The increase in housing prices in Istanbul has fallen below both the inflation rate and the increase in construction costs, signaling serous trouble for a sector that has long been a driving force of the Turkish economy.

Under the Justice and Development Party’s 15-year rule, housing-dominated construction became a main pillar of the Turkish economy. The building spree is in plain sight, especially in Istanbul where countless new buildings have sprung up across the city, in addition to infrastructure projects, including the so-called megaprojects in the transport realm. The city’s historical silhouette and green spaces have taken a severe blow, forcing even President Recep Tayyip Erdogan to search his soul. “We have betrayed Istanbul. I, too, am responsible for that,” he said Oct. 21, in a rare instance of self-criticism.

The funds needed for the construction drive have been met largely from foreign sources. Turkey’s external debt stock stands at $432 billion today, amounting to some 52% of the gross domestic product. No precise data exists on how much of that money went to the construction sector and related fields, but existing clues suggest that a significant portion of the funds became capital for construction companies and home loans for consumers. Like other emerging economies, Turkey enjoyed abundant flows of funds from the United States and the European Union, the result of anti-crisis liquidity expansion, which kept the dollar’s price low and encouraged borrowing. Buoyed by this climate of “dolce vita,” Turkish builders — especially those active in Istanbul — rushed to grab any building plots they could find, paying little mind to the prices.

Building, selling and investing in Istanbul’s housing sector became so lucrative that the annual increase in home prices reached 30% in years when inflation fluctuated in the 8-10% range. The year 2015, for instance, was one of them. This, however, was specific to Istanbul only. The price increases in Turkey’s two other biggest cities — Ankara and Izmir — as well as the country’s overall were not even half of those in Istanbul. According to Central Bank data, the price of an average apartment in Istanbul can buy two apartments in Ankara.

Many rushed to buy homes, not for accommodation but as investments, eager to profit from the high yields the sector offered. The buying spree further stoked the builders, and the supply increased. But, as it often happens in such situations, the price increases have begun to slow down and even decline. This year, the price increases in Istanbul stand at only 8%, below the inflation rate. So what happened?

It is worth lending an ear to an insider, namely Ali Agaoglu, a top construction tycoon who has built a series of luxury residential complexes in Istanbul, many of them in cooperation with the government’s housing agency, TOKI. Under this model — called “revenue-sharing partnership” — TOKI allocates valuable public land to contractors for luxury housing projects and then shares with them the proceeds from the sales. Agaoglu, who has emerged as a prominent TOKI partner, is known for his close ties with the Justice and Development Party and especially the president.

In a newspaper interview, published Oct. 23, Agaoglu warned of impending bankruptciesin the sector. “The prices are falling [while] costs are on the rise,” the outspoken tycoon said, stressing that builders who had bought overpriced plots were in deep trouble. “The calculations have become upside down. I personally fear that new Fi Yapi incidents could occur,” he said, referring to the collapse of a major construction company several years ago.

According to Agaoglu, construction companies need to make painful sacrifices to survive. “To keep the wheels turning, some will have to cut off a finger; others an arm. At Cekmekoy, we cut off an arm by deducting the cost of the building land,” he said, referring to a major price discount his company has recently made in a housing project in Istanbul.

Agaoglu underscores the land prices because they are the most important cost item in the construction sector, especially in Istanbul where they sometimes reach up to 40% or 50% of the total cost. Now, many big contractors who believed they could make up for the high land prices by raising the home prices are said to be in a serious bottleneck.

Other construction costs have shot up as well, mainly because of the Turkish lira’s depreciation against the dollar in the past two years. Turkish builders use both locally produced and imported materials. A more expensive dollar means that imported materials have also become more expensive. The same goes for imported intermediate goods and machinery. According to October figures from the Turkish Statistical Institute, the construction cost of buildings has increased by 22.1% in the past year. The breakdown shows that labor costs were up by nearly 13% and material costs by 25%. All those figures are well above the overall price increase — that is, the consumer inflation rate, which stands at about 11%. And what about the increase in home prices? The Central Bank data puts the overall figure for Turkey at 11.6%, meaning that the increase in home prices is roughly half of the increase in overall costs.

In Istanbul, the increase in home prices has been even lower, standing at about 8% year-on-year. This suggests that builders are struggling to raise home prices in line with the increase in their costs, and they are compelled to make discounts. Whether they are still making profits or are incurring losses will become clear in time.

No doubt, disappointment runs deep among the deep pockets who invested in homes and especially in luxury residences, hoping that the 30% price increases would last. The same goes for those who put money in construction company shares. More importantly, tough times are now ahead for companies that have bought overpriced plots or sealed hasty contracts with landowners. Those who have taken loans from foreign creditors or foreign-exchange-denominated loans from local lenders have already incurred losses simply because of the lira’s depreciation.

Housing builders are said to be meeting frequently with Erdogan, pressing for the lowering of interest rates. The falling demand for homes is a major reason why the president often fumes at banks over interest rates. Official data points to a tangible decrease in the number of those who use loans to buy homes. Mortgaged home sales, for instance, were down about 4% in September. Yet with the economic “climate change” underway both in Turkey and globally, the prospect of interest rates going down seems to be a distant one.

In sum, Turkey’s housing sector appears headed for a harsh season. And given its central place in the country’s economy, any turmoil in the sector is likely to have a far-reaching impact on the entire economy.

Written by Mustafa Sönmez