The Jeonse System Cannot Continue as It Is

The “Special Act on Support for Victims of Jeonse Fraud and Housing Stability,” which supports victims of jeonse fraud, passed the National Assembly plenary session on the 25th. This came just 25 days after the special act was introduced. It was possible because the National Assembly responded sensitively to public opinion as large-scale jeonse fraud cases and the victims’ extreme choices occurred one after another. It is fortunate that, even belatedly, this may offer at least some help to victims of jeonse fraud, but attention must be paid to the fact that the risks inherent in the jeonse system itself have not been reduced.

The jeonse system is a uniquely Korean institution. It is hard to find countries with advanced financial systems that have a jeonse system. Of course, the reason jeonse, a form of private financing between individuals, has been able to exist is that it has advantages for both tenants and landlords.

For tenants, it allows housing at a lower cost than monthly rent. In Korea, 14.7% of disposable income is spent on housing costs, which is very low compared with the OECD average of 20.5%. In fact, in the OECD’s Better Life Index (BLI), Korea ranked 1st out of 42 countries in the housing cost category, making it the country with the lowest rent burden.

Considering various taxes and maintenance and management costs, jeonse deposits should actually be higher than sale prices. Nevertheless, the reason low jeonse price ratios can be maintained is that landlords expect future real estate price increases rather than immediate rental yields. This is also why apartments with a high likelihood of redevelopment have low jeonse price ratios, while villas, urban-type housing, and officetels—where price appreciation is harder to expect—have high jeonse price ratios.

On the other hand, the jeonse system has the fatal drawback of landlords failing to return deposits. This reverse jeonse problem is inevitable during periods of falling housing prices. It is especially severe for ordinary people’s housing, such as villas and officetels, where jeonse price ratios are high. It is a phenomenon that can appear at any time even in the ordinary jeonse market, not just in cases of jeonse fraud.

One reason the jeonse problem has grown as serious as it has now is excessive government intervention. The government made home purchases more difficult through loan regulations while at the same time easing requirements for jeonse loans. During the Moon Jae-in administration, jeonse deposit loans surged from KRW 48.6 trillion in 2017 to KRW 170.5 trillion in 2021. By lending up to 80% of jeonse funds regardless of income, and when jeonse deposits exceeded sale prices, tenants were able to hold multiple homes without any capital of their own.

This is also why gap investment was able to become popular during the real estate boom. Even though jeonse prices were rising, the Moon Jae-in administration’s Lease 3 Act, which it pushed through, has been identified as a cause. By capping rent increases at 5% and extending jeonse contract periods from 2 years to 4 years, jeonse prices soared. That boomerang is now returning in the form of reverse jeonse as real estate prices fall.

The amount of jeonse deposit returns paid by the Korea Housing & Urban Guarantee Corporation to tenants on behalf of landlords surged from KRW 58.3 billion in 2018 to KRW 924.1 billion in 2022. These funds must be recovered through indemnity claims and auctions, but in a situation like the present, where housing prices have plunged, recovery is not easy. If this were a private company, it would have stopped selling the related product once losses of this scale occurred. Of course, falling real estate prices are the main cause, but the government’s push to expand jeonse loans is now presenting the bill.

Minister of Land, Infrastructure and Transport Won Hee-ryong has said that “the jeonse system has now run its course,” expressing his intention to reform the jeonse system. As controversy spread, he again stated that the direction of reform would focus on banning or controlling unlimited gap investment. It is welcome for various rental arrangements to compete in the market. However, the policies the government has poured out with jeonse rentals as their objective should be comprehensively reviewed.

Given the current size of the jeonse market, it is unrealistic to expect jeonse to disappear and be entirely converted into monthly rent. That could also result in the collapse of the housing ladder that runs from monthly rent to jeonse to homeownership. Rather, since the government has distorted the jeonse market all this time, what is needed is a soft landing that gradually reduces the size of the jeonse market by shrinking the government’s role.

The ratio of jeonse loans should be reduced step by step, and reform of the housing subscription system should proceed in parallel. At present, one must maintain no-homeowner status in order to apply for housing subscriptions. It is also worth considering a new housing ladder different from the old one, in which people can purchase villas or officetels based on price and then move into apartments through the subscription system. At the same time, focusing on problems that have already come to light, a wider range of information should be transparently disclosed to tenants.

Younghoon Kim, Secretary General of the Economic Knowledge Network

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Original title: 전세제도, 이대로는 안 된다

Author: Young-hoon Kim

Date: 2023-06-05

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&idx=25704