KDI - Korea Development Institute - RESEARCH - Research Areas

Summary

Research Monograph KOR Korean Unique Regulations in Housing Market

We study regulations in the housing market, which are very unique and have great influences in Korea. Due to COVID-19, the housing market have experienced rapid changes. Thus, the government responded boldly with unprecedented policies. Among others, 3 special regulations are on the table for discussion. The first is the Land Transaction Permit, which was implemented to reduce demand on housing in specific regions. Second, the Price Cap on New Houses is investigated for housing supply policy. The final is a regulation on the contract renewal claims in the housing rental market.

Chapter 2 analyzes the direct and indirect price effects of the Land Transaction Permit (LTP), a selective regulation introduced in 2020 for high-priced houses in Seoul to stabilize skyrocketing prices. The LTP is an administrative regulation that requires local governments to permit transactions in designated "areas," and as of 2022, the total area covered by the LTP is about 9% of Seoul's land area.Houses in the LTP zone can only be purchased by buyers who are either homeless or will eventually become single-family homeowners, and they must actually live in the houses for two years immediately after purchase. In this study, we analyzed the price and transaction volume of LTP regulated and unregulated houses, focusing on "Jamsil-dong, Samsung-dong, Daechi-dong, and Cheongdam-dong," which were designated in June 2020. In the regulated area, the LTP scheme directly reduced transaction volumes by 38.3% and prices by 4.3% compared to unregulated areas. However, the LTP scheme unexpectedly had a positive price appreciation effect on homes located closer to the regulated areas. When unregulated dwellings are categorized according to their distance from the regulated area, we estimate that dwellings closer to the regulated area increased in price by 2.3% relative to dwellings further away, and this effect is larger the closer they are to the regulated area. It appears that some of the demand in the regulated area shifts to nearby unregulated areas with higher substitutability. The different direction of the direct effect on regulated areas and the indirect effect on nearby areas suggests that selective regulation, such as LTP, may not be the right regulatory approach to achieve the goal of stabilizing the housing market.

The next chapter, Chapter 3, examines the effects of the Price Cap on New Houses. This price cap, which limits the price of new homes, is one of the controversial regulations that raises concerns that it may limit housing supply in the future. However, this study's analysis found no evidence that the price cap reduces the supply of new homes. Although the pre-sale price cap limits the profits of housing construction projects, it is operated by reflecting all the costs of land and construction for housing supply. Even if the prices of newly supplied homes are limited by the price cap during the period when the housing price is on the rise, the sales of new homes is likely to increase as well. Thereby housing development projects are profitable enough to cover all the costs. Therefore, there appears to be no empirical evidence for concerns that future housing supply will be reduced by this price cap implemented during the housing market boom. However, these results are contradictory to the results of existing studies, so caution needs to be taken when interpreting them further.

Chapter 4 investigates the price impact of the deposit control imposed on the housing repo contract in Korea, known as Jeonse. Jeonse is a unique housing repo contract in Korea where the landlord borrows a deposit from the tenant, using the house as collateral. The tenant is granted the right to occupy the house during the contract period at the expense of the deposit’s opportunity cost. In July 2020, the Korean legislature passed a law granting tenants the right to renew the Jeonse contract once, with the new deposit amount not exceeding a 5% increase from the original amount. While this new regulation has been heavily criticized as the primary driver of the surge in Jeonse deposits during the pandemic, its actual price impact has not been properly estimated.

We estimate the value of the Jeonse renewal option monthly using option pricing techniques, based on reasonable assumptions about the housing price process and information gathered from the current term structure of interest rates. Our estimation results indicate that the deposit control regulation raised Jeonse deposits nationwide by only 0.97% and by 4.80% in Seoul at the time of the introduction of the regulation, a magnitude significantly lower than previously discussed in both media and academic circles. Furthermore, we demonstrate that the renewal option does not have any intrinsic value over the past 10 years, suggesting that the option can be considered pure insurance against an unexpected increase in the equilibrium level of Jeonse deposits by the time of expiry. Based on the background of the regulation and the results of our analysis, we provide policy suggestions.

