of Organisation of Islamic Cooperation for 8 years and General Director of Centre of Islamic History, Art & Culture within the same organization for 24 years. He holds international posts with UNESCO & Harvard University and he is a member of various academic institutions. His relatively secular approach is a big plus for the CHP support. Mr. Ihsanoğlu is not a figure much appreciated by the PM, due to his more democratic stance in the Egyptian coup d’Etat.

As expected, PM Erdoğan has declared his candidacy in the Presidential elections as well. Given the recent municipal election results, we believe that he will have a big chance in the run.

Having mentioned the municipal elections where AKP had a huge success, according to the latest official declaration, the distribution of votes for the Greater Municipalities is as follows: AKP 45.54% ; CHP 31.04% ; MHP 13.65%. For the other municipalities AKP had 43.13% ; CHP had 26.45% and MHP had 17.76%.

This distribution of votes suggest that AKP has 53 cities of which 21 greater municipalities, CHP has 12 cities of which 5 greater municipalities and MHP has 8 cities of which 2 greater municipalities. The surprise is that BDP, the Kurdish ethnicity-based coalition has reached 8 cities mainly on the east-south east with 2 greater municipalities. The participation ratio is another record in Turkish history with almost 90%, whereas this figure was around 83% in 2009.


The results of the municipal elections show certain facts. First of all despite all the rumours, tapes, voice recordings and arguments of fraud and corruption, AKP continues to win as they are really good at municipal level. The AKP municipalities are probably the best performing municipalities in Turkish history given their working rate.

The results also prove that, sociologically speaking, any increasing tension or movement against PM Erdoğan makes AKP base more locked to each other. This has also been a very useful strategy applied consciously by the AKP staff, in order to change the agenda or to align the AKP ranks in the past. Since his legendary move “One Minute!”, PM uses the strategy of tension increasing to pull the ranks and arrange the agenda accordingly. Yet, it seems like the competitors or adversaries do not seem to capture this strategy as after the municipal elections PM has faced 2 critiques, one by the Chief of Constitutional Court and the other by the head of Union of Turkish Bars, both related his interventions to the judiciary system.

Actually both critiques were based on the fact that after the December 17 incidents, government intervened to change the posts of 96 judges and state attorneys , by different accusations or due to rotation; but it was obvious that the moves were done to paralyse the effect of the Community within the judiciary system.

We believe that Mr. Etyen Mahçupyan, a well-known sociologue and a column writer in pro-AKP Zaman Newspaper, is reading the big picture quite right. According to his interview on HaberTürk (April 28,2014) this strategy is actually became the main theme in the government as due to the December 17 incidents, which is perceived as a civil coup d’etat aiming to bring down PM himself and to seize the power by the Community; the government and of course the PM himself became more and more authoritarian, reflecting itself out as the latest MIT (National Intelligence Agency) law and suspension of Twitter & YouTube services, especially after the leakage of a top-secret state meeting. The new internet law was also a result of such self-protective measures, allowing the authority to suspend any website after a fast track court order.

2014 2009PARTY Greater Mun. Municipalities PARTY Greater Mun. MunicipalitiesAKP 21 32 AKP 10 35CHP 5 7 CHP 3 10MHP 2 6 MHP 1 9BDP 2 6 BDP 1 7

Cities Won Cities Won


Although it has been perceived as methods for veiling the alleged corruption in the government, even reaching up to the PM and his family according to some voice records, the government states that these are the protective measures against the Community, or with the official name “Parallel Structure”. We are not in a position to talk about the alleged corruption and fraud as we believe it is the area of expertise for the state judges and lawmakers, but we believe that this is a fight for power between the Community and the Government. As we have stated in Alchemy IV, written in an environment of chaos at the end of 2013, we believe that the real reasons will be obvious within time. The incidents, which seemed like a fraud & corruption outbreak during the last days of 2013 and the strategic moves from the PM & government perceived as self-protecting at the time now seem like the necessary precautions to cleanse the state from a power group, trying to bring down the government. Aside from the obvious question of “is there really a corruption or not?” which we have already left to law enforcements, we must ask to ourselves the basics: “Isn’t it right for a PM to fight against a power group trying to bring down the government?” or “Is it possible to manage this fight within the limits of the western democracy?”.

The suspension of social media intermediaries such as Twitter and YouTube has been seen as another authoritarian move at the time. Although we do not believe in suppression and we are great fans of freedom of speech, it is a reality that Twitter has accepted most of the conditions put forward by the government, such as opening a liaison office in Turkey, becoming taxable and obeying the Turkish laws; which are the rules put forward for any legal and legitimate company in Turkey. Having compromised with the government, Twitter bird has been freed in 14 days.

We believe that PM Erdoğan has done the “unexpected” in the fight against the parallel structure. We are not saying that it is right or wrong but just stating the fact that he does not move within the limits of the conventional thinking or reactions. This is in fact his way of life, since the “One Minute!” incident, and he keeps on doing the unexpected. Suspension of Twitter and You Tube is just a way of saying that the “western” way of democracy is not his playground and that he can build his strategy on a different state of consciousness, unbound from the laws of the Western perception.

This is exactly why a foreigner, or even may be more than half of the Turkish people, do not understand what he is doing and how on earth he is doing it. His recent move on alleged Armenian genocide should be regarded from this point of view. By stating his condolences on events of 1915, he made an unexpected move, surprising even the Armenians. We believe that his ulterior motive is to unleash the chains of perception and to get rid of the ultimate weapon used against Turkey on the international arena when the time is right.


