Korea’s Own “Sub-Prime” Housing Crash in Sight?
by Brendon Carr
A faithful reader forwards this story of ominous portent—construction companies are going bankrupt, while unsold apartments are mounting even in Seoul (the unsold inventory leaped 50% in a month!) because buyers are taking a wait-and-see attitude toward purchase:
Non-Banks Suffer From Housing Market Slump
Korea Times, March 24, 2008The ongoing housing market slump could hit construction firms and the non-banking financial sector hard, creating a crisis that may resemble the unfolding sub-prime mortgage debacle in the U.S, a state-run research institute warned Sunday.
The Korea Institute of Finance (KIF) said in a report that the country’s construction industry is grappling with a large number of unsold apartments, as potential homebuyers have taken a wait-and-see attitude since early last year on expectations that housing prices will fall.
It said if the housing market remains stagnant, many builders, particularly smaller ones based in provincial areas, could go bankrupt. “Paired with surging prices of cement and other construction materials in recent months, the sluggish housing market has worsened the bottom line of construction companies,” KIF researcher Shin Yong-sang said.
He also said savings banks, credit cooperatives and other non-banking institutions could face increasing risks of insolvency as they have extended long-term loans to builders in project financing (PF) deals.
Non-banking financial institutions have extended loans to builders for housing construction over the past few years. But the housing market slump is hitting construction firms hard, weakening their ability to meet interest payments and pay back principals.
“Savings banks exposed to unprofitable PF deals need to secure enough liquidity through the issuance of subordinated bonds and other methods. They also need to diversify revenue streams by focusing more on retail lending businesses, including credit-based loans and asset management,” Shin suggested.
The number of unsold apartments has reached its highest rate in 11 years. According to the Ministry of Land, Transport and Maritime Affairs, the number of unsold apartments nationwide totaled 123,371 in January, up 9.9 percent from a month earlier. The figure was the highest since July 1996 when the figure stood at 127,573.
Construction companies increased the supply of new apartments last year to bypass the apartment price cap. They preferred to sell a few homes at high prices earlier than selling cheaper homes later, in the belief that even the expensive ones will eventually be sold as the prices of neighboring ones go up.
But prospective homebuyers have delayed purchases on expectations that they could buy houses at a cheaper price because of a range of government regulations, resulting in a record number of unsold new apartments.
Not only in provincial areas, but also in Seoul and its adjacent areas, the number of unsold apartments has rapidly increased.
The Seoul metropolitan area had 21,724 unsold apartments in January, up 7,100 from the previous month, while the number of unsold homes in provincial areas increased by 4,017 over the one-month period.
With mounting unsold apartments, many small construction firms have gone bankrupt. The number of builders that went bankrupt totaled 57 during the first two months of the year, up 50 percent from the same period last year.
The smaller construction companies tend to be the ones building “villas” or off-brand smaller apartment complexes with 10-50 units. Demand for that product is less than the demand for larger “tombstone” high-rise apartment complexes.
Make no mistake, the housing market is overvalued. My own crummy little (1150 sq. ft.) apartment at the edge of the central business district is worth, according to the local realtors, W650,000,000. (And it feels worth less than half that.) The question is how to bring prices more in line with incomes—or incomes more in line with prices. Bringing incomes more in line with prices is the preferable method because it involves less pain, but there is a large gap to cover: For Seoul to have a median multiple of just the 7 which is considered insane in London (instead of the 19.8 reported last year), the average household income will have to reach W100 million.
As I previously reported, we bought in November 2003 for W370,000,000. In August 2007 the local realtors had signs up saying similar 43-pyong properties in our complex could be had for W500,000,000. Imagine my surprise to see them telling me I could buy for W650,000,000 just eight months later—a jump of 36%! There are some other factors driving prices in our neighborhood, like the construction of a new complex opening May 2009 whose 43-pyong units sell for W770,000,000 (so they say) which will bring a general improvement in ancillary neighborhood facilities like shopping and hagwon cram schools.
I still think the Seoul unsold inventory problem is primarily one of Roh Moo Hyun’s making, as is the 30% decline in new supply forecast for 2008. But ultimately, if families cannot afford to purchase at the prevailing prices, prices will have to come down or the inventory will remain unsold. If the market thinks that prices will decline on a sustained basis, buyers will hold off. These construction companies are holding inventory, waiting to see who will blink first. But the market never blinks. It is relentless and remorseless.
Anyway, with the local housing bubble showing signs of strain, and North Korea possibly at the brink of collapse (you do read One Free Korea, don’t you?), Korea faces chill economic winds indeed—and without the benefit of a US expansion into which to dump exports. No wonder the Korean won is so volatile!
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An acquaintance who works for a European high-end home fixtures supplier in gangnam volunteered last week that he doesn’t have much work to do at the office these days. Instead, he mostly sits around and reads the paper until supper time, then comes home and works out (when he doesn’t have to go out drinking with his colleagues). This is a marked change from last year when he reported being very busy supplying custom fixtures to the new homes of the very wealthy.
And again we have the daemon named Roh Moo Hyun to blame… But wait a minute. Mr. Carr himself mentions that there are two options out of the housing bubble in Korea. Apparently he prefers one of them:
Unfortunately there is also the other option, the more painful one… and the more realistic one, as Mr. Carr himself understands very well, as seen from his London example.
So the prices have to go down. Yes, it is not nice to see the price of one’s property go down. But this is the only possible outcome. It was in Japan, it is in US, it will be in Korea.
And Roh Moo Hyun has nothing to do with this.
Won’t worry so much about myself, Julian. I’m holding a lot of “notional equity” in my apartment—it’s paid for, and its price has gone up 75% in the five years since we bought it. We can give back a lot of the “gain” and be okay, and my income is higher than average so the probable loss on the original purchase price won’t ruin me.
But there are a lot of Korean families about to take it in the shorts. Roh’s housing policies directly contributed to the inflation of the bubble, by constricting supply. So I blame him.
Besides, it’s my blog. I can blame whoever I want to.
Brendon, I did not mention you specifically. Read my words above again carefully, I am engineer, but I my family is full of lawyers 3 generations back…
However I am sure you will not be happy if your apartment goes down to 200-400 mln. won, which is the realistic price for this size in Seoul compared to the rest of the world. In my previous comments I said something similar to your comment - most Koreans owe a lot of money. So the policy to burst the bubble destroyed the popularity of Roh among the Korean middle class. The prices went down and now we have unsold apartments. The policy is working.
My point is that again and again you mention the daemon himself. Please think about it. Do you know any country in the world with housing bubble where the bubble disappeared as you suggest, by rising the incomes? Not a single one… Make your conclusions, please.
200 million? Bite your tongue, sir! 400 maybe.
I’m relatively new to your blog, but do you have any posts on how developments in Korea’s real estate market may affect (or have affected) the development of reclaimed lands (formerly ocean) near Incheon?
I have been amazed the last few times I’ve flown into Incheon by the gargantuous reclamation efforts underway there. A friend of mine studying real estate at Columbia recently alerted me to the massive venture in Songdo (송도신도시) between Gale International and POSCO. Is something with as much momentum and funding as Songdo immune from failure? Has your firm been involved with the transaction surrounding this particular project?
Yes, we’ve been involved with some of the myriad transactions surrounding the Songdo project. But I haven’t posted about that particular project because it’s not central to my own practice and also because it’s far-off from where I live and work—in other words, Songdo is remote to me.
It’s my belief that Songdo is over-speculated.