International Law

Korea?s Own ?Sub-Prime? Housing Crash in Sight?

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, 2008

The 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!

Full post as published by Korea Law Blog on March 23, 2008 (boomark / email).