Fitch Ratings has affirmed Turkish residential developer Emlak Konut Gayrimenkul Yatirim Ortakligi A.S.'s (Emlak Konut) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'BB-'.

The Outlooks are Stable.

The ratings reflect the company's unique revenue-sharing model (RSM), which generates guaranteed revenue and upside gains, while passing nearly all development risk to developers. Rating weaknesses are exposure to volatile housing demand and price risk as well as regulatory and political risks.

The RSM accounted for 86% of EBITDA in 2020. Emlak Konut holds a priority agreement with Turkey's Housing Development Administration (TOKI), under which it can voluntarily purchase land at independently appraised values without a tendering process, a clear competitive advantage.

Emlak Konut mainly operates in Istanbul, Turkey's largest city with over 15 million residents and growing.

Key Rating Drivers

Challenging Operating Environment: Economic uncertainty remains in Turkey as inflation increases and the lira continues to depreciate, falling more than 15% in 2021. Political and geopolitical risk remains high. The central bank's independence remains in doubt after the dismissal of the central bank governor in March 2021 (the third since July 2019). On 23 September 2021, despite inflation surpassing 19%, the central bank cut the key interest rate to 18% from 19%, making real borrowing costs negative.

Sales Dependent on Interest Rates: Housing sales in Turkey are correlated to interest rates. Despite the pandemic, multiple interest-rate cuts in 2020 caused housing sales to grow nationally more than 11%. Mortgage sales grew more than 70% as banks extended loans on favourable terms. Emlak Konut's sales nearly tripled. In October 2020, interest rates were raised and, consequently, national residential property sales fell 11.5% yoy. Emlak Konut maintained healthy sales through promotional programmes using its strong brand name and quality assets in good locations. The interest-rate cuts in September 2021 may stimulate sales due to a significant supply deficit of quality housing in Turkey.

RSM Removes Most Development Risks: The RSM generates most of the company's EBITDA, provides revenue visibility and eliminates most risks faced by housing developers. Under the RSM, the contractor takes on almost all development risks, including design, build, finance, sales and marketing, while guaranteeing Emlak Konut a minimum revenue that at least covers the cost of land. The contractor shares upside gains with Emlak Konut in pre-agreed percentages. Returns have historically exceeded minimum revenue amounts by more than 2.5 times. The RSM is expected to drive business over the medium term.

Overseer of all Projects: Emlak Konut oversees the building process and collects and distributes project cash flows, including contractor revenue, which is shared at defined milestones. This control provides flexibility to alter projects if demand dynamics change. In 2019, when sales slowed under high interest rates, Emlak Konut delayed the latter stages of three projects. It can cancel projects for any reason, including if bids fall short.

TOKI Relationship Mutually Beneficial: Its exclusive priority agreement with TOKI allows Emlak Konut to buy land from TOKI at independently appraised values with no tendering process. This ability to acquire large plots in good locations, mainly in and around Istanbul, is a significant competitive advantage. TOKI, which holds more than 200 million sqm of land, is mandated to provide social housing across Turkey, but does not receive government funding. Emlak Konut's dividends and land payments are a key funding source for TOKI. These mutual benefits reduce the termination risk of the exclusive relationship. Were it to end, Emlak Konut's business would be weakened, but it could operate under a turnkey model, like other home builders.

Large, Growing Land Bank: The company's land bank exceeds 3.8 million sqm with a value of almost TRY7 billion. This land, which most other contractors would not have access to and in most cases could not afford, is critical to the RSM as the company can attract financially strong contractors to tender bids. Emlak Konut retains the option to buy land from TOKI, but is under no obligation and can return unwanted land to TOKI for any reason at an updated independent value.

Exposure to Contractor Performance: Contractor failure is a risk, but is partly mitigated by the bidding process. Contractors must first meet financial and technical requirements and, if successful, must propose estimated project values and revenue-sharing. If all requirements are met, the highest bidder wins. The preferred bidder must provide a down-payment equal to 10% of the minimum revenue, as well as a guarantee of about 6% of the total estimated project revenue. If Emlak Konut is concerned that a contractor may be unable to complete a project, it can step in and complete the project. No projects have failed to date and the company has only stepped in once, completing the project successfully.

