* Construction sector in focus in corruption probe
* Investigation biggest challenge of Erdogan's rule
* Building boom has fuelled Turkey's economic growth
ISTANBUL, Jan 8 (Reuters) - Look closely on a clear day, and the silhouette of Istanbul's historic peninsula, its minarets puncturing the sky, has changed for the first time in centuries.
Three luxury towers, their top-floor apartments selling for upwards of a million dollars apiece, loom on the horizon, graceless symbols of Turkey's rapid modernisation during a decade of Prime Minister Tayyip Erdogan's rule.
Construction lies close to Erdogan's heart: big real estate projects showcase Turkey's rising prosperity and serve as a vehicle for spreading wealth. They generate jobs and - alongside penthouses for the rich - low-cost housing for poorer voters he hopes will show loyalty at the ballot box.
But that rush for development has become the biggest threat yet to Erdogan's 11-year rule.
Last summer, mass anti-government street protests were triggered across Turkey by plans to bulldoze part of an Istanbul park. And last month, police raided offices and homes, detaining businessmen close to the government in a corruption investigation he has cast as an attempted "judicial coup".
Details of the accusations have not been made public, but Turkish newspaper accounts of unpublished court documents say the allegations include bribes paid to officials to win construction contracts and circumvent urban planning laws.
Several dozen people, including state officials, construction magnates and the sons of three cabinet ministers are among those to have been detained for questioning. Two of the ministers' sons are still being held.
Turks have been captivated by television footage of millions of dollars in cash found at the homes of suspects.
"Unfortunately the urge for profit has ranked above the conservation of our historical assets," said former culture minister Ertugrul Gunay, who quit as an AK Party lawmaker on Dec. 27, ten days after the first wave of arrests.
"We have a saying in Turkish: the rocks and earth of Istanbul are gold," said Gunay. "They truly are. Some people have been working Istanbul like a gold mine."
"URGE FOR PROFIT"
Although they have no connection to the latest scandal, the three towers that loom over views of the 400-year-old Blue Mosque are symbolic of Istanbul's headlong rush to expand.
The towers, called OnaltiDokuz (SixteenNine), are being built just beyond the historic city walls by Astay Real Estate, which has also developed luxury hotels.
After angry Istanbul residents sued, an Istanbul court ruled that the buildings violated urban planning principles and hurt the city's skyline. Another court then ruled that the upper floors would have to be removed, according to local newspapers. The developer is appealing both cases.
Gunay told Reuters he had raised concerns about the Istanbul towers with the prime minister himself: "Instead of listening, the prime minister told me I was exaggerating ... He told me the buildings would not disturb the silhouette."
"As far as I know, the residential buildings rose under the auspices of the prime minister."
Erdogan was quoted by the Radikal newspaper as telling AK Party members in Istanbul last April that while he knew the developer personally, he had warned him to reduce the height of the towers and had been dismayed when he failed to do so.
"The prime minister has been against that building from the beginning and never defended it. Statements to the contrary are not true," one of Erdogan's senior advisers told Reuters.
"The prime minister spoke with the constructors and clearly stated his reaction," he said.
Mesut Toprak, the head of Astay, said that a legal process was ongoing and declined to comment further.
The AK Party rose to power at the beginning of last decade largely on a pledge to sweep out endemic corruption that had plagued a preceding era of fractious coalition governments.
But big real estate projects have tarnished that image with many Turks. Protests against the development of Istanbul's Gezi park grew into mass demonstrations across the country last year.
Erdogan has dismissed both the protests and the subsequent criminal investigations launched by prosecutors and police as foreign-backed plots, engineered by those jealous of Turkey's economic boom.
He has vowed to press on with 150 billion lira ($80 billion) in construction projects that include a third Istanbul airport, billed to be one of the world's biggest, a new bridge over the Bosphorus, a high-speed train line to the capital Ankara and a giant shipping canal.
