Old apartments lose appeal as investment properties
Costly borrowing rate, project financing risks behind concerns over reconstruction
This investment
strategy unfortunately does not guarantee
a successful financial return in recent days, as builders have trouble securing financing capital.
In Korea, old apartment buildings in densely populated areas, particularly in Seoul, have been a lucrative investment property as their values surge when they are rebuilt.
Under the construction law, homes that are 30 years old or older can be reconstructed when living conditions, such as noise level, plumbing and heating, deteriorate and regulators deem reconstruction is necessary.
But they are becoming less profitable as construction costs rise in the face of a deepening slump in the industry.
The profit margin of developers has come mainly from sales of newly added units to would-be homeowners after old apartment buildings are demolished and replaced with larger buildings.
The sales system offers existing homeowners some advantages.
With their rights as shareholders of the corresponding property, they can live there as long as they can afford to pay the difference between the selling price and the value of their share in the property.
Furthermore, sale prices would be set lower for existing owners than new buyers.
If they do not want to live in the new apartment, they have the right to sell their unit for more than the initial sale price and reap a return that could be multiple times higher than their initial investment.
“But this investment strategy unfortunately does not guarantee a successful financial return in recent days, as builders have trouble securing financing capital and even existing homeowners are asked to pay more for their new homes,” said Kwon Dae-jung, a real estate professor at Sogang University.
He pointed out that builders secure funding for large-scale development projects from banks through project financing.
Project financing refers to longterm financing of infrastructure or industrial projects based upon the projected cash flows of the project rather than the balance sheets of the corresponding firms.
High interest rates, however, have pushed up costs of taking out loans, with the base rate standing at a 15-year high of 3.5 percent.
In return, many developers are ridden with debts with their existing project financing. They thus shy away from launching new projects to reconstruct homes.
And even if they do, they ask existing homeowners to bear more costs to ensure their profit margin.
According to the Ministry of Land, Infrastructure and Transport, a total of 2.62 million apartments nationwide are eligible for reconstruction.
The number of those homes more than doubled after the Yun Suk Yeol administration eased rules on reconstruction to boost the housing market.
The government in January softened safety requirements to rebuild homes that are 30 years old or older and have living conditions below the acceptable level.
The eased rules, nevertheless, fall short of boosting reconstruction, as prices of construction across the country went up sharply.
For every 3.3 square meters, the cost of rebuilding averaged at 6.87 million won ($5,135) in December 2023, a 43 percent increase over the preceding three years.
The cost increase was more severe in Seoul. For every 3.3 square meters, the cost ranged between 8 million won and 9 million won.
“The higher cost is burdensome, considering more than half of the country’s entire population is in Seoul and the greater Seoul area,” said Kim Je-kyung, a chief consultant at real estate agency Tumi.
Some 47 percent of homes that are 30 years old or older are in Seoul, Incheon and Gyeonggi Province.
In Seoul, the districts where those homes are concentrated are Dobong, Gangnam, Gangseo and Nowon.
In Gyeonggi Province, they are concentrated in Ansan, Suwon, Gwangmyeong and Pyeongtaek.
To save the costs of reconstruction, existing tenants of multiple reconstruction areas have foregone plans to include extra amenities that are popular in recently built apartments, such as gyms or cafeteria.
Some others living by the Han River also axed plans to build a 70-storey skyscraper-like building offering a riverfront view. They instead suggested it to be lowered to 30 floors.
Asked whether the old apartment buildings are no longer lucrative as investment properties, Kwon said it depends on the interest rate.
“The rate should be lowered to the level that developers find appropriate to take out loans and proceed with project financing,” the professor said.
Kim of Tumi said the rate is “also a key factor whether would-be homeowners can afford to buy a new home,” noting housing loans account for most housing transactions in Korea.
The experts warned against reckless reconstruction projects. They pointed out the country is struggling with a dwindling population and that an excessive supply of homes may only result in debt for both owners of old apartments and developers.