Another important event to note is that for the first time in 18 years, a senior state official, President of the Iran Islamic Republic, has visited Turkey. As we have stated in early issues, Iran is getting stronger in the region and getting closer with US and the Western world. Iran is also important for Turkey in terms of commercial cooperation as Turkey is a net importer from Iran by USD 5 billion p.a., due to the petroleum imports. Turkey tried to decrease the price during bilateral negotiations, yet the rumours state that Iran was very keen on holding the price as it is.

A sad news on the socio – political side is the catastrophe lived in Soma, Manisa. As the whole world knows, the collapse in the coal mine has caused more than 300 miners to die, as there was no escape room or life support. This opened a huge case investigating the level of obligatory security precautions in the mines and unfortunately Turkey failed compared to the western standards.


Economics

We always state that the Turkish economy unfortunately cannot be fully understood, at least not right, by international institutions. This is an argument we have been continuously stating since the first Alchemy, and has been proven right ever since. An event supporting this argument was the behaviour of the S&P during the 1H, and one of the reasons why we have extended the Alchemy’s interval to 6 months to fully understand and show the volatility of these institutions.

Given the volatility on the world markets during 1Q, S&P has downgraded Turkey’s and other emerging markets’ outlooks and credit ratings. Turkey was partly lucky as S&P downgraded just the outlook from stable to negative and decreased the expectations for growth, in line with other international institutions. Yet just after 3 months later, everything changed upside down and inside out, S&P reiterating Turkey’s position and credit rating as well as other institutions upgrading growth expectations on Turkey drastically. You may find in the below table the growth expectations of certain institutions changing in 3 months’ time:

As seen from the table above, just after the 1Q growth figure released as 4.3%, despite negative effects of December 17 and elections, supposed to bring huge burdens to the economy, all the financial institutions have upgraded their expectations drastically. This makes us question the integrity and the reliability of the models used in such forecasts.

The 1Q growth itself was surprising for most of the people, to some extent to us as well despite all our positive expectations. Yet, figures such as 2% seemed almost disastrous as we have always stated and should not be stated unless a very sound and proven model is involved. Our investment banking background suggests that these financial institutions always are extreme cautious, as the creator of these models are never accused of being on the safe side, yet they are crucified by being bullish in case of a crisis. As Mr. Nouriel Roubini still expects the second bottom of the crisis, since his famous speech a couple of years ago,

New OldJP Morgan 3.0 1.9 Goldman Sachs 3.5 2.0 Morgan Stanley 3.0 2.5 Citi 3.5 2.2 Deutsche Bank 3.0 2.2


thank God we have not yet seen it coming and do not foresee it in the near future. Experience suggests that Turkey is a country that cannot be understood with common models or like a like comparisons, we still argue that one should be very very cautious to talk negative on Turkey, especially if living abroad and trying to figure out what’s happening. We would also want our readers to recall the negative mood at the beginning of 2013, where everyone was talking about crisis scenarios and we were keeping our bullish stance by the below words from Alchemy I:

“Although we have seen a lot of noise after the announcement of the 4Q 2012 and the yearly GDP growth figure, we believe that this is not an hard landing scenario as it does not include a stress in the markets or a recession in the economic activity. The good side of the announcements is that the economy administration is aware that the GDP growth figure is well under the expectations and growth is sacrificed for the sake of controlled Current Account deficit and immediate statements are done to satisfy the market; signalling that 2013 will be a year of better growth.”

We have also stated multiple times, despite the negative mood on the market especially during 1H 2013, that 2013 would be a year of take-off after soft landing in 2012. 2013 growth of 4% proves our thesis and expectations right, as seen in the below chart of annual growth. Please note that the 2013 figure of 4%, coloured in grey as an expectation in before Alchemy issues, now became the fact.

Annual GDP Growth 2000-2014

Source: Treasury, Middle Term Programme

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Enough said about the misperception for the moment, the 1Q growth is important as this is the first time in history that Turkey has grown thanks to exports, with an unparalleled contribution of 2.9%. Gold exports are only 0.6% of this, and the domestic consumption has supported the growth 2.1%. Private investments are quite stable with almost nothing, as the only effect of elections and the public investments has almost no effect with 0.2%. This figures show us that the domestic demand is in line with the international one and the argument that Turkey is growing with consumption is almost eroded with the export contribution to growth. Although we may state that the downturn in investment expenditures are a bad sign for future growth, we believe that this negative effect will be off-set with exports, thanks to the already high levels of currency. This also strengthens our thesis that CAD is not a cause but a consequence and will come down with easing of growth / increasing currency.

Quarterly Growth Figures 2007-2014

The above argument on Turkish economy, growth based on consumption, is not a wrong statement considering the last 10 years, though. The below table forces the government to establish a new model of growth, preferably based on growth via exports and energy moves.


Distribution of Credits 2002 - 2012

The table suggests that Turkey has grown with consumption and the share of manufacturing in credits is shrinking drastically. Hence, the government is looking for a new growth model, close to what we have experienced in 1Q14, based on more exports and less VAT, with a support from the private sector investments.

To further clarify the subject, the below chart shows us the contribution to GDP growth of private consumption, public and private investments and net exports. Please note that after 2002, by the restructuring of the economy, the biggest contribution, after private consumption of course, comes from the private investments, replacing the public investments. This is a structural change in the economy, decreasing the interest rates and strengthening the immunity of the economy against external shocks.

