Housing Policy and the Korean Dream
by Brendon Carr
The average apartment in Korea, according to a recent report in the Dong-A Ilbo, costs W8,010,000 per 3.3 square meters (thanks to government edict, we can’t use the traditional unit of pyong). Think about those housing costs for a moment. The average apartment in Korea nationwide, which includes all those depopulated rural areas—sells for US$237 per square foot of gross floor area (net floor area tends to be only 75% of the gross).
This makes the average cost of a 32-pyong apartment (1165 gross square feet, 875 net) W256,320,000, or US$276,000. While this would be an incredible bargain in Palo Alto, Seoul is not Palo Alto. Far from it.
I live in a grand palace of a 43 pyong apartment (1565 gross sq. ft., 1175 net) which provokes oooh from average Koreans when they hear about the massive size of the spread my family of four occupies. The average nationwide cost of this size apartment is W344,430,000, or US$371,000.
In Seoul, the average price is almost precisely double that of the national average. The Dong-A Ilbo reports the average price per 3.3 square meters for apartments in Seoul now stands at W16.27 million (US$17,500). That same notional average 32-pyong apartment in Seoul is W520,640,000 (US$560,325); the 43-pyong, W699,610,000 (US$753,000). Again, these prices are medians, which means there are many units which are less expensive, and many which are more expensive.
For example, my partner Doil Son and I are working on a project which will involve the sale and purchase of a development that includes very luxurious apartment units in a building which has all the character and attendant services of a five-star hotel. That development features apartments which are on sale for the price of W35 million per 3.3 square meters. The 32 pyong apartment over there, with net floor space of 815 square feet, sells for W1.12 billion (US$1.2 million), and also carries a monthly management fee (for the other services) of thousands of dollars per month. It’s really nice; it would be grand to live there.
Alas, I live like a regular guy, and the neighborhood I live in is not doing me any favors with respect to property value. My own apartment is sited at the northwest edge of the central business district, perched on a low hill overlooking the building where Shin & Kim keeps its offices. It’s a seven-minute walking commute to Shin & Kim. But I don’t work there any more. My offices at Hwang Mok Park are further away—it takes 20-25 minutes to walk home from HMP, maybe 10 minutes by car. Because our district is still undergoing redevelopment, our per-3.3 square meters price is less than the Seoul average: In the current market, my apartment would fetch W500,000,000 or W11.63 million per pyong (US$345 per square foot), a real bargain in Seoul. I found it pretty affordable (indeed, I could still afford to move into a new apartment of the same size at the average per-pyong market price—but why would I?), and our key consideration was convenience of the location.
We bought our place at W8.6 million per pyong (W370,000,000—which at that time was US$308,333 because the exchange rate was 1200 to the dollar) in November 2003, so apart from notional foreign-currency gains my relative investment performance (only 8% appreciation per year) in this house has been poorer than the average increase in Seoul apartment prices over the five years since I bought.
But I am rich. My income level is considerably higher than the average Korean’s.
There are two factors at work in Korea’s housing-price bubble. Both of them are results of horrible government policy.
One is the loose-money policy of the Bank of Korea—until pretty recently the streets have been awash with cash dumped into the system to prop up the KOSPI and fend off “speculative capital” (i.e. foreign investors who might push restructuring), and all this cash has to go somewhere. Koreans traditionally know only one asset class: Real estate. That means only a fraction of the excess liquidity finds its way into shares, and the rest goes after real estate. So more won chases the same properties. And home prices galloped ahead as a result.
The second factor is that new supply of housing has evaporated as a result of deliberate policy choices of the market-hating Roh administration. The supply of new housing had already received a staggering blow from the 1998-2002 “IMF Crisis”, which put many developers out of business. Then Amateur Hour got underway. It is already extraordinarily difficult and expensive for developers to secure redevelopment rights and construction permits for the soul-crushing apartment blocks that Koreans all want to live in. Average time to market is 10 years, with three of it being physical construction and five to 10 years of pre-construction wrangling being involved in getting the legal side wrapped up.
In Kangnam, where everybody wants to live, it is now well-nigh impossible to get approval for any new construction or reconstruction (of existing complexes). Since everyone wants to live there, what this will do is price Kangnam out of the reach of any normal people.
(For those of you not living in Seoul, think of Kangnam as Malibu without the sun and sand, or Manhattan without all the interesting people.)
Thomas Sowell, writing in the Baltimore Sun, nails this factor in an op-ed about America’s housing crisis from August 8 titled ”Government regulations nurtured subprime mortgage crisis” (thanks to Instapundit for the tip):
While many other factors can be involved - rising incomes, population growth, construction costs - a scrutiny of the times and places where housing prices doubled, tripled or quadrupled within a decade shows that restrictions on building have been the key.
Attractive and heady phrases like “open space,” “smart growth” and the like have accompanied land-use restrictions that made the cost of land rise in many places to the point where it greatly exceeded the cost of the homes built on the land.
