Recent development
The Turkish real estate market faced a slowdown in the second half of 2016 prompting the Turkish Government to implement a number of serious remedies to draw local and international investor interest into the market following the coup attempt. As part of this initiative and in order to provide liquidity, the Turkish Capital Markets Board (the “CMB“) amended the Communiqué on Real Estate Certificates No. VII-128.2 (the “Communiqué“) on August 3, 2016. The Communiqué replaces mandatory bank guarantees by private audit, creating an investor-friendly environment that also enables state-owned entities to engage in real estate certificate issuances.
Background
- Real estate certificates and similar instruments were used in 1989 and 1996 for financing mass housing projects in Istanbul. The CMB issued the original Communiqué on July 5, 2013, but this measure did not succeed in revitalizing the real estate certificates market or in the securitization of the Turkish real estate market. The revitalization and securitization goals were not attained due to the cumbersome procedures imposed on non-public entities, such as bank guarantees mandatory for all public offerings.
- A construction company incorporated as a joint stock company or a real estate investment trust (or alternatively an authorized governmental entity) can issue or sell real estate certificates to investors in order to finance a real estate project.
- The real estate certificates are listed and traded in Borsa Istanbul, allowing investors to trade their certificates in the secondary market through banks or brokerage firms, before the project is completed.
- The offering documents must include the project completion and primary and ancillary obligation performance schedules. The issuer must pay penalties to its investors if it fails to complete the project and perform its primary and ancillary obligations within the periods established under the offering documents.
- Investors holding real estate certificates can redeem their certificates by (i) purchasing residential and/or commercial properties in exchange for a predetermined amount of real estate certificates (the “primary obligation“), or (ii) receiving the sales proceeds of the real estate certificates not transferred to investors due to their exercise of their primary obligation right pro rata (the “ancillary obligation“).
- Turkey has adopted a considerable legislative framework for urban renewal; these projects aim to increase housing standards and mitigate the effects of potential earthquakes.
What the Communiqué says
- The Housing Development Administration (TOKİ), İlbank (the state-owned investment and development bank established to finance urbanization in Turkey), municipalities and other governmental entities (the “state-owned entities“) are now entitled to issue real estate certificates for urban renewal projects upon receiving the Ministry of Environment and Urban Affairs’ approval. These entities will not be subject to all the requirements applicable to other non-governmental issuers. The state-owned entities can also enter into an agreement with other legal entities for real estate certificate issuances related to urban renewal projects.
- The investors of urban renewal projects which are undertaken or commissioned by the state-owned entities can request extra financing if they hold insufficient real estate certificates to exercise the primary obligation as set out under the offering documents. The state-owned entities must also announce buy-back prices of their issued real estate certificates, the value of which is subject to a minimum revaluation based on the inflation indices. The independent audit requirements, penalty fee requirements and share capital requirements do not apply to real estate certificates related to urban renewal projects undertaken or commissioned by the state-owned entities.
- The limitation of the total issuance value is still in force and it will also be applicable to issuances guaranteed by banks, which was previously exempt from this requirement. The total issuance value cannot exceed 50% of the sale price of all the real estate for which the real estate certificates are issued.
- The issuer’s obligation to obtain a bank guarantee, as well as the issuer’s obligation to purchase all unsold properties of the project, have been removed from the Communiqué. Instead, the issuer and the auditor must enter into an agreement regarding the periodical oversight of the issuer’s obligations and undertakings prior to their application to the CMB.
- On a quarterly basis for public offerings (or six-month periods for other sales), the auditor must confirm that (i) the issuer has acted in line with the offering documents; (ii) the sales prices of real estate sold to perform the ancillary obligation are in compliance with the Turkish capital markets rules, appraisal reports and market conditions; and (iii) the investors have received their respective amounts arising from the sale of properties used to perform the ancillary obligations. The issuer must disclose this confirmation to the public upon receipt from the auditor. If the auditor identifies any irregularities in its report, the issuer’s offering documents must include details on investor compensation and rights.
- In the offering documents, the issuer can now determine the due dates of the ancillary obligation without any predetermined periods, which was previously set at 120 days following the project completion. Furthermore, the issuer’s obligation to sell the properties that will be sold to perform the issuer’s ancillary obligation through only three auctions is no longer in force.
- The sum of the issuer’s equity must exceed its issued or paid-in share capital; this must now be evidenced by a CMB-approved independent auditor. Furthermore, the issuer must be considered investment grade level by a CMB-approved credit rating agency. These requirements do not apply to the state-owned entities.
- If the investor requests that the issuer performs its primary obligation prior to the completion of the project, the issuer may grant a call option to the investors (or enter into a promise to sell agreement) which must be annotated with the land registry. Furthermore, the Communiqué prohibits the issuer from selling these properties to any other third parties. If the investor exercises his right to enter into a call option or exercises his purchase right under the promise to sell the agreement, the bank or brokerage firm acting as the intermediary will suspend any trading on these certificates.
- The issuer can now use the amount it generates from the sale of project properties to partially redeem the real estate certificates before the ancillary obligation becomes due and payable. Partial redemption is carried out by transferring the proceeds to investors pro rata to the certificates they hold. However, the properties that the issuer will sell to perform its ancillary obligations cannot be sold to the issuer or its related parties.
- After the ancillary obligation becomes due and payable in accordance with the offering documents, unsold properties must be re-appraised. The appraisal amount will serve as the base value for the payments issuers must make to investors when redeeming these certificates. The unsold properties may also be sold to related parties of the issuer, on the condition that the price is not below the price determined in the appraisal report.
- 10% of the proceeds generated from the issuing must be directly transferred to the issuer before the construction begins. This requirement does not apply to the state-owned entities.
Conclusion
Taking notice of the necessity for urban renewal construction projects and the clouds accumulating over the Turkish real estate market, the CMB is incentivizing the securitization of real estate projects. The CMB’s measures are expected to provide (i) alternative real estate financing methods, other than bank loans, to construction companies; (ii) a novel investment tool for investors through real estate ownership and/or capital gains returns; and (iii) transparently valued securities in the housing market, thereby controlling price bubbles by “leaning” as opposed to “cleaning.” The CMB will cut red tape by transferring the issuers’ significant responsibilities and guarantees to independent auditors; simultaneously, by lifting the mandatory bank guarantees for public offerings, they will provide a favorable investment climate. Furthermore, considering the recent segregation process in the Turkish construction industry, this dynamic method for financing the projects is expected to constitute a milestone for the market, as long as the investors are assured that appropriate and consistent measures are taken by the regulatory authorities.
