Real Estate The ever-increasing need for Korea to push harder with its restructuring efforts is bringing more and more focus on asset values. More and more companies are feeling the need to sell down non-core business assets. And many are realizing that corporate funds are better deployed in the core business, and not necessarily in real estate, to maximize shareholder values. Never in history have we seen so many major corporations willing to sell their non-core real estate assets. Real Estate Investment Opportunity in Korea In an effort to induce foreign capital, the Korean government liberalized the real estate sector to 100% foreign ownership in June 1998. Foreign individuals and corporations (whether resident in Korea or not) are now permitted to acquire land and buildings on the same terms and conditions as Koreans. But, as more and more foreign investors are finding out, an equal footing with Koreans does not necessarily make real estate investment a simple process. Since June 1998, there has been growing interest by international investors, operators, developers and end users in the various property sectors - hotels, prime and secondary grade office buildings, serviced apartments, retail and industrial facilities. The huge, and seemingly irreconcilable, price expectations between buyer and seller narrowed in 1999, which allowed for some real estate trades to occur. Acquisitions of plant facilities involved the transfer of real estate, and some major office buildings were acquired by international investors. But, the price gap still remains a significant deterrent to the closure of deals. Seller's asking prices based on book values or inflated local appraisal reports are still far away from the yield requirements of foreign investors. Development of Korea's Real Estate Industry In the past, the "Old School" of thought dominated the real estate market: Real estate prices would never decline. Those with money bought and amassed real estate and rarely sold. Large construction companies bought land to build apartments for sale. Large companies built office buildings, primarily for their own use. Real estate financing techniques were almost non-existent. And information concerning real estate transactions was difficult to obtain. Experience has shown elsewhere that foreign investment in domestic property markets contributes considerably to introducing transparency and structure to what has long been a speculative market. New concepts of valuation, management and financing have already begun to bring about enhanced liquidity, greater accountability and more social responsibility to the real estate process. To foster a stable real estate market, AMCHAM recommends the Republic of Korea Government (ROKG) take a comprehensive approach and develop a long term Master Plan. Progress has been made in some areas, but faster actions by the ROKG are required. Money that is tied up in real estate needs to be unlocked quickly to help fuel Korea's overall restructuring efforts. Introduction of new concepts and imple mentation of the following recommendations would contribute greatly to the development and stability of the Korea real estate market and enhance liquidity. AMCHAM recommends action be taken on the following areas: a) Availability of reliable market information b) Adoption of internationally accepted valuation methods c) Improved leasing practices based on cash flow (away from chonsei) d) Independent property management services e) Real estate financing tools and new laws to develop capital market access f) Revamping of the real estate tax system g) Title insurance system A) Availability of Market Information There remains criticism with regards the generally poor availability, transparency and dissemination of publicly available transaction data upon which investment decisions can be made. The situation has improved since 1998 with a growing number of local and international real estate consultants providing information to select clients. Information on auction award prices in court foreclosures is starting to be stored on databases. But, generally speaking, the availability is sporadic, at best, and very, very expensive. Recommendations: The local brokerage community could make huge contributions here. The brokerage fees are regulated so transactions are not transparent. Allow higher fee rates and introduce a "Multiple Listing Service" network where participating brokers share information on sell and buy requests and have pre-determined fee splits. Greater public access to real transactions data and improved dissemination of the same data by official sources. Some information is compiled and made available by the Korean government now, but it is aggregate data from which it is not possible to ascertain the identity, location and price of property transactions. It may be possible for the Korean government to retain the services of the consulting companies to compile official transactions data on a monthly basis to promote better investment decisions.· In some areas in the U.S., real estate transactions are officially recorded on a database (buyer, seller, description of the real estate, price at which the real estate traded, date of the sale) and the public can access the data through the computer. It may be worthwhile for the Korean government to embark on such a project to induce more transparency into the real estate sector. B) Real Estate Valuation Methodology The three basic real estate valuation methods are: (1) cost approach (2) market approach and (3) income approach. The local appraisal industry applies these different approaches but has typically over-weighted the "cost approach" to arrive at their value conclusions. This nurtured the idea that real estate values increased proportionately to how much one invests in the property. Lack of information on what comparable properties traded for almost precluded the use of the market approach. And, the concept of deriving real estate value through income yield analysis is relatively a new concept for Koreans because many buildings were built for their own use. It is only now that Korean sellers are realizing the importance of real estate valuation methods other than the cost approach. This does not mean that sellers' expectations are any lower. But, over time, there will be increasing downward pressure on real estate prices because sellers are starting to understand the concept that yields are an important determinant of price. Recommendations: Again, availability of information can help tremendously. Dissemination of official transactions data would enable the "market approach" method. Buyers and sellers could access