In places that resisted this political rhetoric, home prices remained reasonable, despite rising incomes and population growth. Construction costs were seldom a major factor, for there was relatively little construction in places with severe building restrictions and skyrocketing home prices.
In short, government has been the principal factor preventing the “affordable housing” that politicians talk about so much.
There’s nothing we can do about the supply of land. That’s a constant. But the supply of developable land is another question altogether. To the extent that allowing more intensive use of the land we have could alleviate the cost of housing, I have to question why there are so many restrictions.
Instead of doing this, Korea has implemented virtually every wrong-headed prescription mentioned in this article. I’ve previously mentioned how the IMF Crisis interrupted the supply of housing. But we also have “green belt” zones around Seoul declared off limits to development, and we have severe constraints (including building-height restrictions) on development of land in the city. Thanks to Amateur Hour, we now have price controls on new apartments (try to find one for less than W600,000,000 this fall, the new government-mandated “price ceiling"), official pressure to reveal cost bases to ferret out “excessive profit” and “undue luxury”, and manipulation of housing loan ratios to make it more difficult for citizens to buy an apartment—now the required down payment is 60% of the purchase price.
How far is Korea from the “affordable housing” ideal? St. Louis-area consultant Wendell Cox’s Demographia site is a treasure-trove of information including an index of housing affordability. He published a housing affordability study for 2007, which uses a simple multiple of Median House Price to Median Household Income (the “Median Multiple"). Where average housing prices are three times’ Median Household Income or less, Cox rates housing as “affordable”.
The US market currently has a Median Multiple of 3.7, which implies that the US market is a bit out of whack with US income levels. A Median Multiple between 3.1 and 4.0 is “Moderately Unaffordable”, 4.1 to 5.0 “Seriously Unaffordable”, and 5.1 and above, “Severely Unaffordable”.
Where is Seoul’s housing market in relation to Wendell Cox’s Median Multiple? Remember, this is based on comparing the median cost of housing to the median income of the people who presumably want to buy that housing. According to the Chosun Ilbo last week, the Median Multiple in the city where I live and work is 17.8 for all housing stock, 19.5 for newly-built apartments of the type I am living in. I’m not sure where 19.5 falls on Cox’s scale—“Disastrously Unaffordable”?
There are two remedies for this imbalance in the Median Multiple: Increasing the income of the populace, whilst holding the line on further increases in housing prices; or bringing down the prices themselves. As an owner of an apartment, I’m not so sure how I feel about bringing down the prices, although my mortgage loan is paid off (after ten years of Cup O’Noodles and holes in my socks) so all I’ll really suffer is an erosion of notional wealth. But both of these remedies call for a reversal of current policies on development of new apartment buildings. We need cranes all over Seoul, building new and better apartments as far as the eye can see. When construction companies’ presidents are reduced to standing on streetcorners with a cardboard sign “Will Build for Food”, that’s when we’ll know we have enough apartments.
UPDATE 2/28/2008: This post continues to be one the most popular on Korea Law Blog. Apparently there are a lot of people interested in the Korean housing situation, including at Korean economic research institutes. (Who knows, though—they may be laughing.) See also these related posts on this topic:
Is There Really a “Glut” of Housing in Korea?
Watch the Construction Companies: Korea’s Canary in the Mine
More Property Fallout: Kwangju Regional Construction Group Foundering
Builders Having Trouble Moving Apartments in Seoul
Housing Bubble: Home Supply Down 30% in 2008
More on Land-Use Regulation and Housing Prices, Plus News From Seattle
900 Sq. Ft. Korean Apartment Construction Cost $150K
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I think levels of that nature can be said to indicate a housing bubble. The question is will the bursting of the bubble result in something as disastrous as Japan’s Lost Decade. Any thoughts?
Great commentary again, Brendon. Why have we not seen this kind of analysis in the Korean media? (At least I havent and I poke around the Chosun Ilbo once a day, everyday).
About the 2 factors you named: I bet the next president of Korea will loosen restrictions on building in Seoul. But what about the Bank of Korea’s loose money policy - what could bring that to an end?
I guess the reason you don’t see this commentary in the Korean press could be that I’m wrong. That could be possible. I don’t think so, but it is possible.
Even the Korea Times acknowledges the money supply problem. We might have a change in policy when the administration changes, but not sooner. The Roh gang doesn’t understand economics.
Instead of slowing down the printing presses on money, they choose to “attack” some of the symptoms instead of the cause. Artificial measures like price controls on apartments, and squeezing the banks not to make mortgage loans—these things do nothing to address the surfeit of money seeking returns.