Summary

Policy Study KOR Inflation Expectations Through the Lens of the Slack in the Real Estate Asset Market

This study examines inflation expectations implied in the real estate asset market. Land is an asset that accounts for more than half of South Korea's national wealth and, like labor, is an essential input factor despite its inelastic supply. Based on this idea, we examine whether a similar regularity as the Phillips curve observed in the labor market is also observed in the real estate asset market. The main results are as follows. First, an increase in the relative price of land can be a pass-through, transferring inflationary pressure over the years. Second, comparing the existing expected inflation indices, an expected inflation rate extracted from the real estate asset market can provide additional information. Third, theoretical analysis shows that the relative price of land and expected inflation can be positively correlated in general equilibrium.

Summary

Research Monograph KOR Housing Market Regulations and Housing Supply: Focusing on LTV, DSR, Property Tax, and the Improvement of Pre-Sale Housing

The Korean government often implements financial regulations, such as the Loan-to-Value (LTV) and Debt-Service-Ratio (DSR), ratios, to stabilize the housing market. This study investigates the effectiveness of these policies in the housing market and, if effective, determines whether they enhance the utility for housing consumers.

Additionally, the government employs housing supply policies, which greatly impact the housing market. Housing provision is a lengthy and capital-intensive process. Korea supplies most of the new housing through a system known as the pre-sale policy. In fact, this system has consistently faced the challenge of overheating subscriptions for over 40 years. In light of the current housing market dynamics, Chapter 3 explores possible improvements to the existing housing supply policy.

As for the effect of financial regulation, the policy that lowers the upper limit of the LTV ratio from 70% to 40% reduces household loans by more than 31% while increasing the relative price of housing by 0.005%. If the upper limit on LTV ratios is lowered, households experience a low productivity shock, making it difficult to maintain consumption levels by increasing mortgage lending when incomes fall. As a result, they are motivated to increase savings. When the capital stock in the model economy increases due to the increase in household savings, the real interest rate falls. Wealthy households with relatively large amounts of assets reduce the share of financial assets in their asset portfolios and increase the share of housing because the real interest rate, which is the rate of return on investment in financial assets, has fallen.

The analysis in this study reveals that policies tightening household lending regulations do not effectively curtail housing prices in the long run. If the goal is long-term price stabilization, the study suggests that increasing the supply of new housing is more effective than suppressing housing demand through stricter lending regulations.

Lastly, the study proposes a new policy model for improving housing supply, especially for the younger demographic. This model seeks to address both the housing service and investment needs of younger people. Regarding public offerings and transactions of fractional ownership, housing demand is categorized into the demand for residential services and the demand for investment in housing assets. In the current pre-sale subscription method, the share of the house is divided, and public offering subscriptions are received. This method distributes shares to each subscriber in proportion to the competition rate for subscriptions. In this scenario, new housing is provided to young adults as rental properties in line with the existing subscription method to meet the need for residential demand.

Summary

KDI FOCUS Galapagos Syndrome in South Korea’s Real Estate PF, and the Need for Fundamental Structural Reform

Over the past several decades, real estate project financing (PF) has repeatedly triggered economic disturbances in Korea, with no fundamental remedies in sight until now. Project sponsors are at the heart of this issue, investing minimal equity while heavily relying on guarantees from third parties, such as construction firms, to push forward development projects entirely on debt. This financing structure is unheard of in major advanced countries. Korea needs to reform its unique PF structure by augmenting capital and reducing dependence on guarantees.

- Over several decades, real estate project financing (PF) has repeatedly destabilized the Korean economy, but fundamental improvements have not been made.

- The root cause of PF problems lies in the unique financing practice of relying almost entirely on debt, where developers invest very little equity and depend heavily on third-party guarantees.

- In Korea, the equity ratio of developers is around 3%, while in major advanced countries, it exceeds 30%.

