Tuesday, September 21, 2010

Gangnam Real Estate: Time to Buy? Just Maybe....

Cheong Da Wae is worried about Korean Real Estate Prices
It is true.  The Blue House isn't thrilled about the BOK's raising of interest rates, because Cheong Da Wae knows that the single most important factor on real estate prices is the interest rate charged on mortgages.  There is no doubt that real estate prices have flattened, if not declined, especially in Gangnam.  Even the prices of Eunma in Daechi-dong, a bellweather of sorts, have dipped slightly, desptie the widely anticipated reconstruction of the the sprawling apartment complex. 

There are many complex dynamics in play
It is indisputable that interest rates affect real estate prices.  In addition, there are also a few other factors to consider.  The subsidies offered at the new developments outside of Seoul (신도시) have made Seoul real estate seem very expensive.  Given the dependence of the home-buying generation on their parents, Seoul real-estate, especially in the five speculative areas, seems out of reach, and out of reason.
In addition, the bottom line is that the average age of the population is rising, and rapidly.  It is a well-know, commonly-held belief that Korea mirrors Japan's economy, except that Korea is 10 years behind.  Well, if that is the case, the Korea is in for a world of hurt (Englsih phrase that you should learn if you do not know it already).  With little/no faith in the National Pension Service, the elderly want to save, and the home-buying generation knows it.  The result?  Less demand. 
Of course there are countervailing factors.  One is the lust for education.  Have you ever been to Eunma?  You must be kidding.  It is decrepit and needs immediate reconstruction.  There is no hot water oince a month.  The parking is absolutely untenable.  Why then are prices even where they are?  One word says it all:  HAGWON.  One hagwon owner (참부자) called Daechi-dong the "Silicon Valley" of the educational system in Korea.  Math hagwons have students coming from (강북) north of the river which must take 30-40 minutes by car.  Debating whether or not this is pure insanity will be the topic of another blog entry.  Nevertheless, the fact is that Gangnam is host to the nation's most famous hagwons, and fame for Koreans is everything.
Over the long run, demographics will create a drag on the market.  Korea's population is like Japan's 20 years ago.  Slowing birth rate has led to a increase in the average age of Korea's population.  The elderly are less likely to live in the most congested areas.

The level of the KOSPI and the JPY/KRW exchange rate are overlooked and important
Korea is changing, and rapidly.  So too, are the people. 
It is undeniable, and regrettable in some respects, that the Chaebols have regainted their control, and increased their importance.  The over-borrowing, over-dependence by Korean banks on a select few Chaebols has dramatically declined, which is good.  That has been the result of increased regulations.  In turn, those regulations have increased the transparency of Korean Chaebols (relatively speaking).  That has resulted in far greater shareholder rights compared to the 1908s.  Why does this matter?   It matters because shareholders have greater confidence in the numbers that the Chaebols are reporting, and are less fearful of dilution that has so frequently occured in the past.  So, it is a fact that increased shareholder rights has given investors increased confidence in other asset classes, when compared to real estate.  This is actually a good sign about corporate governance in Korea, and has been long overdue.  As Koreans become more sophisticated investors, and as corporate governance improves, those newly-educated investors will reallocate resources away from the real estate market (their apartments) and into stocks, bonds, and other investments.  This can change rapidly because information travels at lightspeed in Korea, and trends turn into fads.  Those fads can be strong enough to influence behavior drastically.  Therefore, this dynamic must be closely watched in the months and years ahead.

The JPY/KRW exchange rate has hurt Korean real estate prices
How is this possible?  You may ask this question and with good reason.  Well, a not-well-known fact about Korea is that the rich can behave like small Korean companies just before the Financial Crisis of 2007.  In what way?  Well, Koreans can borrow with the repayment plans being Yen-based.  Huh?  Because the Yen interest rates are low compared to Korea, rich Koreans (like the ones that buy expensive Gangnam real estate) have been able to borrow at the low Japanese Yen-based rates, and pay back according the to the value of the Yen.  While on the surface that sounds like it was a good idea, the problem is that the Yen has appreciated by over 30% compared to the Korean Won over the past 2 years.  That means that the borrowers (the Korean rich) has to pay back 30% more.  These types of loans (which are made to finance offices, or plastic surgery laser equipment) are usually 2-3 years long.  Guess what?  Many are coming due now, and over the next year, and the borrowers must be under great duress, because unless business has improved by an amount greater than the Yen's appreciation, the borrowers may have a very difficult time in repaying these loans.  One possible way to repay the loans?  Sell real estate, or take additional loans against the value of their apartments. The result of either, or both, of these is clear:  lower demand for Gangnam real estate.  Prices follow the lower demand,  i.e. prices are under pressure.

Given the JPY/KRW appreciation almost cannot last, now may actually be the time to buy
The oldest saying in buying anything of value is to "buy low, sell high."  given the fact that most of the economic activity of Korea is in Seoul, and within Seoul, that means Gangnam, when added to the JPY/KRW appreciation which has pressured borrowers that would otherwise be investors or purchasers of Gangnam real estate, it may be a chance to now "buy low." 
This is not without risks.  There is speculation that the reason for the JPY appreciation is the Chinese who have been huge buyers of JGBs (Japanese Government Bonds).  In order to buy, Chinese Yuan is sold, and JPY are bought, and then used to purche the JGBs.  The current maritime dispute has made the Chinese angry, some suggest that they are trying to squeeze the Japanese further, and make the Japanese strife worse.  In other words, it may be early to buy Korean real estate on this basis at the current time.  However, the fact is that once the problem corrects itself, it will most likely not be gradual, but a quick re-alignment may well occur.  If that occurs, then the opportunity will vanish.  So, for those that have the means, then ironically, this may be a golden opportunity.

Betting Against the Government is a Dangerous Gambit
The Korean government, whether that is local or national, have the same goal: rising real estate prices.  It is obvious why. Higher real estate valuations means that higher property taxes can be levied.  In addition, the wealth effect of increasing value of homes leads to much better consumer spending.  That consumer spending is of particular concern to countries like export-dominated Korea.  It needs to weaken the reliance on exports, relatively speaking.  That process would all come to stunning, painful halt, if there is a real estate market crash.  If you look at the U.S. experience, the rapid decline in housing has led to dramatically painful economic consequences, including unemployment of greater than 9.5%.  Other, more appropriate statistics actually point out a worse picture than that.  While Korea's official unemployment rate is very low compared to the U.S., it could be argued that underemployment (people working at jobs for which they are vastly overqualified), when added to unemployment, in Korea is actually worse than that of the U.S.  No official statistics really point this out in Korea, but anecdotal evidence and the size of the black market economy is the obvious evidence.
The bottom line:  Korea can't afford a real estate market crash, and the government will do almost anything in order to prevent one.   Given that fact, and the fact that prices are this depressed given the otherwise relatively-healthy economy, which has resulted largely from the appreciation of the JPY, that when this reverses, then money will flow out of equites, out of the JPY due to Japan's efforts (coordinated or not), and that money will go...back into real estate.  That is an entirely feasible outcome over the medium term.  In the longer term (5+) years, the demographics, and the re-allocation of overall assets by people with savings in Korea, will most likely dominate.  But before then, it will be difficult for the government to reverse course from its real estate market support activities.

Good luck.


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