“The Roh gang doesn’t understand economics.” A commomly heard complaint among Koreans. But you know what, looking at the reporting on the house price inflation and other matters, I wonder how much the press even understands economics. Eg:
http://english.chosun.com/w21data/html/news/200708/200708220028.html
The reporting on the recent stock turmoil reveals that the press seems to have no clue about securitization. They’re like Chosun dynasty scholars attempting to comprehend a western steam engine. We could probably trace the lack of understanding of economics back to the era of gov’t directed bank loans, which led to banks having no ability to rate loans or keep up with financial innovation. So Korean economic reporters never got experience covering complicated financial transactions & issues.
Incidentally, I think the lack of lawyers and their old-fashioned training contributes to the underdevelopment of Korea’s finance industry (and general understanding of economics). Behind all the western financial innovation of the last 20 years, behind Goldman Sachs, behind hedge funds doing esoteric transnational regulation arbitrage trades—there are really smart lawyers. Koreans think finance and law are 2 totally different industries. I recently had lunch with 2 judges and I mentioned this to the older one and he had no clue, while the younger one had a vague idea about the link between modern finance and skilled lawyers. Financial modernization and knowledge of economics has a long way to go here.
(Hey, maybe you could write a post on the lawyer-finance link in Korea, I’m sure you’ve got alot to say there!)
Thanks for a clearly-written analysis of the problem. Without question, housing prices are completely out of step with the public’s ability to pay. Incidentally, the Demographia housing affordability study is well worth the read.
Brendon, while I was reading, a question came up a couple of times. What you describe here as ‘notional wealth’ is termed by others to be ‘equity’. For most people, whether here in Korea or elsewhere, a home is not merely a place to live; it in an investment - indeed, their most sizable one. Are you suggesting that people cease considering their homes to be investments, or cease considering unrealized gains as assets? I think the former is unrealistic, but the latter is sage. What’s your take on this?
Maybe both.
Re: “Notional wealth”—This is precisely the tack I am taking. Because I believe we are on a massive bubble right now, my own attitude is that the unrealized gain is not equity as I would understand the concept in St. Louis. So I’d better not plan around it.
And i think there’s a case to be made that Korean housing is no longer fit to be considered an investment. At least, not the “risk free” investment that everyone tells me it is. Until a little (or all, but in a controlled way) of the air is let out of this bubble, as an investment Korean residential property is very risky.
I am very glad this administration recognizes there is a problem. If only the policy prescriptions that follow were based on any understanding of basic supply-and-demand economics instead of Das Kapital.
Interesting post. The city under Lee Myung-bak planned to build 25 new towns within the city in areas outside of Gangnam totalling 25 square km or 4% of Seoul’s total area, but as this post hints, the speculation in those areas is making it harder for the developers to acquire the land. Of the first three, two (Eunpyeong and Gileum) located near Seoul’s outskirts are well under way, but Wangshimni, the one closest to downtown, hasn’t even begun yet.
Oh Se-hoon has promised 25 more new towns, but while the point of the new towns was to try to lower prices in Gangnam by creating more demand in Gangbuk, in the short term it seems to be leading to ever-higher prices in these new town areas, inflating the bubble that much more.
I also can’t quite figure out what the problem is with letting people get wealthier. Good homes are ultimately the main source of wealth for the middle class, and keeping them from buying such homes is a ruinous policy.
News today in the Joongang: All of the largest banks have raised their loan rates stepwise by about half a percent in the past 2 months, with more on the way.
Since over 90% of Korean mortgages are variable rate, that makes another 300,000 won per month EXTRA onto the monthly payment of a 600million won mortgage.
Why are the rates rising, though? Because the banks need more money to lend out. Korean banks are poorly diversified, and the great bulk of their income comes from loan interest. That means they have to offer higher interest rates on their CDs to attract more money. The money is then lent out at a higher rate. Very unimaginative, and not exactly financial hub kind of engineering.
How long they think this can go on is a mystery to me. The banks can only pay the interest on the CDs as long as their borrowers pay the interest on their loans. Raising the interest rate invites default. Default would require bank repossession of the properties, which the banks would have to sell the pay the CDs. Either way it’ll be government bailout time, spending more if they want to support home prices, less if they’re willing to let them fall.
Congratulations in writing such an informative article on the housing situation in South Korea.
I have passed it on to the co author of the Annual Demographia International Housing Affordability Survey, Wendell Cox. In the 4th Edition of the Survey (due for release late January 2008) it is likely we will be focusing on what new starter fringe housing should be costing (land and buildings combined) per sq meter all up, within the urban markets surveyed. You may find the recently released Dallas Fort Worth / Sydney Australia Comparative Study on the Demographia website of interest.
In general terms – Dallas Fort Worth is providing new fringe starter housing at $550 per square meter – the land component $150 per square meter – total package around the $700 per sq meter mark.
Our view is that the costs in social and economic terms are going to be significant going forward for urban markets (whether in the Anglo world as surveyed by Demographia or elsewhere) that fail to maintain or restore housing affordability.
With best regards,
Yours sincerely,
Hugh Pavletich
Co author – Annual Demographia International Housing Affordability Survey
http://www.demographia.com
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