- In major countries, land is secured with equity capital, and only construction costs are financed through loans. This approach prevents the issue of refinancing bridge loans into main PF loans, which is typical in Korea.

- In major countries, it is rare for third parties, rather than developers, to guarantee PF loans, unlike in Korea.

- The low-equity and highguarantee structure leads to more developers becoming smaller in scale and underfunded.

- The low-equity and highguarantee structure leads to poorer assessments of project feasibility, no-questions-asked investments, and increased macroeconomic volatility.

- The low-equity and highguarantee structure shifts all risks to the national economy, not developers.

- Since advanced countries base loan issuance on project feasibility and financial structure per PF principles, capital augmentation is a prerequisite for developers to obtain loans.

- However, when Korea introduced PF, the market consisted of small developers and large construction firms. This disparity led to a low-equity, high-guarantee structure, which was reinforced by the pre-sale system.

- The prudent direction would be to raise the equity ratio to the level of advanced economies and abolish third-party guarantees. To that end, Korea should introduce regulations on capital augmentation.

- While regulations to increase capital may constrain the quantity of housing supply, they are expected to improve its stability.

- Even in environments unfavorable for scaling up, some developers have started small and grown into conglomerates, while others are affiliates of large corporations.

- The pool of potential equity investors is not limited.

- Because REITs socialize development profits and are already subject to equity ratio regulations, it is desirable to revitalize their equity investments or foster their direct participation as project sponsors.

- During the transition, it is necessary to implement support policies that encourage capital increases.

- The acute lack of data on real estate PF makes it difficult to even stay current, which in turn only allows temporary measures during crises and hinders regular monitoring or early crisis detection.

- A database system should be set up to collect official statistics on financial and business information by project and company.

Summary

KDI FOCUS Strategies for Refining the Jeonse Deposit Return Guarantee System

Jeonse, a housing lease model unique to Korea, has long served as a cornerstone of housing security for many families. However, recent significant fluctuations in housing prices have highlighted concerns such as underwater jeonse and reverse jeonse, amplifying calls for reform. A crucial step in addressing these challenges and ensuring the stability of the jeonse system is to expand the scope of the Guarantee for a Return of Jeonse Deposit. In pursuit of this, it is important to accurately reflect risks in return guarantees and to consolidate jeonse guarantees under the unified framework of the Guarantee for a Return of Jeonse Deposit.

- As a uniquely Korean housing rental system, jeonse has enhanced housing stability for ordinary families, but recent fluctuations in the housing market have exposed the risk of tenants not getting their deposits back.

- Approximately 8 million general households in Korea reside in properties owned by others under lease contracts. Of all jeonse and wolse transactions, jeonse takes up nearly half, underscoring its sustained significance for the foreseeable future.

- Jeonse prices started to decline in the latter half of 2022, a trend expected to persist through 2024, accompanied by increasing concerns about reverse jeonse.

- While the jeonse-to-price ratio based on the publicly disclosed value decreases as the property value increases, multi-household units consistently show higher ratios than apartments, implying that the former households are at a greater risk of not recovering jeonse deposits.

- The deposit return guarantee system ensures that if leaseholders fail to meet their return obligations, a guarantor agency will refund the deposit. Presently, guarantees from public guarantor agencies amount to around 170 trillion won.

- Due to a marked rise in guarantee-related incidents from 2022 onwards, the application requirements for the refund guarantee were tightened in May 2023.

- Low-priced houses are mostly excluded from the deposit refund guarantee due to stricter eligibility requirements.

- Regrettably, the jeonse deposit return guarantee system does not adequately shield vulnerable tenants from the risk of not retrieving their deposits, as the guarantee fee rate does not accurately reflect the actual risks involved.

- The Guarantee for a Refund of Jeonse Deposit (HUG) has a lower guarantee fee rate compared to other products, especially against the actual incidence rate of guarantee defaults. Hence, guarantee fee rates should be recalibrated to accurately represent risks, taking into account the actual default rates.

- Since recalibration of guarantee fee rates might increase the rates for lower-priced houses, short-term remedies targeting vulnerable households are necessary.