information on what similar properties traded for. Introduction of market orientated valuation principles applied to government land tax assessments. C) Leasing Practices Korea has become much more competitive internationally given the decline in rents and prices during 1998/9, and is ideally positioned to take advantage of this new investment and leasing paradigm within the region. While there is evidence that many landlords are willing to consider international style leases (to retain existing and attract new tenants), many resist changing from the traditional "chonsei " leasing practice (The "chonsei" system, a lump sum is deposited in lieu of rental payments. The leaseholder generates income through investment of the deposit over the period of the lease). Recommendations: Encourage the adoption of standard international leasing practices within the commercial property market in order to allow for a more cash flow-driven structure (for both development and lending practices). The availability of financing based on the cash flows of the property would encourage the use of more monthly rents as opposed to chonsei deposits. D) Property Management The level of property management services throughout the commercial and residential property sectors remains relatively inexperienced. This is primarily because most of the building owners have their own property management companies. Third party property management exists but most owners are reluctant to outsource. With growing foreign investment in real estate, the demand for independent property management companies will grow. The market size is not yet large enough to nurture significant improvements in the near term. Maybe, with more asset securitization of real estate, the demand for independent property management companies will increase further. Recommendations: Encourage the adoption of professional property management practices and permit the participation of professional independent property management companies from overseas. E) Real Estate Financing-Link to Capital Markets One of the major issues to address in developing a stable real estate market in Korea is to develop financing tools. In the past, real estate lending based on the cash flows generated by the property had been minimal. Banks typically lent to businesses and just took the real estate as security collateral. Government policy generally discouraged real estate lending because it promoted real estate speculation and pushed prices higher and higher. On the contrary, if properly managed, the introduction of real estate lending based upon sound credit analysis of the cash flows generated by the property and conservative loan -to-value ratios (with appraisals based more on the income approach), liquidity and stability in the real estate market can be enhanced. In fact, prices may come down and stabilize. In addition to real estate lending, liquidity can be further enhanced by promulgating laws to promote the development of real estate based products for the capital markets. Korea passed the "Asset Backed Securitization Law" which has been mostly used to securitize Non-Performing Loans transactions and a few real estate transactions. The mortgage backed securitization market has only begun to emerge while a mortgage system is in its infancy. And, more recently, the government is looking to pass a "Real Estate Investment Trust (REIT) Law" to promote REITs in the second half of 2001. Recommendations: AMCHAM recommends the ROKG take sweeping measures here. It should be done swiftly and effectively within the framework of a long term "Master Plan". To introduce liquidity into the market, promote sound real estate lending practices by financial institutions, based on cash flows and conservative loan-to-value ratios. To promote residential and commercial mortgage lending, an adjustment in the Banking Laws and/or guidelines may be needed because the government historically discouraged real estate lending. This will nurture the primary market for real estate mortgages. Promote the development of the secondary market for real estate mortgages. It may entail a simple amendment of existing Asset Backed Securities (ABS) legislation or the enactment of new laws. (REITs, real estate mutual funds, etc.) Better coordination among the Korean lawmakers and the Korea Tax Authority. Some laws are passed with minimal tax advantages. F) Real Estate Taxation The National Tax Authority (NTA) recently changed its name to the National Tax Service (NTS) to emphasize "service". This is an opportune time to request "service" on coordinating tax breaks and rulings with the new laws that are designed to promote investment by both local and foreign investors.For example, the ABS Law was very unclear and vague on its tax position when it was first promulgated, mostly due to the lack of coordination with the NTS. Only after a painful two years we are starting to understand our tax obligations. Uncertainties related to tax often inhibit and delay investment decisions. Some foreign investors' decisions have been delayed for months, and at times, for more than a year, because of tax uncertainty.The new REIT Law scheduled to be passed in mid-2001 does not provide the "pass-through" of taxes to the end investor, like the U.S. style REITs. This means that there will be double taxation, severely inhibiting the development of REITs. Recommendations: Clarification of tax assessments on acquisition, retention and disposal of property. Make it easier to obtain tax rulings. Removal or lowering of property taxes on acquisition at least to a level comparable with other investment jurisdictions in Asia. The 5.8% acquisition/registration tax is a cost to buyers that is, in most cases, passed through to the Korean seller. The tax multiplier of 3x or 5x the acquisition/registration tax in cases where the property is located in the major Metro area is also prohibitive. This needs adjustment of removal. Eliminate punitive taxes for the holding of undeveloped land so as to eliminate eccentric and, in most cases, unnecessary real estate development. G) Title Insurance There is no title insurance system in Korea. Checking the appropriate documents to confirm clean title is difficult. And there are certain laws that protect the small tenant even in the event they failed to register their claim on the registry. In these cases, it is also difficult to quantify their potential claim or lien on the property. Recommendations: Develop an improved system of facilitating the transfer of clean title from seller to buyer. ROKG should work closely with major title insurance companies to develop a safe and secure system.