The Turkish mortgage market

The mortgage market in Turkey is small but growing and has had its ups and downs, as Doga Taslardan explains
he Turkish economy has been growing by around 6 per cent a year for the last five years, which is faster than many developed economies and most emerging markets.
Turkey lured in yield-seeking foreign investors thanks to a lucky combination of several factors such as: the global abandonment of liquidity, low returns in safe-heaven countries, overall positive outlook towards emerging markets, EU accession talks kicking off by late 2004, increased transparency and stability of the Turkish financial sector as well as positive relations with the USA regarding geo-politics of the Middle East.
The making of an ‘economic boom’ was rather simple: as confidence lifted towards Turkey global money poured in – in the form of both savings and loans – and as a result of considerable access to longer and less expensive international funding by Turkish banks, borrowing rates fell, which in turn fuelled consumption and thus the economic engine.
Rosy macroeconomics enabled the Turkish finance sector to offer long-term funding at relatively cheap prices for the first time in history. Thus the overall loan portfolio has risen considerably for the last two years, reaching US$110 billion by September 2006.

Total Loan Portfolio & % of GDPSource: Central Bank of Turkish Republic (Colored bars represents economic downturns.)
Despite the rapid growth, total loan volume is still minimal, with only 29 per cent of GDP compared to European countries where the average is 121 per cent of GDP.

Total Loan Portfolios / GDPSource: European Central Bank & Central Bank of Turkish Republic
Consumer credit explosion
Economic growth gave birth to better job prospects, improved real wages, higher GDP per capita and consequently more purchasing power, which in turn fuelled the demand for higher living standards. The Turkish lira gained strength and stability against the US dollar and the euro, allowing for low and steady prices on both imported and local goods. Relatively low prices coupled with the availability – for the first time – of long-term funds and low interest rates saw individuals rushing to finance new homes, imported vehicles and other big-ticket items. Such favourable lending conditions allowed more people to buy, bringing about a consumer credit explosion. The rapid growth of consumer loans together with credit cards had reached 40 per cent of the overall loan portfolio as of September 2006.

Total Loan Portfolio BreakdownAs the figures demonstrate, the economic recovery first manifested itself within the consumer loan sector. This increased appetite for borrowing was born out of pent-up demand along with a dramatic shift in public attitudes towards the notion of credit. Turks used to frown upon borrowing and bought goods with whatever was in their pockets or however much they could gather from their networks of family and friends. Within the last few years, however, owning a product or service without making an immediate payment is seen as acceptable, if not desirable. Since banks usually obtain above-market margins for consumer lending they were eager to fund to individuals.
Despite the rapid growth, however, as of September 2006, consumer lending was only 7 per cent of Turkey’s GDP, far behind that of developed economies (around 57 per cent in the Eurozone, 65 per cent in the US and over 70 per cent in the UK). Closing of this gap also presents lucrative opportunities for European banks squeezed by tight margins in their home countries who have rushed into Turkey over the last couple of years. These include Citibank, GE Consumer Finance, HSBC, BNP Paribas, Fortis and Uni Credito, which have been effectively operating in Turkey since 2005.

Consumer Loans / GDPSource: European Central Bank & Central Bank of Turkish Republic Mortgage lending. The pick-up in consumer lending has been particularly striking in mortgages after the long-awaited fall in interest rates gathered pace in 2005. The breakdown of consumer loans in Chart 3 demonstrates the effects of the 1998 and 2001 financial crises, which helped dry out consumer lending due to unacceptably high interest rates. The graph also reveals how mortgage volumes increased the most within the overall consumer loan portfolio to reach unprecedented levels by September 2006. In 2003, mortgages represented only 14 per cent of the overall loan portfolio, whereas today mortgages have a share of 49 per cent.

Consumer Loan Breakdown (Million $)Source: Turkish Banking Association & Central Bank of the Turkish Republic
In 2004, the Turkish mortgage market grew by 200 per cent, reaching $1.8 billion from $625 million the year before. In 2005, mortgage lending quadrupled, up by 407 per cent to $9.5 billion, thanks to the most favourable lending conditions in history and the pent-up demand for quality housing.
The two main reasons behind the 2005 ‘gold-rush’ for mortgages were falling rates from 2.5 per cent down to 1.05 per cent monthly (13.35 per cent APR) and extending maturities up to 30 years from only three. This was the first time such striking financing schemes had occurred in living memory due to the lack of an ‘affordable’ housing finance system in Turkey.
As of September 2006, mortgage loans totalled up to $15.1 billion while experts believe if the right circumstances were in place, the $20 billion threshold will be broken by 2007. On a top-down comparison, if Turkey’s outstanding mortgages/GDP reaches 10 per cent, similar to other emerging countries (like Hungary), the mortgage market could easily reach $35–40 billion within the next three to four years.
The main factors preventing faster development of mortgage volumes are relatively high interest rates at around 1.9 per cent monthly (25 per cent APR), a high initial down-payment requirement of around 15 to 20 per cent, other accessibility issues (low, undocumented, seasonal income, etc) and the overall lack of consumer confidence thanks to a rollercoaster economy since the mini-crisis felt in May 2006.
The country missed out on multiple socioeconomic benefits of a comprehensive national housing policy, which would maximise funds for housing or create subsidies. In the absence of favourable lending terms and regulatory frameworks to ensure healthy competition among lenders, only a negligible part of society was able to get a mortgage and so own a house. The share of mortgage lending in GDP in Turkey is still as low as 4 per cent (55 per cent in the USA and 39 per cent in the Eurozone).