Source: Turkish Statistical Institute

2002 2012Retail & Wholesale Credits 8% 12%Real Estate Credits 0% 11%Consumer Credits 0% 12%Credit Cards 0% 10%Manufacturing Credits 33% 19%

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As suggested by the above paragraphs, 1Q growth signals another change in the contribution details, where Turkey starts to grow with external demand, rather than the domestic private consumption. Obviously it is very early to talk about a structural change as it has happened just once for the last 10 years, but it shows us that the economy has the capacity to be re-structured to decrease the CAD, considered a structural soft belly of the economy.

Having mentioned the CAD, we are happy to see that the figures are as expected by previous Alchemy reports. As the currency went up, exports increased sharply and imports came down, shrinking the CAD drastically. 2013 CAD was USD 65 billion, corresponding to 7.9% of the GDP. 1Q 2014 figure was much better where the figure came down to USD 11.5 billion from USD 16.5 billion on quarterly basis. As we are always keen on the financing, the 1Q figure is alarming with a real zero (0), down from from USD 28 billion. Net errors and omissions were again the saviour of the system, with an unknown financing of USD 10 billion. Remaining USD 5 billion has been financed from the central bank reserves. With these figures, 1Q CAD has come down to 7.3%, showing a sign of recovery.

Growth & Current Account Deficit 1998-2015E

Source: Treasury, Middle Term Programme

It is no surprise to the veteran readers of our Alchemy reports or to anyone following the Turkish economy objectively, that the CAD finished 2013 at a dangerous level. Since the beginning of 2013, we have stated that the CAD would be higher in 2013, yet this is a

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consequence of growth given the structure of the Turkish economy. The high jump of the FX rates, coupled with the December 17 events, has provided the ground for the recovery of the CAD in 2014, and for the first 4 months, we have seen an impressive recovery from USD 24 billion in 2013 to USD 16 billion in 2014 for the same period. Given the expected growth and the recovery in the international trade figures, we expect the CAD to be under 7% levels, in line with the medium-term program of the government.

Ex-Im Coverage Ratio

As seen from the above chart, the Ex-Im coverage of the Turkish economy is increasing, despite a retreat from a peak over 73%, thanks to the easing of the TRL. Our veteran readers will recall that as long as the figure is not under 60% for a long time, we do not ring the alarm bells.

Hence, we still believe that the CAD is not a crisis-bearing indicator anymore but one should be aware of the FX volatility possibility created by the deficit in the medium run. The volatility so far created the adjustment by overreacting to an event or an indicator and established a new equilibrium level according to the demand & supply. However, as statistically proven by one of our previous papers, the unexpected volatility itself is the problem for market players rather than the level of FX rates. For further details on the subject, we suggest our readers to refer our paper, “FX or TRL Rents”¸ found in the library section of our website.

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The financing of USD 5 billion from the CBRT reserves is an important development as no one prefers such financing of the CAD and we believe this might be alarming if continues. However, for the moment, we believe that this is temporary due to the aftereffects of the December 17 and the following volatility of the market. As seen from the below chart that we always keep an eye on, the CB reserves recovered in 1H 2014, shaded in bold to ease such comparison.

CBRT International Reserves incl. Gold

Source: CBRT

The State Institute of Statistics have declared that in order to comply with the EU standards, they have started to use a new methodology on unemployment. The past data has been revised back to 2005 and the new methodology seems more favourable as it shows the unemployment almost 1% better on average. Yet, we were bullish even with the old series, therefore we do not see any problem in using the recent one, fully compliant with the EU standards. As the table below shows, the recent data suggest that despite the peak at the end of 2013, the trend seems downward again, thanks to the strong growth, and the indicator has retracted back to below 10% levels.

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Source: Turkish Statistical Institute

Such impressive growth with acceptable unemployment rates have again awaken the issue of debt in Turkish economy. Lots of debates have been made about the indebtedness of Turkish economy in 2013 and then these debate makers at last understood that Turkish economy is one of the least indebted country in Europe. Then, within the 1Q 2014, same debate makers, mostly on the printed media side, started to talk about private sector indebtedness, especially private sector’s FX debts. The debates have been fired as usual with some misinterpretations coming from the foreign institutions, who updates & changes their forecasts after the debates cool off.

Coming back to our theme of the year, “misperception”, one of the biggest mistakes in interpretation of the external debt is stemming from the chart below, suggesting that the Debt / GDP is increasing and is nearly 50% of the GDP. However, as we always suggest, just the numbers may be misleading.

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Source: Treasury

Quoting from our most favoured economist in the market, Mr. Cevdet Akçay from Koç Financial Services, “We like to talk on numbers yet we do not know maths”. First of all, the above chart is prepared to show total gross debt in the economy and suggests that financial sector debts are also included, which will be a mistake. Banking sector debt should not be considered with the same risk perception of the real sector as there are financial transactions involved in the banking sector figures. For us, the most important data is that of the real sector and its term structure, which is still misunderstood despite all details given.

At the end of the 1Q, Fitch declared that Turkish companies have high debt figures and that they are extremely fragile. This is another lack of trust and misperception in our belief as the Minister of Public Finance, Mr. Mehmet Şimşek rightfully stated that Turkish private sector, banks excluded, has only USD 174 billion FX debt whereas only USD 18 billion is short-term. Plus, it is officially stated by the government officials that Turkish companies have USD 130 billion net cash abroad, rendering the net debt at extremely acceptable levels. It is a common knowledge that Turkish companies hold huge amount of reserves abroad and this is not seen in national records, causing the strength of the structure to be misinterpreted frequently.