"Our global projects which have been targeted by these attacks ... will continue at the same pace, and God willing we will begin new ones," Erdogan said last week, referring to both the protests and the graft probe. "Turkey is in safe hands and is continuing its walk to the future."
The government has hit back after last month's arrests by dismissing or reassigning hundreds of police officers across the country. A second wave of the investigation, also involving the construction sector, appeared to stall after a state prosecutor co-leading the inquiry, Muammer Akkas, was pulled from the case.
In a statement on Dec. 26, Akkas said police had obstructed proceedings by failing to carry out some arrests. Istanbul's chief prosecutor later said Akkas was removed for leaking information to the media and not updating his superiors.
Among those questioned in the initial sweep were the mayor of Istanbul's Fatih municipality, which includes the city's historic peninsula, construction magnate Ali Agaoglu and Murat Kurum, the general manager of real estate firm Emlak Konut GYO , partly owned by state housing developer TOKI.
All three were later released. Agaoglu's company said at the time no criminal evidence had been found. Emlak Konut said days later Kurum had returned to work.
According to the Radikal newspaper, the head of construction firm Cengiz Insaat, part of the consortium which made the winning 22 billion euro ($30 billion) bid to build the new Istanbul airport, was named in a list of those wanted for questioning in the blocked second phase of the inquiry.
The firm's role in the investigation could not be determined by Reuters and its head Mehmet Cengiz could not immediately be reached for comment.
Former Environment and Urban Planning Minister Erdogan Bayraktar, one of three cabinet members to quit in the scandal, said in a defiant Dec. 25 resignation speech that some of the urban plans mentioned in the initial investigation had been drawn up on the prime minister's instructions.
He called on Erdogan to resign "for the well-being of the nation".
Erdogan, who has been travelling to Asia this week, has made clear he has no plans to step down and dismisses all accusations against his government as a smear.
"The prime minister has and would never order anything about permits that would be against the law. These baseless allegations aim to wear him down," the senior Erdogan adviser said, when asked about Bayraktar's comments.
The government's critics say the legal framework surrounding the construction sector, a key driver of the economy, has been repeatedly watered down in recent years, creating loopholes that developers can exploit for profit.
Turkey's Public Tender Act has been amended 31 times since the AK Party came to power, according to Oya Ozarslan, head of the local chapter of anti-corruption watchdog Transparency International.
The changes put ever more sectors outside its scope, including urban development projects and a significant proportion of TOKI's activity building housing.
"This law has become like a Swiss cheese," Ozarslan said, estimating that close to half of government procurement fell outside the scope of the act.
"We know TOKI makes a lot of money but how? It should be transparent and it should be open to audit."
TOKI had no immediate comment.
Under the motto "Building Turkey of the Future", it is the government's main urban development arm, charged with transforming shanty towns and developing mass housing projects, much of it through revenue-sharing deals with private companies.
An investigation from 2004 by the prime ministry's own audit board, seen by Reuters, said TOKI's revenue-sharing model was not fully transparent and public assets had been sold at below fair value. The opposition CHP accused the ruling AK Party in a 2011 report of using TOKI to transfer state property to firms close to the government, which AK denies.
"TOKI is not just building housing and hospitals, it is selling government land," said Aykut Erdogdu, a CHP member of parliament who compiled the opposition party's dossier. "We don't know how they sell it, what the real value is."
Deniz Incedayi, Istanbul president of Turkey's Chamber of Architects and an advisor to UNESCO on the management of the city's world heritage sites, said some private projects, including shopping malls and residential developments, ignored a blueprint meant to preserve Istanbul's historical and environmental integrity.
"Many natural and historical areas and sites are under big threat," she said.
Serhan Gungor, an Istanbul historian and tour guide whose apartment looks across the Bosphorus at the minarets of the old city, pointed at the three apartment blocks now poking through the haze.
"This view had been unchanged since the 19th Century," he said. "I wonder what these so called 'conservative' politicians will conserve in this country, if not the world famous historical skyline of Istanbul."