K-pop and K-dramas have been captivating international audiences since the late 1990s. They continue to shape mainstream media today as part of the Hallyu, or the Korean wave. However, the rising interest in Korea extends beyond the entertainment industry. Over the past decade, we’ve seen a growing interest in Korean real estate. Most recently, the build-to-rent (BTR) market has blossomed, prompting us to put our pens – and calculators – to paper.

Is Seoul the next Tokyo?

The fundamentals for BTR in Seoul are promising. After a slight pandemic-related dip in 2021, net migration into Korea’s capital has rebounded, thanks to an influx of 20-29-year-olds. Attracted by opportunities from large conglomerates and startups, job seekers and entrepreneurs are flocking to Seoul. Many are focusing exclusively on their careers, choosing to remain single. The correlation between office employment and housing demand remains strong in Seoul. With an average office attendance of 4.2 days per week, most Seoullites prefer to rent somewhere close to their offices.

The parallels between Seoul and Tokyo are clear: both capital cities are experiencing high levels of in-migration; there’s an increasing trend of young households staying single for longer; and both face a limited supply of housing. However, one key factor separates the two – inflation. Japan’s BTR market matured in a unique environment caused by deflation, which encouraged people to rent rather than own homes. This resulted in Tokyo having a low home-ownership rate of 27% – a figure not seen in other markets. 

By contrast, Korean inflation has been healthy over the past two decades, leading to steady capital appreciation for residential properties. The potential for capital gains has motivated many South Koreans to invest in property over the past 20 years. However, like trends in other countries, incomes have not increased at the same rate as housing prices. Consequently, many young residents of Seoul find themselves unable to afford a home. It’s true that the unaffordability of housing drives the rental market. However, the growth of the BTR sector in Korea might develop more slowly than it did in Japan.

Jeonse versus Wolse – the long road of transitioning

South Korea is a developed country, but its rental housing market behaves like a developing one. The preferred rental method is called Jeonse, which entails a one-off refundable rental deposit, usually equivalent to usually 80% of the property’s market value. Landlords retain the lump sum for the duration of the tenant's stay, usually around two years, and are required to return the full principal amount when the term ends. Instead of collecting monthly rent, the landlord benefits from reinvesting the principal. For landlords, Jeonse is an easy way to raise capital, which they often reinvest in fixed-term deposits or use as downpayment on additional rental properties. Jeonse bank loans are more accessible for renters, with considerably lower interest rates compared with regular mortgages. They also allow renters to borrow up to 80% of the rental deposit.

Wolse, by contrast, operates on a monthly rent system The shift from Jeonse to Wolse introduces challenges that could slow the institutionalisation of the BTR market in Korea. The deeply rooted tradition of Jeonse among Korean renters poses a significant contrast to the conventional rental approach preferred by institutional BTR operators.

Affordability pressures

This begs the question: if tenants are already paying up to 80% of the property’s value, why not simply secure a mortgage to buy the property outright? The answer lies in restrictive bank loan-to-value (LTV) ratios. Mortgage LTV ratios in South Korea are typically set between 40%-60%, requiring a significant initial cash payment to purchase a home. Traditionally, homeowners relied on a combination of savings and family support to meet these requirements. However, given the current economic climate, many parents are often unable to provide the necessary financial support. 

Over the past two decades, rising property prices have pushed the Jeonse-to-value ratio close to 100% of the property’s underlying value. Most notably, in prime areas near Seoul’s central business district and Gangnam. As a result, Jeonse agreements in these locations have become virtually unaffordable, despite the availability of Jeonse bank loans. Additionally, Jeonse fraud has been on the rise, with many landlords unable to return the Jeonse at the end of the two-year lease. 

Structurally higher interest rates are encouraging a shift towards monthly renting (Wolse). However, despite the economic benefits, we don’t expect this to be the norm overnight. As we highlighted, tenants are refunded their entire Jeonse deposit at the end of the lease. Many therefore view this as a form of savings. This is not the case with monthly rent, even though the interest on those payments might be lower. 

Co-living versus youth housing

Recently, we’ve seen an influx of interest and potential entrants into the Seoul BTR market. This includes joint ventures such as KKR with Weave Living, and Honors AMC with Cove Living. Incumbents like SK D&D and MGRV, already operating within Seoul, are also expanding, particularly into the co-living space. This growth has been partly driven by government incentives, such as increased floor-area ratios and tax relief for co-living and youth housing (19-39-year-olds). The latter programme, a private-public partnership, provides subsidised apartments to young people at rents between 75%-85% of the market price.

To qualify, housing sites must be within 350 metres of a metro station or within 50 metres of a main road. Land within 350 metres of a medical facility is also eligible. This is designed to make co-living facilities suitable for young people and the elderly living alone. 

Final thoughts…

With elevated interest rates making Wolse a more economical renting option for tenants, coupled with the increasing instances of Jeonse fraud, we expect demand will increasingly shift towards institutional BTR landlords. These landlords predominantly offer Wolse as their standard rental system and protect tenants against rental fraud.

In the institutionalised BTR market, we believe co-living is a better investment option than youth housing. Co-living projects involve the conversion of hotels into offices, and usually offer a relatively quick turnaround time allowing investors to quickly access the market. By contrast, youth housing projects are typically ground-up developments, which can be complex and take a lot of time.

Additionally, co-living is non-subsidised and can command higher rents than youth housing. Co-living properties are also categorised as ‘dormitories for rental purposes’, exempting them from the minimum eight-year holding periods imposed on youth housing developments. As a result, co-living can generate superior internal rates of return and provide investors with greater flexibility for exit strategies compared with youth housing.