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Source: Treasury

Another surprise came from the reputable Goldman Sachs, at the beginning of the year. The institution prophesized that the TRL would be 2.50 vs USD during the turmoil and will remain there for a long time, which did not happen thankfully.

Another misinterpretation and lack of trust showed itself with the M&A report of Deloitte Turkey. According to the report, the Company was expecting the value of Turkish companies, especially of the listed ones, to fall between 20-30% within 2014, due to the drought and elections. Yet, since the issue of the report, the very beginning of 2014, the ISE index has risen almost 20% in USD basis, exactly opposite of what has been prophesized. For the forecast of the Company to be realized, the index should fall more than 40% in USD terms in the second half, which we do not expect unless a “force majeur” occurs.

One important statistical finding in the report was that for the M&As in Turkey, domestic investors have beaten the foreign investors for the first time in history, strengthening our argument of misinterpretation. In addition to this, the below chart shows us the improvement and change in the M&A, including the share of the privatisation. Although it is stated that FDI is lower in 2013 and that the foreign investors are more cautious (USD 12.7 billion vs USD 13.2) , it is observed from the chart that 2013 M&A figures are in line with the average for the last 5 years. Considering the privatisation only, the 2013 figure is over the 5 year average. Thus, we see the change temporary and the breakdown where domestics are over foreigners show us that our argument is true.

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Another important finding is that we have seen the share of real estate increasing within the FDIs. Although the FDI figure came down slightly from USD 13.2 billion to USD 12.7 billion in 2013, we have observed that the real estate figure has increased slightly over USD 3 billion from USD 2.36 billion.

Source: CBRT, Treasury

Enough said of the misinterpretation and lack of understanding, it is time to note some positive developments and news. One of the biggest private sector investments, the 3rd airport project has been started with the foundation ceremony. The expected opening is October 29th of 2017, corresponding to the 94th anniversary of the Republic. The project’s construction is expected to cost USD 10.2 billion where the total cost for the consortium, including the rights and 25 year-rent, is expected to be USD 22 billion. The 3rd airport is expected to host 6 runways and 4 terminals, hosting around 180 million passengers on annual basis. The state will not invest a single penny to the project, as it will be in a BOT model.

Given the frequency of bigger projects, we must state that the recent research shows us that only 5% of the biggest projects, USD 67.3 billion, have been funded by foreign banks for the last 5 years. The main reasons are stated as the speed of decision process in Turkish banks, being more creative, working in longer maturities up to 12-14 years where the foreign banks work mostly between 5-7 and the crisis in EU forcing the foreign banks to decrease their total risk.

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Although we have spoken a lot on misunderstanding, it is a reality that sometimes we are doing our best to be misunderstood, or at least to market ourselves negatively. The biggest debate of the 1H was on the independency of the CBRT, which we see as a huge risk and a development which may de-rail the current situation. The PM attacked aggressively to the monetary policy of the CB during the 2Q, claiming that CB should cut rates aggressively and found the small adjustments in the interest policy as “mocking”. The PM, although he is not a trained economist, also claimed that interest rates and inflation are positively correlated and that interest rates are the reason of inflation, not the way around. Thus, he claimed that the interest rates should be cut aggressively. With this argument, Mr. PM surprised almost each and every economist in the world as in all textbooks exactly the opposite is stated. Normally he is not backed by any of his cabinet members and the argument is kind of closed immediately. However, some economy writers stated that during the 12 year reign of AKP, Turkey has experienced 7 tax amnesties, where from the last one TL 33.5 billion will be lost. Given PM’s own declaration that 1% of interest increase costs Turkey USD 2.5 billion, it is almost impossible for Turkey to decrease the rates as long as AKP governments keep doing tax amnesties.

Source: CBRT

Despite all the efforts of the PM, forcing CBRT to cut down the rates aggressively, the governor Mr. Erdem Başçı, has done his best to keep the independency of the CB and did not yield to the political power so far. Despite all the pressure, Mr. Başçı has decreased the rates slowly, in order to keep the policy intact. During the first 6 months, the CB has cut rates 3 times, after the huge jump of 5.5% during the December 17 events, all cuts in small portions,

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fuelling the anger of the PM. The CB cut rates only a half percent in May, and another 75 bps in the recent monetary policy meeting.

VAT debate was another important point during the first half. Government is working on a project to decrease VAT from 18% to 10% on certain items; yet the VAT is supposed to remain 18% for the luxury goods, consumer goods and electronics. This will have a supporting effect on economy but may create some temporary easing on the tax income.

Government is also working on a social security amnesty where most of the premium penalties will be forgiven. According to calculations, the project will propose an amnesty clearing almost 50 billion USD worth of interest on the unpaid premiums as long as the original amount is paid in annuities. This brought another debate on the economic area as such amnesty will weaken the budget and may bring burden on the financing by underpinning the interests, as we have stated on the previous page.

Energy is another area where we are very fond of. Turkey has increased its share in TANAP to 30% from previous 20%, securing an important share in transportation of Azeri natural gas and petroleum. In addition to this, TPAO, Turkey’s national petroleum company, has increased its share in Şahdeniz Project, biggest Natural gas project in Azerbaijan, from 9% to 19%, buying an additional shares from TOTAL in exchange of USD 1.5 billion. We believe that such moves will strengthen Turkey’s position in energy wars in the long run.