- As the Guarantee for Jeonse Deposit Loan can drive up jeonse prices by expanding jeonse loans, mitigation is necessary by mandating the purchase of deposit refund guarantees during jeonse loan acquisition process.

- A hybrid guarantee system that utilizes escrow not only ensures the protection of the tenant’s deposit but also allows for the application of LTV regulations, typically exclusive to home mortgages, across all housing types.

- In addressing the inherent weaknesses of the jeonse model, all related guarantee products should be consolidated within one unified framework while adjusting and differentiating guarantee fee rates.

- It is essential to expand the scope and availability of market price data for jeonse properties and strengthen the duties and responsibilities of realtors.

Summary

Policy Study KOR Price Spillover Effects in Housing Market: Reconstruction of Apartment

This paper studies price spillover effects in housing market, utilizing a policy change on apartment reconstruction. Under the circumstance of various years built of houses in Seoul, the policy on reconstruction applies to a part of houses in Seoul. However, the policy change may affect the whole housing market via spillover effects of the policy.

To investigate spillover effects, I suggest an extended version of difference- in-difference model that captures both the direct and spillover effects of the policy. Using thorough data on apartments in Seoul, combined with geographical information, I found a significant spillover effect that diminishes with the distance from apartments in the process of reconstruction. Meanwhile, the direct effect is found insignificant. The spillover effect seems to make it hard to capture the direct effect of the policy since the prices of houses near the reconstruction apartments follow the prices of the reconstruction apartments. In sum, the spillover effect of the policy was a crucial factor in the housing market of Seoul in 2018.

This study finds a type of externalities which is prevalent in housing market. This spillover effect must be taken into account when policies are applied not only to the whole market, but to a part of the houses.

Summary

Research Monograph KOR The Economic Implication of Land Purchase: A Study on the Net Purchase of Land by Corporate Sector Over the Long Term

This study uncovers the fact that Korean companies have been purchasing a large amount of land from households for about 40 years using various statistics such as national accounts and corporate financial data and examines empirically the incentives of corporations to purchase land.

We argue that the accumulation of land assets over a long period of time by Korean corporations is an unusual phenomenon. From 1975 to 2018 in which South Korea's sectoral national accounts statistics exist, the large net purchases of land by Korea's non-financial corporations from the household sector have been observed every year except before and after the foreign exchange crisis in 1998 and the global financial crisis in 2008. We find that among OECD countries Japan in the 1960s to early 1990s is the only case where the non- financial corporations had purchased a large amount of land from the household sector every year such as South Korea.

Firms can purchase land for either productive or speculative activities. In the case of productive activities, we investigate a hypothesis that companies' demand for land could have increased significantly, especially since the 2000s, due to the changes in the industrial structure of South Korea. We use the Economic Census by Statistics Korea (2010, 2015) to show that firms in the place where service industries are more agglomerated are likely to purchase more land than those resided in less service-intensive areas. By using a firm- level micro dataset, KIS-DATA, to estimate the elasticity of land as a firm's production input, we also show that the contribution of land to production has increased significantly after the 2000s.

Unlike capital goods such as equipment and buildings, the land does not suffer from depreciation and its supply is inelastic, so the land is an investment good that can benefit from rising prices as the economy develops. Companies, thus, could have speculative incentives to invest part of their operating profits on land. We use the Economic Census by Statistics Korea (2010, 2015) to show that some firms experiencing positive operating profits and decreased production facilities are likely to purchase land. This suggests that the net purchases of land by corporations could occur in part due to their speculative motive.

Summary

KDI Policy Forum Korea’s Housing Supply: Issues and Resolutions

■ Korea’s housing supply ratio, based on the number of households, and housing stock, based on population size, are rising rapidly on the back of large-scale provisions of apartments.

■ The supply market, however, has become highly volatile, with sharp recurring ascents and descents, and the recent spike, in particular, has become a burden on the construction industry and housing market, among others.

