Replies to This Discussion | 이 토론에 대한 답글들

Permalink Reply by stephanemot on August 5, 2010 at 8:22am

To me, the jeonse system made much more sense when banks provided a nice return (heck - 20 years ago, my money "sleeping" on my bank account produced 18% !). Now the equation has dramatically changed, and there is no inflation hedge in the system anymore.

Furthermore, jeonse profits were not taxed but recent reforms are changing that as well.

What you see now, increasingly, is a mix of classic rent and jeonse, the latter converging with the guarantee you see on many markets. Of course we're far from there, but it starts to look like it.

Koreans have been addicted to a model over the past decades : dwellings were consumer goods to change every 3 years or so with a fat profit, and this is simply not sustainable. You can't beat demographics and common sense forever.


Stephane


PS: actually, density is even much higher : Indiana is not as mountainous as Korea

Permalink Reply by Robert Eberenz on August 5, 2010 at 8:33am

Great points Stephane. The high interest rate environment is indeed over in the short term. I'm interested to see whether the developers and owners of new units can find more creative methods to turning property into positive cash flow assets through methods other than Jeonse.

Permalink Reply by Geoff Beer on August 5, 2010 at 10:18am

Great article, Robert. You have cleared up some longstanding questions for me regarding Jeonse, including whether or not such a system could be implemented outside of Korea. Notwithstanding cultural familiarity, the answer would seem to be "no," since a lessor can earn a much higher return on his/her capital investment using a traditional rent model, versus Jeonse, even after accounting for lessee defaults, which most likely would be de minimis in the Jeonse system.

Is it possible that a developer can collect Jeonse payments in advance of construction (a pre-lease, if you will), which would then avail the developer of a very attractive form of construction financing? Also, in a Jeonse system, are the lessors or the lessees responsible for the operating expenses of their buildings - utilities, maintenance, insurance, etc.? If the former, then it would seem even less likely that Jeonse could ever propagate outside of Korea, since the current return on liquid, low-risk securities would not likely cover the operating expenses of the building, leaving a developer with an annual deficit, versus a typical 6% to 8% annual return (unleveraged) using a traditional rent model.

Many thanks,

Geoff

Permalink Reply by Steven S. Bammel on August 5, 2010 at 10:52am

Geoff,

The traditional rent model in Korea still involves a huge deposit amount, compared with the US, so lessee defaults are indeed very rare in Korea and/or there is plenty of deposit money to cover it.

As for collecting Jeonse payments in advance of construction, the answer is a resounding yes! Perhaps someone else can fill in the details here (or correct me where I'm wrong) but the approach being taken on the "redevelopments", where they tear down old apartments to build new, is for homeowners to cover almost all of it with bank loans, long before construction is finished (or even started)

In the Jeonse system, the lessee is responsible for operating expenses. Indeed, once an apartment goes under Jeonse, the lessee may have absolutely NO CONTACT with the owner until the end of the lease. As an illustration, we rented an apartment many years ago with a two-year Jeonse lease. The ownership of the apartment changed in the middle but we did not know this and only found out about it when we went to get our money to move.

I see the Jeonse system as a carry-over from the days of rapid real estate appreciation. People would buy an apartment, get 60-80% of the apartment back in Jeonse and then go out and buy another... and another... and another... Going back to my illustration above, that's what happened to the new owner of our apartment; we weren't sure if he would have the money for us since real estate prices had actually fallen (it was during the IMF period of 1996-1998). And in many (most) cases, it is not possible to get ones Jeonse back until another lessee is lined up....

Permalink Reply by Geoff Beer on August 5, 2010 at 5:00pm

Steve, thank you for the education. I now better comprehend the upside to the lessor/owner in a Jeonse transaction, although I am still a bit baffled how all of the lessees coordinate payment of building repairs, insurance, taxes, etc. Do they pay some kind of monthly fee (like an HOA fee here in the U.S.) to cover ongoing operating expenses, in addition to the upfront Jeonse payment?

