Real Estate Lease Securitization by ouu17680

VIEWS: 122 PAGES: 6

More Info
									                                        REAL ESTATE


Overview

Korea’s real estate market has seen a rapid rise in real estate prices throughout much of the
country, especially in the Seoul metropolitan area. In 2002, residential apartment prices were
up a sharp 50 percent over the previous year, while commercial building prices spiked up by
about 10 percent. This seemingly ever-upward trend in real estate prices is expected to
continue through the end of 2003. At the same time, price increases for non-residential units
are beginning to show signs of abating given the growing imbalance between market supply
and demand.

Most of the recent activity in Korea’s real estate market has been caused by speculative
demand, resulting from the large amounts of capital and low interest rates available during the
past couple years. As the rate of return on financial capital has fallen in recent years, investors
have turned to real estate as a possible option that may offer greater returns. At the same time,
mortgage-backed loans have also surfaced as one of more active sectors for financial
institutions, and the development of a real estate financing market, including home financing,
has also become more pronounced. It is expected that Korea’s real estate financing market
will continue to grow due to the increasing demand spurred by Korean government policies
that promote the secondary mortgage market. A number of industry observers have expressed
concern over Korea’s current real estate values. In fact, many have forecast that the current
rising trend in the real estate market will come to an end within two years. In this regard,
recent actions by the Korean government to curb this speculation and thereby stabilize real
estate prices signal an effort to exert some control on market prices. Notwithstanding these
measures, the flow of capital in real estate, much of it speculative, is continuing, particularly,
in the Seoul and Daejon metropolitan areas. This has triggered concerns by many observers
that much of Korea’s real estate market has entered a speculative bubble phase.


Real Estate Investment Opportunities in Korea

Since 1998, foreigners have been free to own land in Korea and their ownership of Korean
real estate has steadily increased. Major U.S. real estate and real estate-related financial
service firms operating in Korea include Jones Lang Lasalle, Lehman Brothers Investment,
Lone Star Advisors, ERA, Century 21, Morgan Stanley Properties, CB Richard Ellis, and
Cushman & Wakerfield. The Korean government’s ongoing efforts to further open Korea’s
real estate markets further and related financial sector deregulation have provided
opportunities for foreign investors to integrate their real estate services with their financial
products, such as Asset-Backed Securities (ABS), Mortgage-Backed Securities (MBS), and
Real Estate Investment Systems (REITS) are offered in Korea. In the months ahead as these
markets further develop, the Korean government will refine its regulations on asset
management, which cover securities investment trusts, mutual funds and bank trusts. The
Korean government is also expected to permit asset management companies to pool their
investment portfolios into those of real estate.

However, real estate practices still remain quite different in Korea compared with those in the
United States. First, information about real estate is not available through public sources.
Instead this information usually comes from industry associations, real estate registration
offices, and tax authorities. In Korea, real estate valuation practices still largely overlook the
fundamentals of income-based evaluation and analysis, and many Korean companies still
conduct their real estate valuations by increasing the book value to lower their debt-to-equity
ratios. As a result, their real estate often is too overvalued to produce attractive rental income
for investors.

The lack of transparency in the real estate transaction process is an issue cited by foreign
investors seeking investment opportunities in the Korean real estate market. They also remain
concerned over the quality of information that is available from Korean government agencies.
Although the Korean government publishes the government-set land prices, it does not
provide a reference reflecting the actual market mechanism. In addition, Koreans place great
emphasis on short-term capital gains, and less on risk management and compliance. Perhaps
realizing these shortfalls, the Korean government plans to establish a “Commercial
Information Exchange (CIE)” system within the commercial real estate industry, similar to
ones available in most of the U.S.

