Leave it to the market

“Deposit-based leases (jeonse) are crazy,” people complain. The key money deposit for apartments is currently 70 percent of the market value of the property. It is an unprecedentedly high ratio. Tenants are in agony as they suddenly have to pay tens of millions won more in deposit money.

The government is perplexed. Regulations on housing loans were lifted and the interest rate is super low in order to boost the housing market. The authorities predicted that tenants who have extra money would start to buy and leases would stabilize eventually. But housing prices are slowly rising as the lease deposit climbs. An increased number of housing transactions is all that has been accomplished, but those transactions are mostly in the most popular areas, such as the reconstruction projects. In the past, housing prices would go up when the lease deposit exceeded 60 percent of the price. But the situation is clearly different now.

Why is this happening? Banks are making generous housing loans at very low interest rates of about 3 percent. Lease deposits for apartments in Seoul are mostly in the range of 400 million won to 600 million won ($569,692). These tenants could actually purchase if they get real estate loans, so why aren’t they buying?

Probably they have decided not to buy because housing values are not likely to go up substantially. Considering acquisition and registration fees, property taxes, depreciation and inflation, owning an apartment or house makes sense if its value appreciates an average of 5 percent annually. Let’s look at reality. Because the economy is in a prolonged slump, household income remains the same or decreases a bit. Soon, Korea’s population will be shrinking. In the long run, Korea’s housing prices have a higher risk of falling, rather than increasing.

The biggest advantage of the deposit-based lease is getting the money back. Considering the current deposit-to-price ratio, tenants can rest assured, unless the housing prices fall by more than 30 percent. Moreover, the government is reinforcing protections for lease tenants. In Korea, those living in houses with deposits of 500 million won to 1 billion won are considered to be socially disadvantaged because they are not homeowners, especially when various low interest rate housing loans have drastically reduced the cost of financing.

In addition, the lease deposit is openly used as a way to avoid inheritance and gift taxes. Registration is not required for deposit-based leases, therefore it frequently is not on the radar of the National Tax Service. Many affluent parents in Gangnam get deposit-based leases for their children without paying taxes. So many tenants take advantage of this lease system that is unique to Korea, in particular, the ones who benefit the most are the people with extra money. Low-income households, who used to be the majority of deposit-based lessees, cannot afford to meet the increasing deposit money and have to agree to monthly leases or half-deposit, half-monthly terms.

How high can the deposit go? Based on the aforementioned grounds, it would not be too strange if jeonse were to approach 100 percent of the value of the housing. The risk of housing prices falling is a variable, and real estate experts say the deposit could get as high as 80 to 90 percent of the price. Then the demand to buy would increase and housing transactions would be normalized, and low-income households would mostly opt for monthly rent. It is a scenario for the extinction of the deposit-based lease market.

At present, the total of lease deposits nationwide is nearly 450 trillion won, 100 trillion more than mortgages. The lease deposit means landlords are privately financing household debt for the tenant. The extinction of the deposit-based lease market would convert the private loans to the institutional loans, expanding the household debt in statistics.

The government is ready to act to stabilize the lease market. A plan to extend the lease term to three years is being considered. But government intervention is likely to be futile. The mainstream of the deposit-based lease market is the middle class and above. Government housing policy should focus on low-income households, which are priced out of the monthly rental market. To establish a social safety net, the government needs to provide public housing projects at low monthly rental fees. The government should protect underprivileged, hard-working people from being driven out into the street. It requires a drastic change of mind-set to let the market deal with general housing supply and deposit-based leases.

JoongAng Ilbo, Oct. 30, Page 32

The author is the head of the Economist, a weekly business news magazine published by the JoongAng Ilbo, and the Korean edition of Forbes.

by Kim Kwang-ki