Jeonse's weaknesses raise questions about system

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Jeonse's weaknesses raise questions about system

Published: 10 Jun. 2023, 06:00 Updated: 11 Jun. 2023, 18:04

Apartments seen from Namsan Tower in central Seoul on May 14 [NEWS1]

Discovery of possibly fraudulent housing schemes is raising questions about the sustainability of jeonse.

Under the system, people can live rent-free for a fixed term in exchange for a massive deposit, which for cheaper properties can be close to the value of the units.

Jeonse works fine at times of rising real estate prices and low rates, as deposit prices rise accordingly. But problems arise when the weak property market drags down deposit prices, forcing some landlords to default.

Since last year, hundreds of tenants have failed to receive their deposits back at the end of the term. They were mostly people living in "villa," an affordable type of housing where the tracking of prices is relatively difficult. In some cases, they were scammed, contracts at times being forged.

"Jeonse scams are not new, but there wasn't a time when the amount of damage totaled billions of won and thousands of houses," said Kim Jin-yoo, who teaches at the department of urban planning and transportation engineering at Kyonggi University.

"The lifespan of the jeonse system has now run its course," said Minister of Land, Infrastructure and Transport Won Hee-ryong during a press conference on May 16. The ministry will "fix the system without fail this time," Won added in a separate press event last month.

Housing prices are displayed in the window of a real estate agent's office in central Seoul on May 22. [YONHAP]

Jeonse popularity

Jeonse has benefited both landlords, willing to take risks to buy a property on expectation of its price increase, and tenants who needed a place to stay without risking a plunge in property prices.

The system has been around for many years, but it became more prevalent after the government raised the limit for jeonse loans in 2008.

It has grown into a popular housing rental system, with many believing they can build savings while living in a jeonse unit.

Deposits for jeonse usually fluctuate, but the prices jumped dramatically in 2020 after tenant protection laws were introduced. One of the bills limits landlords from raising the deposit by more than 5 percent when a contract is automatically extended once.

The restriction forced landlords to steeply up the deposit in the initial contract. Jeonse prices jumped 9.4 percent in 2021, the steepest increase since 2011, according to a report from KB research, a division at KB Financial Group.

The balance for jeonse deposit loans at banks skyrocketed from 64 trillion won ($49 billion) in 2018 to 171.9 trillion won last year, according to the Bank of Korea.

The rise in deposits and the rapid rise of prices in 2021 encouraged speculators to purchase villas with just a bit more than the deposit money. They chose villas because they are cheaper than high-rise apartments and possibly because of the lack of pricing transparency.

The average jeonse-to-sales-price ratio for villas in Seoul was 71.5 percent in 2021, much higher than the 51.2 percent for apartments.

One of the speculators who took advantage of the strong market was the so-called "villa king," who purchased more than a thousand homes in greater Seoul from 2020 using the deposits. He died last year, leaving behind 54.2 billion won in deposits unpaid.

Many villa investors defaulted following the central bank's rapid monetary tightening and the weakening of the property market.

Jeonse deposits started to fall from last year. The prices declined 9.9 percent in greater Seoul in March from a year earlier.

As tenants face damages from landlord defaults, the government and some experts called for the improvement, or even possibly the end of, jeonse.

Sustainability of jeonse

Questions on the sustainability of jeonse were triggered by Land Minister Won following his remarks last month.

"Jeonse system has played its role in our society, but it seems it has run its course," Won said.

The statement triggered a strong backlash from people who feared the abolishment of the system.

Won added at a separate event that the ministry "will not approach jeonse in a way that eliminates," but improves the system.

Measures proposed include the adoption of escrow and capping the deposit-property-value ratio to 70 percent.

Escrow would require landlords to place the jeonse deposit with a third party. They would receive interest on the funds.

"Escrow is the most extreme measure that has been proposed for jeonse," Won said last month. The government "wouldn't go that far, but it seems the time has come for a fix to protect tenants."

Details of the escrow system have not been disclosed, but the involvement of a third party, possibly banks or the government, "could trigger strong backlash from landlords as it would prevent them from using the deposit at their own will, like investing using the capital," said Sohn Eun-kyung, a senior researcher at KB research.

"Landlords who rent out their unit and live in jeonse at another residence will also lose the right to move," Sohn added.

"There have been systematic problems with jeonse, but it should not be abolished because there are people that cannot pay monthly rent, like senior citizens without a monthly income." Kim from Kyonggi University said.

He added the "gradual changes" are required to prevent the potential risks of the system.

"It isn't desirable for the government to artificially abolish jeonse," said Lee Han-joon, president of the state-run Korea Land & Housing Corporation, at the press conference last month. "Jeonse is an important shortcut in Korea in climbing the housing ladder."

"Collapse of the system will make it difficult for people to buy a house," Lee added.

BY JIN MIN-JI [jin.minji@joongang.co.kr]