South Korea's Real Estate Market: A Hidden Crisis

According to recent reports from South Korean media, the country's housing market is experiencing a significant decline, with both property prices and transaction volumes continuously decreasing. In April, the total number of real estate transactions across South Korea dropped to just 91,669, marking an 8.4% month-on-month decrease and a staggering 27.7% decline year-on-year.

This downturn affects nearly all types of properties, including residences, commercial spaces, office buildings, and factories. While the overall market shows signs of despair, property prices for luxury homes in prime areas of Seoul continue to rise. For the average citizen, however, these luxurious properties seem out of reach. Faced with falling home prices, diminishing asset values, and the detrimental impact on rental profits, many ordinary citizens grapple with the harsh realities of the current economic climate. Looking ahead, this crisis could potentially extend to the financial system and government stability.

A Widening Gap

Before this phase of decline, South Korea's housing market saw a period of frenzied growth. Much like other countries around the world, the pandemic led to a loosening of personal loan policies by South Korean banks three years ago, which in turn stimulated demand for home purchases. Although the government implemented measures to curb the overheating real estate market, these restrictions further fueled demand, contrary to their intended effect.

From 2020 onward, waves of eager buyers flocked to the real estate market, especially in the Seoul Capital Area, where property prices soared. Between 2020 and 2021, some prices surged by over 40%, with Seoul's price hikes exceeding 50%. In the heart of the city, prices soared to historic highs, exceeding 14 million KRW (approximately 11.5 thousand USD) per square meter.

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However, by 2022, the once booming housing market began to stumble, with depressed conditions persisting until the end of the year. As we entered the first quarter of 2023, a brief resurgence was noted, but by April, prevailing pessimism was reflected in the market data. Compared to the peak in 2021, residential property prices in certain areas of Seoul plummeted by 30% to 40%, with transaction volumes crashing by more than 70%.

Media reports suggest that despite the current slump in property prices nationwide, relaxed lending policies have focused buyer interest on specific high-demand areas. Similar to cities like Shanghai and Beijing, higher-quality residences in Seoul have also faced smaller price declines compared to lower-end properties. Between June 2022 and May 2023, the average price of apartments in the lower 20% dropped by 12.9%, whereas properties in the upper 20% witnessed only a slight decline of 3.5%.

In Seoul's affluent Gangnam District, high-quality properties remain a prime investment choice for the wealthy, with prices continuing to rise. For instance, in April, a 145 square meter apartment in Daechi-dong was sold for 4.18 billion KRW, rising to 4.5 billion KRW in May at the time of contract signing. Similarly, in the Songpa District's Jamsil-dong, a 116 square meter unit was sold for 2.35 billion KRW, exceeding its asking price by 450 million KRW.

Foreign investors have also displayed a preference for properties in core districts of Seoul. Reports indicate that a humoristic saying circulated among foreigners in Seoul’s investment circle is "Gangnam never loses." In total, 257 foreign investors purchased properties in Seoul between April and May, with around 46% being Chinese buyers (118 individuals), closely followed by American buyers (63 individuals, approximately 25%). Chinese buyers predominantly favored properties in the Songpa District while Americans opted for areas like the Seocho District.

In stark contrast, properties in the periphery of Seoul have seen their prices reduced by approximately 50% compared to two years ago. In a residential area in Yongin City, second-hand home prices have generally fallen by 30% to 40%. A recent sale of an 84-square-meter residence reached 700 million KRW, down from peak values by 585 million KRW.

Professor Seo Jin-hyung from Kyunghee University points out that easing loan restrictions concentrates demand in core areas, causing expensive apartments to escalate in price while widening the gap further. Even if the overall market displays signs of recovery, this polarization is likely to persist.

The Rental Market in Turmoil

It is important to note that the surge in housing prices correlates back to the five-year presidential term of Moon Jae-in.