As our followers will recall, we are also very keen on developments on Northern Iraqi petroleum and believe that this issue is quite important for the future of Turkey. As stated in previous “Alchemy”s, the transportation of Northern Iraqi petroleum over Turkey is extremely important, both politically and economically. Turkey has sold more than 1 million barrels in the 1H of 2014, of which the proceedings will be hosted in Halkbank until a sharing solution is found between Northern Iraq & Baghdad. This amount is expected to reach 2.5 million barrels in 2014. Although USA and Baghdad declared that they are not happy for the pumping of oil before a sharing agreement is reached, it is essential for Northern Iraq to sell this oil as there is no other income provided from the central government for them. Germany and Italy are thought to be the first buyers of this shipment. Necirvan Barzani, the PM of the Northern Iraq stated that the agreement with Turkey is for 50 years and USD 9 billion worth of petroleum is pumped. He also stated that the proceedings are not used for the moment but blocked in Halkbank until a solution for sharing is found. Turkey is expected to generate an annual profit of USD 2 billion from this agreement.


Coming back to the streamline economic aggregates, the negative real interest rate at the beginning of 2013 has turned to positive at the yearend as this was not sustainable at all. Then during the last 6 months, a new equilibrium has been formed, where the PPI has increased enormously, due to the FX volatility and the turmoil on the markets. The CPI seemed more cautious for the 1H as it was not possible to charge the effects of FX volatility directly to the consumer by price increases. Yet we are again in the negative real interest zone, forcing us to keep an eye on it.

Inflation & Benchmark Rates

Source: Turkish Statistical Institute, Foreks

However, given the sound fundamentals of the economy, and the less fragile structure compared to previous years, the period of negative real interest rate has started again with bullish expectations, just after the municipal elections. As always stated in previous issues of the Alchemy, we believe that Turkey is becoming normalized, therefore giving more normal reactions to such stimuli. Even after certain overreaction, we see that the recovery takes lesser time.

The selected part of the above graph is actually very much alike with the 2011-2012 period where we had the same volatility between these three indicators, followed by a huge growth

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and a lovely soft-landing. This may again be the case, depending the result of the one last unknown parameter, the result of the presidential elections.

Industrial Production Index

Source: TurkStat, CBRT

Capacity Utilization Rate

Other aggregates are also supportive of our bullish stance about the economy. Industrial production and the consumer confidence indices provide volatile but upwards improvement where the capacity utilization rate is stable in a wide range.

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Consumer Confidence Index

Source: TurkStat, CBRT

An important legal development, effecting the retail market and taken in order to control the monetary and economic activity is that as of February 1st, the new consumer law dictates the payment methods in purchasing certain items, directly effecting the retail sector. According to this, there will be no more instalments for jewellery, restaurants & food spending and the number of instalments is limited with 9 for electronics & telecom. The move basically was aiming to control the consumption on mobile phones and tablets, reaching to a net import of USD 4 billion p.a.. 2013 sales data suggests that nearly 15 million mobile phones are sold in Turkey, of which 9 million are smartphones. However, as Turkey is a country full of street smart people and as we always find a solution against prohibitions, even the biggest institutional names on the electronic / telecom sector were selling phones and tablets with more than 12 instalments by using gift cards as intermediaries.

After analysing these main economic aggregates, we can summarize our thoughts and implications on our real estate strategy as follows, also self-criticising our findings in previous issues:

1. As we were expecting and forecasting, 2013 was a success year and it was better than expected with the best growth in Europe. The only volatility was on the FX side during the 2H and some on the employment figure.

2. Despite all the negative socio-political events in 2013, the economy was strong and the fundamentals of the structure resisted a collapse very well.

3. The battle between the Community and the government is seemed to cool off for the moment but may start again as the presidential elections. Yet we believe that

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efficiency of the PM Erdoğan’s operations on cleansing the cabinet and the bureaucracy has already proven itself on the municipal elections.

4. We do not expect a crisis or turmoil in the economic side UNLESS nothing extraordinary happens on the political side. We expect PM Erdoğan to win the presidential election and become the President, and we see no effect of this on the market in short term.

5. We believe that Turkish economy can not be fully understood from abroad. Looking at just the figures, especially during the volatility, is probably the worst way of forecasting on Turkish economy. Most of the institutions upgraded their growth expectations in the 2Q, despite their own negative declarations in the 1Q.

6. We expect the CAD to compress at an important level, as seen during the first 4 months of the year, nearly 30% down from 2013. As the growth continues, the denominator effect intervenes yet it is offset by the CAD bringer effect of the growth. We expect that the expectations of the government’s middle term program may be achievable, even the 5% aggressive growth rate depending on the international conditions, although we expect a figure slightly over 4%.

7. We expect inflation to wander at these levels. The pass-through effect is already done and a new equilibrium level on the markets are formed.

8. We still believe that the low level of leverage in the economy (36%) is still the biggest cannon in the arsenal. We believe that the indebtedness of the Turkish companies is not an issue as they have huge cash abroad.

9. People on the street are immune from the FX volatility, at least directly, as individuals cannot borrow in FX terms legally. This is extremely important and prevents the panic environment.

10. Despite the outlook downgrades by some credit rating agencies, we have seen the economy and the indicators recovering afterwards. This shows us that the downgrades are ill-timed and will be corrected soon. However, we are aware that the results of the presidential election will be important.

11. Obviously we see certain risks on the market. Apart from the political risk, we see that the PM’s intervention to the CBRT’s independence is a huge risk that the market


is not yet pricing. We believe that the independency of the CBRT is crucial and fatal and if such an invasion happens, we may need to change our main theme drastically.