Now that I understand that developers can finance the majority of a building's construction with the equivalent of 0% interest loans provided by the building's future Jeonse residents, it makes sense why developers would build a Jeonse tower, rather than a traditional apartment or condominium tower, since the time and cost of arranging and repaying a construction loan is one of the more disagreeable parts of the real estate development process, especially in a high interest rate environment, when the spreads between conventional financing and "Jeonse financing" are at their zenith.

Geoff

Permalink Reply by Steven S. Bammel on August 5, 2010 at 7:21pm

Yes, each apartment complex has a management office and a residents representatives team and monthly fees to cover those various ongoing expenses, which are paid by the lessee. Insurance, if carried, is paid by the lessee. Major repairs are the responsibility of the owner.

There's been a lot of corruption and conflict within the management at our complex:
http://seongpodong.koreanconsulting.com/2010/05/we-demand-our-volun...
http://seongpodong.koreanconsulting.com/2010/06/the-management-stri...

Permalink Reply by Robert Eberenz on August 6, 2010 at 7:34am

Many thanks to both of you, Geoff and Steven, for taking the practical implications of Jeonse to a second level of magnitude.

Steven, your comment regarding the ability of a lessee to recover their Jeonse payment once their contract has expired, or lack thereof, strikes a key I had been pondering for some time... What happens if the lessor doesn't have the Jeonse when it's time to leave, and furthermore what legal recourse can be taken by the lessee to regain the time value of money lost if they cannot immediately recover their capital?

It seems that the growing supply of housing units and especially the rate at which supply growth is out-pacing demand, depicted in the graph from this week's article as the "housing supply ratio", are rapidly increasing the chances of a Jeonse meltdown at some future date. If the market experiences an environment of duress, such as the '96-'98 Asia currency crisis, and the housing supply ratio continues climbing past 110%, the Jeonse system could actually exacerbate any potential economic contraction due to home price declines.

According to my research and Steven's first hand knowledge, the Jeonse system seems much like a leverage scheme, whereby landlords have utilized their strength, born from years of far higher demand than supply, to demand large deposits that facilitate their financing and purchases of more real estate. These speculative methods are now being partly fought through the regulations in Korea which impose loan-to-value requirements at 50%.

However, the majority of equity that has been leveraged to finance the purchase of Jeonse managed real estate is actually owned by the lessees, not the lessors. In the event of a further economic contraction, before the housing supply ratio has a chance to re-balance towards 100%, we will see a massive wave of defaults on mortgage financing as landlords face contract expiry and vacancy simultaneously.

Even a small percentage of vacant units for a short period of time could trigger landlords and REITs to miss payments and default on their financing agreements.

Time will certainly judge whether the rate of economic expansion pulls ahead fast enough to ward off pessimism tied to the risk of holding real estate. In the current higher supply than demand environment, where prices should naturally fall, the net present value of properties must be lifted by expectations of higher future demand. We will see if such optimism can be derived from economic signals in Korea over the next few years. If sentiment turns pessimistic and the housing supply ratio remains well over equilibrium (+100%), I see no trajectory for Korean real estate prices other than down.

Permalink Reply by Steven S. Bammel on August 8, 2010 at 8:33pm

Robert: In response to your question of what legal recourse can be taken by the lessee if the Jeonse cannot be recovered immediately, I know that the Jeonse is a lean against the property and the property can be foreclosed on by the lessee. This is a long, drawn out process though. In our case, we didn't have time and started the process on the lessor even before he'd defaulted in the form of official three letters of notice so that, should he not have the money for us on the date due, we could go straight into legal proceedings without needing to start again with the three letters.

In fact, we were concerned that the lessor would use the fact of our needing to leave the country against us and so we lied, saying we were simply moving to another apartment rather than that we were getting ready to return to the US. We also did this six months before our drop-dead deadline for leaving the country, which left us needing to move and then rent elsewhere under a traditional rent model for six months when we ended up not having any problems.

You can see from our experience that we were preparing for a worst-case scenario, which fortunately didn't come to pass.