- Following an unprecedented increase in the housing supply in 2015-2017―even by basic housingdemand standards―the number of unsold new housing has continued to rise as the supply of housing completions and move-ins continue to enter the housing market.

ㆍThe increase in unsold new housing after completion could negatively impact the financial soundness of construction firms as well as housing finance-related institutions.

- In addition, a reverse-jeonse phenomenon is expected this year, in which tenants may possibly encounter cash flow problems while landlords face growing pressure as they deal with increasing difficulties in finding new tenants and returning jeonse deposits on time.

■ Therefore, efforts are needed from the government in seeking measures to curb the volatility in the housing supply.

- Construction firms should be bound by a higher equity burden and housing finance-related institutions should be more specialized and have more responsibility.

- A demand-centric housing supply system, which can meet the needs arising from social change, including low birth rates, population aging and increasing single-person households, is required.

Summary

Policy Study KOR The Effect of the Volatility of Housing Supply on the Construction Industry

The equilibrium of housing supply suggests a situation where the demand side and the supply side are in harmony at the same time. If housing demand increases due to a rise in housing supply, the construction price of the house will rise naturally. On the other hand, if housing supply increases due to a rise in housing demand, the construction price of the house will decrease. Hence, considering the low real price of housing construction recently, it can be understood that housing supply is more likely to have increased due to the rise in housing supply rather than housing demand.

Currently, the supply of pre-sale housing volumes from 2015 has reached a peak since the implementation of the 2007 pre-sale price ceiling system. In addition, the level of housing supply recently supplied is much higher than the fundamental demand for housing. Furthermore, when the pre-sale volumes supplied is fully completed in 3 or 4 years, there is a possibility, which will be a burden on the housing market. And this particular situation that is the rapid increase in the volume of housing supply has occurred periodically. Therefore, it is suspected that the supply of housing in Korea is being implemented by the coordination failure of construction companies, rather than by an equilibrium view of housing supply.

According to the panel regression analysis, 1% increase in pre-sale volume is estimated to increase 0.38% of unsold pre-sale volume after completion with 3-year time lag even after controlling for changes in demand conditions. These results suggest that the rapidly increasing sales volume from 2015 in the past three years may have accompanied the increase in unsold housing units after the completion since 2018. Scenario analysis suggests that if the current macroeconomic environment and user costs remain the same and there is a similar housing demand, the number of unsold units will reach about 25,000 in 2019 after completion. These volumes exceeded about 20,000 unsold units after the completion of the construction from 2001 to 2017 on average. Of course, the situations where the macroeconomic environment, the economic growth rate, is better than the present, or the house price is higher than the present and the user cost is decreased, reduce the amount of unsold housing after completion. And according to the analysis of the effect of unsold pre-sale housing on the construction industry after the completion, in the case of publicly listed construction companies, when the number of unsold units increased by 1,000 after completion, the interest coverage ratio is estimated to decrease by 0.12 with 3 years time lag,

In the case of registered construction companies, the effect of unsold housing on the interest coverage ratio was the largest at 1 year after the completion of construction. When the number of unsold units increased by 1,000 after completion, the interest coverage ratio of -0.04 is obtained with a time lag of one year. In other words, as the number of unsold housing units after completion is larger, the interest cost is faster than the operating profit rate, and the financial soundness of construction companies becomes worse. This implies that the increase in unsold housing after construction will ultimately have a negative impact on the financial soundness of the construction industry.

As a policy measure to reduce the volatility of housing supply, first, local governments and central government need to share various information related to housing supply (licensing and permit, construction completion permit, housing planning in mid to long term) and efforts to design with the housing supply plan are needed. It is also necessary to expand the share of capital of construction company, so that a housing supply structure may be under self responsibility. In addition, the expansion of the post-sale system to the private sector as well as the public sector will help to reduce the volatility of the housing supply. Therefore, we need to improve the introduction of the post-sale housing system and diversify the housing finance for the construction industry. Although it is true that the pre-sale system, which is centered on suppliers in the past, has played a sufficient role in housing supply, it is time to prepare a new consumer-centered post-sale housing system as it is time to establish a new housing market system for housing management and maintenance.