Improved Debt Profile: Emlak Konut took advantage of banks offering low interest rates in 2020 to lower its average cost of debt to 10.9% at end-2020 (end-2019: 17.7%). In addition, it extended its debt profile to around three years. It has 56% of debt on five-year maturities, which is long for the Turkish market. Liquidity is a risk due to large working-capital swings, the short-term nature of its debt, and dividend payments, which were TRY74 million in 2020. We expect FFO leverage to remain high at 5.9x (gross) and 4.2x (net) on average for 2021 and 2022.

Derivation Summary

Emlak Konut does not have a direct peer. While its turnkey model is similar to home builders', the RSM, which generates most revenue and EBITDA, is unique. Under this model, the company only contributes land to the project. It receives a minimum guaranteed revenue amount that will cover the cost of the land, and will receive a share of any upside gains, while passing nearly all development risks to private contractors. In addition, the priority agreement with TOKI-unique among rated home builders - provides access to significant and desirable parcels of land that other developers do not have. This also exposes Emlak Konut to potential political or regulatory risks that do not affect peers.

The operating and regulation environments differ across EMEA, making a direct comparison difficult, especially given Emlak Konut's distinct business model. Emlak Konut is of similar size to UK-based Miller Homes (BB-/Positive) and Keepmoat's Maison Bidco Limited (BB-/Stable) - both offering predominantly standardised single-family homes - but smaller than Russia's PJSC LSR Group (B+/Stable) and PJSC PIK Group (BB-/Stable). Emlak Konut operates with much higher FFO margins that have historically exceeded 50%, while most other rated peers' tends to be less than 20%.

Emlak Konut historically had FFO leverage of under 1.0x, but debt has been increasing, particularly in 2020, owing to low interest rates. Projected FFO gross leverage is 5.8x (4.2x net) to 2022. FFO gross leverage is therefore forecast to average 3.3x between 2020 and 2023.

Emlak Konut is in a much more volatile operating environment than rated peers. While Turkey has a significant housing deficit and a growing population, the economy remains highly volatile.

Key Assumptions

Sustainable EBITDA margin above 20% as EBITDA generation increases from 2021 onwards

Working-capital outflow totalling about TRY800 million in 2021-2023

Stable dividend policy averaging 50% of net income

Relationship with TOKI unchanged during 2021-2024

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade (provided that Turkey's Country Ceiling is also upgraded to 'BB'):

Reduced volatility of profits derived from the Turkish housing market

Consistently strong GDP growth, along with political stabilisation

FFO gross leverage below 2.5x.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Deterioration of the operating environment and downgrade of the Country Ceiling

FFO adjusted gross and net leverage above 5x and 4.5x, respectively

Material change in the relationship with TOKI, causing deterioration in Emlak Konut's financial profile and financial flexibility

Deterioration in liquidity profile over a sustained period.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Lumpy Debt Profile: Liquidity improved in 2020 with readily available cash of TRY1.2 billion and in 1H21 with TRY1.45 billion. We expect liquidity to remain sufficient in 2021 despite short-term debt amortisation of TRY1.16 billion in 2022 and 2023. The average interest rate increased slightly to 11.43% in 1H21 from 10.9% in 2020 after a significant drop from 2019 levels of 17.7%.

Its debt maturity profile remains short relative to peers', at three years on average, due to limited long-term funding in the Turkish market, increasing the company's liquidity risk. Emlak Konut is expected to use readily available cash to expand its land bank and meet short-term liquidity needs in 2022. All debt is lira-denominated.

Issuer Profile

Emlak Konut is the largest real estate investment company in Turkey and focuses on developing residential projects, mainly in Istanbul, the country's largest city. Although registered as a REIT, Emlak Konut operates largely as a home builder as it holds negligible rent-generating assets. TOKI is Emlak Konut's largest shareholder, holding 49.4% and all A shares.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

RATING ACTIONSENTITY/DEBT	RATING		PRIOR
Emlak Konut Gayrimenkul Yatirim Ortakligi A.S.	LT IDR	BB- 	Affirmed		BB-
	LC LT IDR	BB- 	Affirmed		BB-
	Natl LT	AA(tur) 	Affirmed		AA(tur)

VIEW ADDITIONAL RATING DETAILS

Additional information is available on www.fitchratings.com

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