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Jeonse: Private Lending in the Korean Real Estate Market

The Jeonse system is a product of South Korea’s development era during the 1960’s and ‘70s. This was a period of rapid urban migration, and in order to facilitate mobility, the South Korean government passed legislation to restrict banks from lending to real estate developers, landlords, or tenants. The idea of “Jeonse” or “helping one’s self” was born. ((South Korea’s Housing Market: Landlords are Having to Ditch a Century-Old Rental System, The ECONOMIST (Feb. 15, 2014), http://www.economist.com/news/finance-and-economics/21596566-landlords-are-having-ditch-century-old-rental-system-lumping-it.))

Jeonse is both a housing rental and informal lending scheme unique to South Korea. It is a private contractual agreement between tenant and landlord, which stipulates no monthly rental payments. Rather, the tenant raises a one time upfront payment (usually 40-90% of the property’s market value) and provides it to the landlord who is free to invest it for the duration of the lease. ((Id.)) At the end of the lease period (usually two years), the landlord returns the lump payment in full to the tenant but is permitted to keep any gains from his investments. ((Id.)) The tenant holds the home as collateral against the deposit. This system promotes interest-free lending to landlords who often re-reinvest the lump deposits in other properties or stash it away at the bank. Sun Dae-In, South Korean real estate market author, estimated that “half of all Jeonse money is used to finance a second or third property.” ((Id.)) Jeonse also simultaneously incentivized tenants to pool their savings as the “deposit would become their own home-purchase fund,” once their lease ended and they received the deposit back. ((Id.))

However, this lease system is considered outdated by some critics. In the past few years, both landlords and tenants seem to have been hurt by the scheme, as the benefits of the Jeonse system have slowly disappeared. Since 2008, both interest rates and home values have declined, resulting in an increase in Jeonse deposit prices. Moreover, there has been a mismatch between supply and demand for Jeonse contract homes. Many of the tenants in Jeonse contracts choose to “extend their contracts” and other landlords not participating in Jeonse deals are transitioning towards monthly rent contracts—thus, “higher demand is driving the prices up.” ((Choi Kyong-Ae, Jeonse Prices May Continue to Rise, KOREA TIMES (Jan. 26, 2014, 8:33 PM), http://www.koreatimes.co.kr/www/news/biz/2014/01/488_150543.html.))

The average Jeonse deposit has increased for 64 straight weeks and is 35% higher than in 2008. ((Derek Long, How do you Solve a Problem like Korea’s Dysfunctional Housing Market?, GUARDIAN (Jan. 20, 2014, 6:31AM), http://www.theguardian.com/housing-network/2014/jan/20/south-korea-housing-problem-jeonse-rent.)) Average Jeonse deposits are now at 65% of the market value of the house. ((Choi, supra note 7.)) According to Real Estate 114, a Seoul-based real estate information provider, the average Jeonse price for an apartment in Seoul last year was equivalent to 5 years and 8 months of income of urban worker households. ((Jeonse for Seoul Apartment Equivalent to 6 Yrs. Of Average Income of Urban Workers, MAEIL BUS. (Feb. 24, 2014, 1:46 PM), http://news.mk.co.kr/english/newsRead.php?sc=30800006&cm=English+News_&year=2014&no=295087&selFlag&relatedcode&wonNo&sID=308.)) This has forced many tenants (most who already struggle with raising the lump payment) to turn to banks in order to cover the jump in prices. Borrowing for Jeonse deposits has doubled since 2009 and is taking its toll on the middle class, which took on 75% of the $56 billion lent in the first half of 2013. ((Long, supra note 8.)) The Bank of Korea has stated that the national household debt totaled 991.7 trillion Won, leading to concerns that the enormous debt would slow down national economic growth. ((Song Su-Hyun, Housing Headache: Jeonse Homes Drying Up, KOREA JOONGANG DAILY (Nov. 25, 2013),

http://koreajoongangdaily.joins.com/news/article/article.aspx?aid=2980960.)) In response, the government recently passed an initiative to provide cheaper loans, with 1-2% interest rates from a state-run housing fund. This assistance, however, was limited to couples who earned less than 55 million Won. ((Id.))