12. We still believe that on the real estate side, the residential sub-sector is still a risk. This is the area where the interest rate is subject to change quite easily, hence the investment appetite and given the stock in the market, we suggest to keep an eye here as it directly affects the banking sector and other players in the market. Having said that, we have seen that despite the Gezi event and the December 17 incidents, the house selling figures were the record levels for the last 10 years.

At this very point in Alchemy IV, we have stated:

“From this point of stand, we see no reason for changing our bullish stance for the economy as well as the real estate markets, as long as the political risk does not escalate. We do accept and expect that the 2014 will be a year of lesser growth but also of a lesser CAD and will be a year of stabilization for a possible second take off after general elections in 2015. We see no reason to cut exposure but we recommend to be cautious and watch the aggregates closer.”

We do not see any reason to change any statement from this expectation, other than the growth figure which may be better than expected.


Commercial Real Estate Markets

As we have stated in the previous issue, 2013 was a year where we have seen some important change in the stock, especially on the retail side of the market. 2014 is no different from this, as we have seen an addition of almost 390,000 sqm of stock, creating a more than 4% growth for the first half of the centre.

Source: Turkish Council of Shopping Centres

In the first half of 2014, we have seen 6 centres opening in 4 different cities. Although 3 of 6 centres opened are in Istanbul, this ratio is more than half when considered according to the GLA, thanks to the giant Mall of Istanbul and another super-regional centre, Akasya Acıbadem. In terms of GLA, 69% of the new openings is in Istanbul, strengthening the accustomed 40/60 ratio slightly. In the second half, we do not expect further giant openings in Istanbul.

Actually, without any further giant openings, 2014 will be a softer year given that Turkish market grows on average almost 13-14% in terms of GLA on annual basis for the last couple of years, yet as we are approaching to saturation, we consider this level of opening quite normal.

1H 14 Openings City GLA (sqm)Ceylan Karavil Park AVM Diyarbakır 66.286 Akasya Acıbadem Istanbul 80.000 Canpark AVM Istanbul 40.000 Mall Of İstanbul Istanbul 148.840 Kırıkkale Podium AVM Kırıkkale 26.000 Novada Tokat Tokat 28.000


Source: Turkish Council of Shopping Centres, Mergen Consulting.

As stated previously, AYD figures take into account each and every publicly announced shopping centre project as “pipeline”, regardless of the realization possibility or opening time, therefore AYD data has an enormous and scary amount of pipeline but shows a longer-term future as a possibility picture. Therefore we had to make a small filtration of opening probability on the pipeline. Updated AYD figures suggest that we have closed the first half of 2014 with 331 shopping centres all over Turkey, reaching a total GLA of 9.5 million. After the opening of Mall of Istanbul & Akasya, Istanbul holds 39% again, with a total GLA of 3.7 million sqm where the rest of the country holds 5.8 million sqm of retail in 234 centres. After our simple filtering, the dataset suggests a pipeline of approximately 4 million sqm further until the end of 2016. The figures show us that there will be a bigger stock increase in out-of-Istanbul, with 46%, compared to Istanbul’s pipeline growth of 33%. Therefore, the ratio will be skewed in favour of the “other” cities compared to Istanbul in 2 years’ time.


As of 1H 2014 Active Under Const / Planned TotalUnit 97 33 130

IstanbulGLA (sqm) 3.718.594 1.259.320 4.977.914

Unit 234 82 316Other

GLA (sqm) 5.765.249 2.670.403 8.435.652

Unit 331 115 446Total

GLA (sqm) 9.483.843 3.929.723 13.413.566

City Unit GLA GLA / 000

Capita Istanbul 97 3.718.594 268,40 Ankara 33 1.280.455 257,87 Karabük 3 48.248 214,30 Kırıkkale 3 53.106 193,30 Bolu 2 45.100 160,45 Antalya 16 327.249 156,39 Eskişehir 4 123.000 155,75 Bursa 11 383.325 142,60 Muğla 8 118.185 138,85 Gaziantep 6 245.409 136,37 TURKEY 331 9.517.350 125,85


One of the notable openings in this period was Novada Tokat, being the first shopping centre in the city with a 28,000 sqm GLA. The recent openings in Istanbul, coupled with a no single opening in Ankara during this period gave Istanbul the leadership back in GLA per 000 capita figures. As of 1H 2014, Istanbul is the densest city in terms of retail, followed by Ankara normally, with 268 to 258 sqm / 000 capita respectively. The recent opening of Podium AVM in Kırıkkale favoured Kırıkkale as the fourth just after Karabük, with 214 to 193 sqm/ 000 capita respectively. Please note that Karabük, Kırıkkale and Bolu, the fifth densest city, are in the list due to their small population, where statistically the average size of the centre in these cities is extremely small, as stated in previous Alchemy reports.

AYD dataset suggest that the GLA/000 capita is 125.85 for the whole country for 1H 2014, whereas for 2013 and 2012 this figure was 123 and 115 respectively. AYD figures suggest that this figure will increase further to 142 until the end of 2015.


As known by our veteran readers and followers of Turkish market, the noise on the number and density of shopping centres still continued all during the 2013, but people seems more accustomed to the idea that these figures will be regulated by the market rules such as supply & demand, not by the government.