Mortgage Loans / GDPSource: European Central Bank & Central Bank of Turkish Republic Investments.
With a population of over 70 million, Turkey has a lucrative mortgage market potential. Plus, real estate has been the primary investment choice in the country due to decades of high inflation and an unstable economy, along with an unsophisticated investor profile to profit from stock markets, equities, bonds, bills, etc. Houses, on the other hand, prevented people’s savings from being eroded by inflation – houses don’t lose their value in the long run, unless there is a major earthquake.
An ineffective and almost non-existent housing finance system hinders the growth and development of a potentially booming Turkish real estate sector. Restricted to short maturities and relatively high interest rates, over the years Turks had to fund homes through a combination of personal savings (66 per cent), help of family and friends (23 per cent), participation in housing cooperatives (8 per cent) and loans (3 per cent).
Every year, all over the world, approximately US$5 trillion worth of funds are transferred to homebuyers over the capital markets. The lack of a modern housing finance system prevents Turkey from taking advantage of these widely available funds and services. This all changed when the rates gradually came down during 2005. Due to favourable economic conditions, both local and foreign investors were willing to provide funds to Turkish homebuyers with better terms.
The availability of longer-term funds to banks significantly extended maturities, which in turn altered the investment behaviour of households from short-term to mid- and long-term investments. Thanks to the recent boom in consumer loans borrowers were able to make long-term investments, such as buying a house through mortgages, and build up down-payments for housing.

Housing shortage
Now that the appetite is there to use the financial sector’s leverage to own a house, consumers were faced with another well-known reality of Turkey: quality-housing shortages. Turkey has struggled with overpopulation, internal migration, unplanned urbanisation, and unqualified and illegal housing for decades. More than 60 per cent of the housing stock is built illegally without a proper licence, while at least 40 per cent needs renewal, especially in the face of a significant earthquake threat.
It is estimated that Turkey needs approximately 400,000 new residences each year, of which only around 200,000 are being built. However, along with the population growth, downsizing of family units and the increase in urbanisation, the annual housing need is estimated at 600,000 in 2010 and 800,000 in 2015.

Proposed mortgage law
Finally, recognising the severe housing problems caused by the lack of a housing finance system, the government appointed the Capital Markets Board to establish the legal framework for the mortgage business back in mid-2004. The proposed mortgage law drafted by the board has still not been enacted by Parliament, yet is promised to be in effect by Q1 2007. Since the pent-up demand for quality housing is enormous, establishing a healthy mortgage market will improve the standard of living and make Turkey a more attractive EU candidate.
The efficiency of the proposed housing finance system depends on a variety of factors, including macroeconomic stability and implementation of adequate internal infrastructure, such as:
Well-functioning and independent appraisal profession
Effective and quicker foreclosure procedure
Capital market institutions and instruments for securitisation of mortgages
Minimised operational costs in lending and securitisation
Government support through tax incentives, at least during the infancy period.

According to the draft law, only legally built, registered and certified houses will be eligible as collateral when taking out a mortgage. Only Capital Market Board-certified appraisers will be legally permitted to perform the valuations.
From the banks’ point of view, the new legislation will allow for new funding mechanisms, such as asset-backed securitisations and covered bond issues, which are currently uncommon in Turkey. Furthermore, the banks, along with the construction companies, will be jointly responsible and liable in case of non-delivery, late-delivery and/ or defects in constructions for the amount of loan granted within the first year of origination. In addition, foreclosure processes will be improved significantly, allowing for easier and timely default collection and auctioning.
For the consumers, the draft law introduces early payment fees of up to 2 per cent of the outstanding balance, which currently do not exist. The proposed mortgage law allows for floating rates, indexed to a common index and with certain caps, along with hybrid products (fixed and floating rates). Currently only fixed-rate mortgages are available.

Housing accessibilityProspects of mortgage legislation had raised hopes in many burdened by high rents for decades. This goal to become a homeowner with the new mortgage law – which is taking two and a half years to be enacted – coupled with favourable financing conditions increased the number of households eligible for homeownership, only to see house prices rocket through the roof. The government failed to fight against supply shortages with techniques such as active land supply and land development policy. Thus the ‘accessibility’’ provided by cheap rates has been absorbed by high prices, thanks to unexpectedly high demand.
This all came to a halt last spring. Triggered by the US Federal Reserve’s rising benchmark interest rates in May, investors pulled their money out of emerging markets in a frenzy. Turkey suffered the most from heavy sell-offs, thanks to its monstrous current-account deficit. When investors become sceptical about the sustainability of the country’s economic boom Turks had to watch the Turkish lira sink by around 30 per cent in value over a month.
The overall shakiness of the economy has definitely hurt the mortgage market as well. Mortgage rates rose back up to 1.8 per cent (monthly) from where they stood at 1.05 per cent just a few weeks before. With increasing interest rates, consumers shy away from loans, bringing the housing sales to a near halt. Between June 2005 and June 2006 the mortgage market grew at about 2.46 per cent each week on average. In July, however, the effects of the crisis of May to June started to be felt severely, and the the average weekly growth for July to September fell to 0.2 per cent. There were three main reasons
behind these figures: decreasing consumer confidence, increasing mortgage rates and rising house prices indexed to the US dollar.
In the short run it looks hard to recover from the setbacks suffered by the mortgage market in May. But there is unlikely to be permanent damage with a population of 70 million hungry for quality housing. MFG
Doga Taslardan is a specialist in the Turkish mortgage market
Endnotes:
1 Some investors recorded unprecedented returns around 50-70 per cent on short-term bonds over the last three years while monthly-rolled-over annual savings gained over 20 per cent just last year.
2 Local goods produced with relatively cheap imported raw materials.
3 Before 2005 maturities on mortgages were up to three years. Throughout 2005 they were extended to 30 years.


Source : MFG