The newfound reliance on bank loans severely undermines some of the main advantages of the Jeonse system. The “large cash deposits that tenants had to build up” protected the real estate market from over-valuation as it restrained price increases, and the high amounts of cash on hand provided buyers from a real estate bust as well. ((Id.)) The introduction of a third party (the bank) within the private contractual Jeonse agreements between landlord and tenant (the initial premise of Jeonse) has increased banks’ exposures to risky mortgages and effectively removed the advantages of the system.

Moreover, the Jeonse system has placed additional stress on tenants because many landlords have attempted to maximize the return on their deposits by investing in more real estate. However, real estate values have fallen in South Korea and many landlords are stuck with ever increasing interest payments. As a result, many of the tenants’ deposits are still tied up in other properties and landlords must take on even more debt in order to be able to pay back their expiring lease deposits on time or find new Jeonse tenants willing to front a higher deposit percentage. ((Kang Hyun-Kyung, Double-Check Jeonse Contract to Avoid Loss, KOREA TIMES (Oct. 21, 2013, 3:41PM), http://www.koreatimes.co.kr/www/news/nation/2013/12/180_144665.html.)) Some landlords have even taken steps to draft a contract with a potential tenant, explicitly stating that they have no debt at the time of the contract, but then “borrow money from lenders by offering the property as collateral just before finalizing the contract.” ((Id.)) The Bank of Korea also reported that 10% of the 3.7 million Jeonse landlords could have difficulty repaying the Jeonse money they owe to tenants. ((Id.)) Unfortunately for many tenants, South Korea law requires that tenants be compensated only after the first creditor. ((Kim Daye, Hidden Risks Behind Jeonse, KOREA TIMES (Aug. 12, 2012, 4:32 PM), http://www.koreatimes.co.kr/www/news/biz/2013/12/335_117194.html.)) Thus, if a landlord borrows money from a bank, tenants can lose all or part of their deposits.     In response to the risks associated with rising household debt, the South Korean government has introduced measures to assist tenants. The Korea Housing Finance Corporation passed a regulation, which enabled low-income tenants to borrow additional money to move into a new home when their landlords do not return their deposits as scheduled. ((Id.)) Additionally, The Ministry of Strategy and Finance as well as the Ministry of Land, Infrastructure, and Transport adopted a tax credit system aimed at transitioning away from the Jeonse system and into a monthly rent system. Under the new tax system, monthly rent payers received a tax refund of 600,000 Won. ((Song Su-Hyun, Government Tries to Shift Market to Monthly Rentals, KOREA JOONGANG DAILY (Feb. 27, 2014), http://koreajoongangdaily.joins.com/news/article/article.aspx?aid=2985576.)) On the other hand, Jeonse contract tenants received less government assistance as housing grant funds cuts and loan limits were instated to incentivize the switch to monthly rent. ((Id.))

Today, it appears the trend is shifting towards a small deposit plus monthly rental fee system, or Wolse. As of last year, 40% of landlords reported that they had switched from Jeonse to Wolse and had started to collect monthly fees. ((South Korea’s Housing Market, supra note 1.)) This shift is based on the fact that landlords can make more money off the interest of a small deposit plus monthly rental income rather than by investing a large sum at the bank (especially when interest rates are low). ((Yu Sun-Hui, Monthly Rent Rises as Landlords Favor Wolse Contracts, HANI (Sept. 15, 2011, 10:21 AM), http://www.hani.co.kr/arti/english_edition/e_national/496222.html.)) In addition to low interest rates, an aging population in South Korea means there is more demand for a steady stream of income (monthly rent). The aging landlords “no longer expected housing values to rise, so they shifted to Wolse monthly rent arrangements.” ((Id.)) Jeonse properties are still in the majority (making up over half of all rentals) but even these landlords have started to offer an option to substitute a monthly payment for an increase in the initial Jeonse deposit, effectively creating a hybrid rental scheme which will likely complement the Jeonse system in the future. ((South Korea’s Housing Market, supra note 1.))

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