As a natural outcome of a developing and expanding economy, increasing population and urban transformation projects in Turkey, financing for real estate investments has become an important issue for the market. BURAK GENCOGLU writes.
The real estate market of Turkey has expanded and demonstrated an outstanding performance during the past couple of years. In addition to the increase in demand and high-quality office and retail space, decreasing interest rates and the mortgage system have been the main reasons for the remarkable growth of the real estate market.
In terms of real estate investments, real estate investment companies (REICs) have a significant role in the Turkish real estate market. Real estate investment trusts are structured as REICs, since ‘trust’ is not a model existing in Turkey. REICs can be defined as the institutions which can only invest in real estate, capital market instruments based on real estate, real estate projects and rights based on real estate. There are currently 31 REICs currently operating in the Turkish real estate market. REICs were introduced more than 20 years ago in 1995 after the Capital Markets Board (CMB) completed the required legal arrangements.
REICs, which comply with the requirements of the CMB, operate as corporate income tax-exempt stock companies and they are listed on an organized stock market in Istanbul. REICs are also considered as a useful vehicle that offers easy access to the profits of huge real estate portfolios in the real estate market. Therefore, they have attracted the attention of both local and foreign investors. REICs have a high growth potential; however, in order to achieve the desired levels, it is crucial for these companies to have opportunities to boost their investments such as establishing new financing instruments.
Lease certificates as a financing method for REICs
While REICs play an important role for the real estate market, it is of utmost importance to provide finance for their investments and diversify their financing instruments. REICs traditionally provide financing for their investments through their equity capital or bank loans. However, REICs have also added lease certificates (Sukuk) into their financing sources in recent years. One of the main advantages of REICs is that since they are listed on the stock market, they can also benefit from capital market financing opportunities.
The real estate market has become more familiar with Islamic finance instruments, namely lease certificates, due to the legislative developments during the past years. However, as an alternative to the traditional financing instruments, lease certificates are still at the development stage. REICs can incorporate asset leasing companies (ALCs), which issue lease certificates, to provide funds to be used by REICs in the investment projects.
The main regulation regarding lease certificates is the communiqué numbered III-61.1 (communiqué) enforced by the CMB and published on the Official Gazette dated the 7th June 2013 and numbered 28670. The communiqué regulates matters such as the guidelines for defining the lease certificate types, establishment, articles of association of ALCs and rights and assets which can be acquired by these companies.
As per the communiqué, lease certificates may be issued in five different forms. These are the lease certificates which may be based on: (i) ownership (Sukuk Ijarah), (ii) management agreements (Sukuk Musharakah), (iii) trading (Sukuk Murabahah), (iv) partnership (Sukuk Mudarabah) and (v) contractor agreements (Sukuk Istisnah) or by combining these different structures. Lease certificate holders generate revenues in the same ratio as their percentage on the underlying assets and rights.
As a regulatory requirement, REICs should have a minimum of 50% real estate investment within their portfolio. However, in order to establish the issuance structure of lease certificates, REICs should transfer their real estates to ALCs. Since such a transfer transaction affects the distribution of the REIC’s asset portfolio, it is essential to protect the minimum 50% real estate investment ratio which should be held by the REIC itself.
Therefore, REICs should direct the financing provided through the lease certificate issuance to new real estate investments which will enable them to meet the minimum requirement. This way, the portfolio distribution of REICs can be protected to comply with the real estate-related investment limit.
Lease certificates are considered as an advantageous method to carry out the securitization of the real estates owned by REICs. The issuance of lease certificates may provide a less costly financing tool compared with bank loans and other traditional methods due to factors such as the ALC and its asset-based structure. Additionally, the Turkish real estate sector attracts a considerable number of foreign investors who prefer to invest in Islamic finance instruments.
Interest-free and Islamic finance tools have increasing popularity both in Turkey and in the world as they attract the Gulf investors. Therefore, Turkey is enacting legislation to provide a favorable tax regime for investors and issuers to promote Islamic finance instruments such as the lease certificates.
By promoting the lease certificates to be issued by REICs, investors may benefit from the advantageous regimes stipulated for both REICs and lease certificates.
Burak Gencoglu is the senior attorney at GSG Attorneys at Law, a PwC network firm in Turkey. He can be contacted at firstname.lastname@example.org.