End 2011 End 2012 End 2013 End 2015Istanbul 232 254 250 324Ankara 236 252 262 263Karabuk 179 186 214 182Bolu 148 171 182 165Denizli 130 144 130 139Bursa 143 143 142 190Trabzon 143 141 119 139Muğla 76 136 148 159Kayseri 124 122 119 161Mersin 96 121 103 115Turkey 103 115 123 142


Retail Stock & Pipeline


As we have stated in our previous issues, the prime rent increased slightly with the opening of Zorlu Centre, to € 85 level. The current volatility in the FX rates and the currency fixations on the retail market limits the further increase, therefore we believe that we will see the next important hike with the opening of Emaar Square.

A continuously stated fact is that finding a trustable & common data is almost impossible in Turkish office market. Amongst several agents, we prefer to use the Propin dataset, showing the total A Grade stock around 3.5 million sqm and the upcoming certain pipeline until 2015 YE as 750,000-1,000,000 sqm.

Normally, CBD holds approximately 38% of the total stock whereas Non-CBD Europe is around 27%. Despite the coming pipeline is almost one third of the current stock, the future breakdown is not promising a huge change, meaning that at least for the coming 3 to 5 years, the breakdown of the stock will not experience a dramatic change.

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Cum GLA Cum Unit


Source: Propin, Mergen Consulting.

The paragraph we have stated in Alchemy IV on this very page seems still valid:

“The above graph suggests the vacancy figures in the notable office regions of Istanbul. The jump in the vacancy is mostly stemmed from the recently completed projects, especially in Maslak and Umraniye districts, therefore does not signify a crisis but a period of suppression in the rent levels. The expected vacancy in the CBD is still around 4-5% levels in time, despite the current jump due to the new entries, whereas in the periphery this figure goes up to double digits, especially in the non-traditional office areas like Basın Express Road & Airport region. Although close-to-airport locations are much preferred in western countries, lack of mass transportation is still a valid factor for these areas, limiting the decision makers to make their choices.”

As stated previously, due to the huge pipeline, we believe that the rent levels will be suppressed for a while despite the demand on the market. Below chart shows us the past average rent levels asked by the landlord for the last 14 quarters:

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Vacancy by Office Regions (%)

Levent Maslak Şişli Kozyataği Altunizade Ümraniye


Source: Propin, Mergen Consulting.

In this regard, we still keep the prime rent stable at € 30 / $ 40 levels. Although we have witnessed some transactions above these levels, we must state that these are individual, small-sized transactions and it is too early to become a trustable market data.

The importance of the 1H 2014 in Turkish office market is that we have witnessed various pre-lease agreements, which were basically non-existent on the market. Denizbank has signed to lease 60,000 sqm of offices in Torun Tower, which is expected to be delivered in 3Q 2014. Also, our market involvement and intelligence suggest that VadIstanbul project, with almost 200,000 sqm office compound, is attracting reputable AAA corporates for pre-lease agreements. The inception of pre-lease concept is a very giant step in Turkish office market, which we believe is a good leap in institutionalisation of the market.

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Investment Market

1H 2014 was a little bit muted in terms of transactional evidence, compared to the relatively hotter 2013 and 2012. As stated previously, 2012 was sealed by transactions from the locals as well as the international big funds such as Blackstone and GIC. 2013, on the contrary, was sealed by office deals from the local investors.

It is a well-known fact by now that Turkish market lacks liquidity and obviously the transactional evidence supporting the assumptions. However, as we have the luxury to be involved in several negotiations in 1H both for locals and internationals, we had the opportunity to observe the yield levels. The negotiations that we are currently involved or have been involved during the 1H suggest that the prime yield is still 7%, yet as we have always stated, the figure is much lower for trophy assets, as we have witnessed a bid of 6,25% for a trophy asset.

In the last issue of the Alchemy, we have stated:

“As known, the long-awaited office project of Pramerica, Skymark, has been brought to the attention of a limited number of possible local buyers by Jones Lang LaSalle Turkey in the 3Q 2013. Our market information suggests that amongst the bids, a local company has managed to sign the deal, but due to the volatility in the financial markets, the deal is not yet closed awaiting for the financing. The expected price is around USD 125-130 million. As the project has not been openly marketed, we believe that it has low chance of creating a benchmark for similar transactions. As known, Pramerica is trying to cut its exposure in Turkey, they are also trying to sell Terracity, their only shopping centre in Turkey, located in Antalya. Our sources point that the bids are around 9% yield levels, and again for the closed nature of the deal, we find it hard to establish a benchmark for future transactions.”

The said office deal has been closed by Ferko, a Turkish developer with a good track record, during the 1Q, with a price of USD 129.5 million, for an expected GLA of almost 37,000 sqm. However, as stated previously, due to the closed nature of the deal, we do not believe that it would be a benchmark for future transactions.


In VadIstanbul, a reputable local firm has acquired an office building for owner-occupier use, at a price of USD 35.4 million for 8,900 sqm, including the VAT. The project is expected to host one of the biggest office complexes in Turkey, as of delivery time (June 2016). Some of the pre-let offices are under bid by local and international investors in the project as well. We believe that due to the nature and size of the project, we may see some benchmark transactions here in the near future.

Although commercial real estate investment market was mute during the 1H, the investments were mostly focused on Turkish companies, either by local groups or international private equity firms. Plus, privatization deals were also eye-catching during this period.

ICBC, one of the biggest banks in terms of asset size, bought 75.5% of Tekstilbank at a price of TL 669 m, or simply USD 325 million at the end of April, 44% over the stock price. Cargill bought Turyag, a well-established vegetable oil producer in Turkey, just after a smaller company Alemdar Kimya, at a value over USD 100 million. Abraaj Private Equity bought Yörsan during the first weeks of the year. Doğuş Group, also a minority shareholder of Coya in London, bought 70% of Günaydın steakhouse at USD 150 million. In addition to this, Esas PE bought a majority share in Ayakkabı Dünyası, one of the leading local shoe manufacturers and chains in Turkey.

