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 monetizing non-core business assets, realizing that to maximize shareholder values, corporate funds are better deployed in the core business, and not necessarily in real estate. 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. There are no restrictions on the purchase and/or use of land or building by foreigners. Foreign property ownership of all property sectors is permissible except for the acquisition of land located in the development- restricted zone (greenbelt zone) such as military areas, cultural relics areas, and ecological areas. Foreign investors also are eligible for long-term land lease contracts of up to 50 years. The acquisition procedure was also changed from one based on permission to one based simply on post hoc declaration. However, 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 prime office buildings were acquired by international investors and developers. However, the price gap still remains a significant deterrent to the closure of deals. Sellers’ 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 led the real estate market: Real estate prices would seldom decline. Those with money bought and amassed and rarely sold real estate. 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 desired. 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 implementation of the following recommendations would contribute greatly to the development and stability of the Korea real estate market and enhance liquidity. AMCHAM recommends the following action be taken: a.) Improve transparency of market transaction information b.) Improve leasing practices based on cash flow (away from chonsei) c.) Develop real estate financing laws to promote capital market access d.) Rationalize real estate tax system A) Availability of Market Information There remains criticism with regard to 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 has been stored on databases since 2001. However, generally speaking, the availability is still inconsistent at best. Recommendations: The local brokerage community could make significant contributions here. Brokerage fees are regulated, suppressing transparency. Allowing higher fee rates and the introduction of a “Multiple Listing Service” network where participating brokers share information on sell and buy requests and have pre-determined fee splits, would greatly improve the flow of information. 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) Leasing Practices Korea has become 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 (in 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). In July 2002, the ROKG introduced the “Commercial Building Lease Protection Law” that effective on November 1, 2002, moves up the enforcement date from January 1, 2003. This law will apply to the lease of commercial buildings for the protection of the lessee from potential abuses by the lessor in terms of increase of deposit and/or rent, early termination, refusal to renew, refusal to return lease deposit, and refusal of registration of lease right. 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). Government support for the development of financial products based on the cash flows of the property would encourage the use of more monthly rents as opposed to chonsei deposits. C) 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. However, foreigners are allowed to have foreign loans or offshore funds secured by the acquired property. 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 enforced the “Asset Backed Securities Law” and the “Mortgage Backed Securities Law” which have 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, in July 2001, the “Real Estate Investment Trust (REIT) Law” became effective to promote REITs in the real estate market. The Korean real estate financing market provides opportunities for U.S. industry as foreigners’ portfolio investment in real estate and property through the REITs. The ROKG plans to enact the “Asset Management Business Law” in 2003, with respect to the creation and management of investment funds. Under this new law, the scope of the assets in which a fund is allowed to invest will be broadened to include real estate property. 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. To promote the development of the secondary market for real estate mortgages. It may entail a simple amendment of existing Asset Backed Securities (ABS), Mortgage Backed Securities (MBS), and REITs legislation or the enactment of new laws. Improve coordination among the Korean lawmakers and the Korea Tax Authority. Some laws with regard to the real estate sector are passed with minimal tax advantages. D) Real Estate Taxation The National Tax Authority (NTA) changed its name to the National Tax Service (NTS) to emphasize “service” in 2001. 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 rather unclear and vague on its tax position when it was first promulgated, mostly due to the lack of coordination with the NTS. 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 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. The NTC provides tax exemption and reduction as incentives for foreign investment in real estate and property as follow: National tax: 100% tax waivers of corporate tax and income tax for seven (7) years, and a 50% tax reduction for an additional three (3) year term. Local tax: 100% tax waivers of acquisition tax, registration tax, property tax, and land tax for five (5) years, and a 50% tax reduction for an additional three (3) year term. The land purchased by foreigners should be utilized for the authorized business purpose within three (3) years from the date of acquisition. Otherwise, the land shall be regarded as non-business use and be subject to an acquisition tax. Recommendations: Clarification of tax assessments on acquisition, retention and disposal of property. Make it easier to obtain tax rulings. The tax multiplier of 3 times or 5 times the acquisition/registration tax in cases where the property is located in the major Metro area may be prohibitive and should be eliminated. Eliminate punitive taxes for the holding of undeveloped land so as to eliminate eccentric and, in most cases, unnecessary real estate development.