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.
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