Summary

Policy Study KOR Enhancing the Sustainability of Housing Pension: Focusing on Housing Prices

According to the 2016 Survey of Household Finances and Living Conditions, a mere 8.7% of retired households answered that their income was ‘sufficient’ enough to cover their living expenses while 39.0% and 21.5% believed it to be ‘insufficient’ or ‘severly lacking.’ In fact, as Korea’s population continues to rapidly age (over 14% of the total population is 65yrs and over), the proportion of households who are unable to afford a comfortable retirement is expected to rise in 2017. Seniors, in particular, are vulnerable in light of their low share of financial assets―mainly cash―compared to other age groups. Accordingly, estate liquidation may be a valid consideration for the government as the majority of assets held by the senior population is comprised of real estate.

Under the circumstances, this study explores the sustainability of the ongoing housing pension scheme in order to determine whether current asset-liquidation measures need to be enhanced in the long-term. For this, assumptions about the current housing pension scheme model were first reviewed and their long-term practicability was analyzed. Specifically, a quantitative analysis was conducted to examine whether the current payment level of the housing pension—which is determined by the present value of housing prices—is sustainable enough to properly respond to possible downward pressures in the housing market. Recommendations are also presented on the various aspects to consider when revising the model.

Among the determinants of housing prices, this study takes into account the demographic structure variable and economic growth rate variable to look into the housing price trends in the mid- to long-term. In doing so, the analysis uses the housing price determinants model constructed on co-integrated regression. The empirical analysis shows that real housing prices are affected positively by the economic growth rate and negatively by population aging. Indeed, if Korea’s economic growth is fixed at 3% until 2030 but the demographic structure changes as projected by Statistics Korea, real housing prices will rise by an annual average of 0.44% until the fourth quarter of 2020 and descend thereafter to 1.52% by 2030. This trend appears to be driven by increasing home sales and decreasing residential areas as those aged 65 and over rapidly become major players in the housing market.

Meanwhile, based on the estimated long-term trends in real housing prices, this study also examines nominal housing prices. Assuming that YoY inflation increases by 1%p and 2%p, respectively, nominal housing prices would decline by an annual average of 0.33% in 2017-2030 for the former and increase 0.66% for the latter. These long-term trends in housing prices differ somewhat from those in the basic assumptions which are reflected in the current housing pension scheme. That is, the scheme assumes an annual average increase of 2.1% in housing prices, which is higher than the growth rate of nominal housing prices estimated in the aforementioned empirical analysis. Ultimately, this implies that the government will likely have to bear the burden of the increased losses. A quantitative analysis reveals that if nominal housing prices grow consistently at –0.33%, the total loss to be covered by government expenditure will surge to 7.8 trillion won by 2044. A growth rate of 0.66% will entail a loss of 4.5 trillion won. These results show that if the growth in housing prices remains below Korea Housing Finance Corporation’s (HF) estimates for the growth in nominal housing prices (2.1%) and moves as assumed in the empirical analysis, the financial burden arising from the government guarantee on the housing pension will be quite substantial. Furthermore, an analysis on the demand for the housing pension scheme reveals that households are 8.86%p more likely to join the scheme when housing prices are expected to descend. This implies that when a decline in housing prices is expected, the housing pension estimation model should be adjusted in a more conservative manner considering the possibility of more households joining the scheme.

To elaborate on the scheme model, regionally differentiated housing prices should be reflected and HF’s assumptions for the growth in housing prices need to be adjusted. In addition, regional price trends must be considered separately as the registration rate is merely 0.88% and the majority of registered households reside in the capital region. At the same time, in regards to the low registration rate, a balance must be struck between promoting the scheme and improving its sustainability. The government is currently developing measures to invigorate the scheme by providing tax benefits. Indeed, tax reductions can serve as a useful means to cash-strapped seniors burdened by taxes. Also, in terms of institutional improvements, HF should be given more options other than the auction sale of mortgaged homes.

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