Emerging Markets Under Basel III: Can Moral Hazard Lead to Systematic Risk and Fragility? Analysis of REIT’s in Turkey

Abstract

This paper is an attempt to explain Emerging market of Turkey REIT’s performance, concerning finance sector reforms and REIT’s with respect to Basel III requirements; as government interference in the sector. Findings presents performance comparison of Turkish direct real estate investments and real estate investment companies (REICs) by three property types (residential, retail and office) using risk-adjusted return. Extant literature on performance of direct and indirect real estate has been investigated by different property types and time periods using various methods. The common data used in the studies are appraisal-based (IPD) and transaction-based (NCREIF) indices for direct real estate, while EPRA and FTSE/NAREIT indices for REITs covering the major international markets. In this paper, first REICs are classified regarding their property portfolio by type (residential, retail and office) to compare benchmark direct real estate investment. Since no index (such as NCREIF, INREV) is available for direct real estate investments in Turkey, quarterly return is calculated for direct commercial investments based on transaction indices while for direct residential investments based on valuation indices. Finally, Sharpe Ratio is used to compare the performance of REIC versus direct real estate for each property types. Two different time period is used; first period covers 43 quarters from 2002Q1 to 2012Q3. Second period runs for 11 quarters from 2010Q1 to 2012Q3, which data for all three property types are available. The performance of direct real estate investments in all property types is quite well compared to REICs in Turkey. In other word, direct real estate provides great return for less risk, however REICs provided less return for the same risk. The weak performance of REICs can be attributed to their portfolio allocation. The current asset composition of REICs emphasizes development of their own assets, due to the lack of investment grade property portfolios in Turkey. REICs become a “developer’s vehicle” for construction companies and contractors. They act like “developer” instead of “investor” and also focus on “developer’s profit” instead of “rental income and “capital gains”. Their behaviours indicate unique characteristics of Turkish REICs, and therefore they may call as “Real Estate Development Companies—REDCs”. Among direct real estate investments, residential provide higher return. It can be attributed to the unique residential investment characteristics in Turkey. Residential are considered for sale instead of income producing asset, compared with mature markets. No large companies invest in residential portfolios for leasing purposes, because residential properties provide much more return from capital gains and less income yield. Also considering two different periods in the study the negative effect of the global credit crunch observed especially on commercial markets in Turkey. Both office and retail markets witnessed a slowdown in rentals and property values. Due to low housing loan ratio in Turkish market, the effect was quite limited on residential market and no sharp decline was observed in residential prices.