Privatization of some projects and sites were also notable during this period, especially on the commercial real estate sector.

Kalamış Marina, managed for the last 15 years by Koc Holding, has recently been brought to tender for 30 year management contract. Koc Holding obtained the contract again for 30 years at a price of USD 664 million. Koc Group will continue investments on Kalamış Marina, increasing the capacity to 1700 boats from 1400 and aims to obtain the 4 anchor status.

The 111,000 sqm land in Zeytinburnu, Istanbul , recently been tendered by Emlak Konut REIT has been acquired by a local joint venture, Özak-Yenigun-Delta Consortium, at a project price of TRL 4.2 billion. The tender result offers a revenue sharing agreement of TRL 1.5 billion to Emlak REIT.


The privatisation did not end with these good news as another tender in Istinye for a land of 158,000 sqm has been awarded by Emlak REIT, at a price of TRL 1.1 billion. The site is perfectly located as it neighbours the ISE, IstinyePark and some luxurious residential projects. The proceedings of this tender will be left to National Ministry of Education.

As seen from these important developments, the interest on Turkish markets still continues despite the double election year and the past events of December 17 & 24. As we have always stated, we believe that the long-term bullish stance is intact and we see no reason to change our main theme unless something extraordinary happens.


Philosopher’s Stone

It is really surprising to see that most of the points we have stated in The Alchemy IV are still valid, either as a wrap-up point or as a risk. We are aware that only a fool has the luxury of not checking his own views continuously, therefore we will keep an open mind to see any sign of deterioration. Hence, it is time for us to look at the developments and review our strategy if needed.

• As stated numerously, Turkey is a net importer of energy, therefore we would be living with a certain level of CAD. In this regard, we believe that government’s move on Northern Iraqi oil & gas reserves are extremely appropriate. Let alone the annual profit of USD 2 billion on the pipeline, the control of such energy is crucial given Turkey’s geographical strategies.

• As expected, Turkey benefited from the recent peak of the FX by increasing the exports and decreasing the imports. First 4 months’ CAD figure shows us a huge recovery, almost 30% decrease in CAD figure. In 2014, CAD will definitely shrink as we have expected and forecasted and will provide cushion for the relative decrease in growth.

• We believe that the independency of the CBRT is crucial and is above everything. We see the recent attack of the PM very very dangerous and we fear that loss of such independency may de-rail the last 10 years’ development.

• Although we previously stated “it will definitely not be able to reach a growth of 5% as expected in the Middle Term Program, our favoured economists expect a growth of 3-3,5% and a CAD of 6-6,5%, still quite manageable for 2014”, making us still more aggressive than anyone, we know give some chance for MTP figures to be reached.

• Domestic demand is still intact and coupled with the international demand, they support the growth in an unexpected way.

• We do not expect a downgrading from the investment grade as there is no more reason for it. Yet the result and the following events of the Presidential election is always a question mark.


• As stated previously, we are in favour of freedom of different lifestyles and speech.

Further anti-democratic pressure from the government may effect Turkey’s perception negatively, despite the 50% votes supporting the government.

• The CB has enormous reserves accumulated for the last 10 years. We see almost no risk of Balance of Payments or a speculative attack as the emission size is much lower than the cash reserves. We believe that size of the private external debt is an issue of profit, not crisis.

• We believe that foreign financial institutions, especially on the capital markets side, cannot fully understand the picture from abroad and unfortunately they have proven our thesis right in the last 6 months, therefore we suggest a re-thinking strategy before giving crucial decisions and re-checking of the models.

• We always suggest to check the integrity of the big picture rather than becoming moody depending on the reports of these financial institutions. We are inclined to keep our long term bullish approach as long as the main theme remains intact and not threatened by the wrong moves stated above, such as an attack on the independency of the CBTR, or more escalating intolerance on the political side.

• We believe that the result of the Presidential elections will be quite important and should be closely followed. Although the markets currently price the presidency of Mr. Erdoğan in a myopic way, the aftermath of the elections will be quite important as the future of AKP will be in question. Mr. Erdoğan’s presidency, if not followed by any other strong figure to hold together the party, may create further cracks in the AKP, shaking the political stability.

• Given the huge supply, we are always cautious on residential sub-sector, especially if the interest rates start to accelerate up, which we do not expect in the near future.

As stated previously, we keep our positive stance in the commercial real estate market and the only risks we perceive are the political fights, possible deterioration in fundamentals on the long run, the risks stated above and the huge stock in the residential sector. We also expect more foreign capital investing once we come to a new equilibrium, probably after the presidential elections. Yet, we put our clause on the risks stated above and unless the main theme is threatened, we will be sticking to our long-term bullish approach.


Dr. Kıvanç ERMAN, MRICS

Owner / Founder +90 212 299 9833 +90 533 608 3661 [email protected] www.mergenconsulting.com The Alchemy aims to bring you the comments and developments from Turkish Real Estate Markets and the effecting developments on other areas. We have collected the news and based our comments on the sources believed to be reliable and trustworthy. It is always possible that despite the utmost care there may be discrepancies about the truth and the collected intelligence, hence the comments. We are always happy to correct and provide our clients the true data as long as it is corrected by the source itself. If you believe that the comments or the intelligence stated do not reflect the truth, please do not hesitate to contact us for correction.


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http://www.mergenconsulting.com/

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