In an effort to attract foreign capital, the Korean government in June 1998 liberalized the real
estate sector to allow 100 percent foreign ownership. 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 use of
land or buildings by foreigners. Foreign property ownership of all property sectors is
permissible except for the acquisition of land located in development-restricted zones
(greenbelt zone) such as military areas, cultural relic 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 that is based on permission to one based simply on post
hoc declaration. However, as more and more foreign investors are finding out, being on 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. The development of land into a new town was also awarded to 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

Korea is slowly moving towards the separation of occupational real estate from real estate
ownership. As corporate owners recognize the need to focus on core business and cease to
rely on ownership of real estate as the sole producers of income, the importance of capital
markets has become greater. Korean investors in the real estate industry primarily seek capital
gains rather than returns from operating income, such as rents and lease payments. They also
seek to utilize real estate as collateral for debt financing.
The current real estate financial systems in Korea include ABS, MBS, and REITS. These real
estate securitization products are largely classified into two types, depending on their
characteristics. The first involves securities based on asset liquidity that are issued with
existing real estate and real estate loans as basic assets, such as ABS and MBS. The other
involves real estate mutual funds or real estate securities based on asset operation in which
capital is collected from investors in real estate and the resulting profits are redistributed to
the investors, such as REITS.

Foreign investment in the Korean real estate market has come in the form of non-performing
loan (NPL) portfolio acquisitions secured by real estate. This relatively new program has been
in effect since the market became fully liberalized in 1998. The new concept of the
combination of real estate with finance has resulted in considerable foreign capital being
attracted to the local real estate market, in addition to the selling of non-performing loans by
the Korea Asset Management Corporation (KAMCO), a government-invested organization.
These new developments also have provided good opportunities for foreign investors to
introduce their new financial services into the local market.

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 has recommended that the Korean
government take a comprehensive approach and develop a long term “master plan.” Progress
has been made in some areas, but faster actions by the government 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. There should be a concerted attempt to improve transparency of market
transaction information; improve leasing practices based on cash flow (away from chonsei);
develop real estate financing laws to promote capital market access; and rationalize the real
estate tax system.


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 in 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 should take place. 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 should 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. It may be worthwhile for the Korean government
       to embark on such a project to induce more transparency into the real estate sector.


Leasing Practices

Korea has become much more competitive internationally given the decline in rents and
prices during 1998-1999. It is ideally positioned to take advantage of the 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 Korean government introduced the
Commercial Building Lease Protection Law, moving up the enforcement date from January 1,
2003. This law applies to the lease of commercial buildings for the protection of the lessee
from potential abuses by the lessor in terms of increase of deposits and/or rents, 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.


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 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. However, foreigners benefit from
having foreign loans or offshore funds available, secured by the acquired property.

If properly managed, with 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 could 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 the mortgage
system is in its infancy. 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 Korean government enacted 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:

      The Korean government should take sweeping measures to expand real estate
       financing. It should be done swiftly and effectively within the framework of a long-
       term master plan.
      The government should introduce liquidity into the market and promote sound real
       estate lending practices by financial institutions, based on cash flows and conservative
       loan-to-value ratios.
      The government should promote residential and commercial mortgage lending, which
       will require an adjustment in banking laws and guidelines as the government
       historically discouraged real estate lending. This will nurture the primary market for
       real estate mortgages.
      It should also promote the development of the secondary market for real estate
       mortgages. This may entail a simple amendment of existing ABS, MBS, and REITs
       legislation or the enactment of new laws.
      There should be improved coordination between Korean lawmakers and the Korean
       tax authorities. Some laws with regard to the real estate sector are passed with
       minimal tax advantages.


Real Estate Taxation

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 National Tax Authority (NTA). 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 follows:

        -National Tax: 100 percent tax waivers of corporate tax and income tax for seven
       years, and a 50 percent tax reduction for an additional three-year term.

       -Local tax: 100 percent tax waivers of acquisition tax, registration tax, property tax,
       and land tax for five years, and a 50 percent tax reduction for an additional three-year
       term. The land purchased by foreigners should be utilized for the authorized business
       purpose within three 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 three times or five times the acquisition/registration tax in cases
       where the property is located in the major metropolitan area can 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.

								
To top