In 2016, as the European debt crisis spread and impacted South Korean export demand, the country lowered its benchmark interest rate from 3.25% to 1.25%. This low-interest environment sparked a real estate boom in South Korea. In response to the COVID-19 pandemic in 2020, South Korea reduced the benchmark rate even further to 0.5%, causing property prices to skyrocket once more. Between 2020 and 2021, the prices for apartments in Seoul doubled.

Despite recent price corrections, many younger individuals still find it impossible to afford homes. A more pressing issue is how the decline in house prices presents considerable challenges for tenants, as their “Jeonse” rent contracts can sometimes exceed the value of the property itself.

The “Jeonse” system is a uniquely South Korean renting method where tenants pay a lump-sum deposit, approximately half the property's value, without needing to pay monthly rent until the lease expires. At that point, the landlord returns the entire deposit to the tenant.

This arrangement benefits tenants, enabling them to occupy properties without ongoing rental expenses, bearing only the losses associated with inflation of the deposit. It also provides landlords with substantial cash flow, which they can use for bank interest or other stable investments.

However, in these unprecedented times, as cryptocurrencies have gained popularity, South Korea has seen a surge in aggressive investment behavior. Many landlords are willing to risk their entire wealth and cash flow to engage in stock or cryptocurrency trading. As a result, when the funding chain collapses, tenants are left holding the bag with their deposits gone. In 2022 alone, South Korea reported 2,073 cases of “Jeonse” deposit scams, involving over 700 billion KRW.

According to statistics from South Korea's central bank, even if landlords sell their properties, 163,000 tenants will face risks of unrecovered deposits. The current situation shows that rental deposit values have fallen in line with declining property prices, meaning landlords may not have enough new funds from new tenants to repay the old deposits.

High Debt Risks Looming

Recently, South Korea's National Statistical Office released the "2022 National Quality of Life" report, indicating that from 2019 to 2021, the average satisfaction level of South Koreans regarding their lives was 5.9 out of 10. This is notably lower than the OECD average of 6.7 across its 38 member countries and aligns closely with countries like Japan (6.0) and Greece (5.9). Only Colombia (5.8) and Turkey (4.7) scored lower than South Korea.

This low life satisfaction can be attributed to a decline in quality of life. While classified as a developed country, the average citizen in South Korea has not reaped the benefits of capital growth, owing to long working hours and a rapidly aging population's associated loneliness, with housing price burdens adding to this misery.

Expressions like “I’ve even loaned out my soul for a mortgage” trend on social media, encapsulating how deeply intertwined real estate has become with South Korean citizens' lives, complicating the government's subsequent regulatory actions. As of 2021, the ratio of household income to debt in South Korea was an astonishing 206.5%, the highest in the world.

As property values plummet, the average net worth of Korean households has decreased from 440 million KRW at the end of 2021 to 390 million KRW by the end of March this year, a staggering reduction of 50 million KRW. In this context, the proportion of high-risk households with weak repayment capabilities has risen from 2.7% to 5.0%.

Faced with escalating debt and diminishing assets, public discontent has built up significantly, prompting the Bank of Korea to take notice of the dire impacts arising from the housing market's sharp decline.

On June 21, the Bank of Korea released its mid-year financial stability report, indicating that the Financial Vulnerability Index (FVI), which reflects overall financial fragility, stood at 48.1 in the first quarter of this year — a slight increase from 46.0 at the end of last year. From the first quarter of 2007 to the first quarter of 2023, this index has remained persistently above 39.4, hinting at the risks that high levels of debt pose.

Experts in South Korea have indicated that the declining financial stability of construction companies not only intensifies bad debt in real estate project financing (PF) loans but could also result in greater fiscal burdens on the government.

To prevent a prolonged downturn in the residential market leading to further losses, some Bank of Korea officials have suggested that preemptive measures need to be taken. These include adjusting sale prices and devising protective measures for tenants facing risks of unrecoverable deposits, while also considering the relaxation of various restrictions for genuine homebuyers in need.