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Saturday, October 8, 2011

Seoul’s residential market

I visited South Korea recently in connection with a valuer (called appraiser there) meeting and although this was not my first visit, I was nonetheless impressed with the generally high level of efficiency in the country. Hassel free, from the well organised public transport, to the high service levels in the hotel and retail sectors.

The smooth and efficient bullet train ride from Seoul to Gyeongju, covering about 400 kilometres in two and a half hours was also impressive.

Not so efficient, in my opinion however, is the housing market in Seoul. Possibly a bubble that will burst, if it does not deflate quietly (which is unlikely), or one that risks growing bigger and then bursting or deflating. Astute policy nudging and/or more in-depth, knowledge-based decision making by market participants are key to a smooth “landing”.

Greater Seoul has 20 million inhabitants and that is 40% of the population of the country, a rather high percentage for a capital city. The Korean Peninsula is mountainous.

The per capita GDP of the country is about RM60,000 (based on a conversion of 1:3) as compared with Malaysia's, which is about RM21,000. The average monthly household income in Seoul is RM12,000. In Greater Kuala Lumpur it is about RM6,000.

The average house price in Seoul is about RM1.4mil and this means that on average the house price is close to 10 times household income, and this is viewed with some consternation by Koreans. About 10 years ago the average house price was 6 times household income, also slightly elevated as measured based on a global long term benchmark for developed countries at three times.

Kuala Lumpur typically has house prices at a long term relationship of around 4 to 4.5 times annual household income, but in many hot spots, in the past few years, there has been a run up to more than 10 to 15 times when viewed from an average household. And it may surprise many, that despite frequent comparisons with high-end condominiums in Singapore, HDB flats in Singapore, that house the majority of households in Singapore, the relationship is only about three times.

Japan which neighbours Korea had a property bubble in the late 1980's and prices soared to close to 20 times annual household income, only to come down crashing, and 20 years later, most of the medium sized cities in Japan have a corrected and stable relationship of about five to six times but with the Tokyo suburbs closer to 10 times.

Net yields, the second driving fundamental in the housing market, in Seoul are nothing much to speak about, being about 2% per annum. In Kuala Lumpur yields have slipped below the 3% benchmark for the ubiquitous double story terrace house. This figure of 3%, in the hierarchy of property yields, is generally acceptable when capital appreciation possibilities are a possibility but when such possibilities dim then a higher return should be the order of the day.

My Valuer friends in Seoul opine that much has to do with “Chonsei” system in Korea that has led to the high house prices in Seoul, apart from a long, inordinate support for the construction industry that has now resulted in construction being a high 20% of GDP, and the other usual culprits of easy money and exceptionally low interest rates.

This system of owning houses for owner occupation and investment is predicated on rising house prices. Landlords, for example, rent out houses by getting the tenant to set aside in a finance company or bank a lump sum for rent over two years and take the interest as rent.

Interest, which in the past, and due to artificial constructs was high, has come down as the economy irons out these constructs as it modernises further. The landlords in the past were happy with this because their focus was on capital appreciation, which was sustained and high.

But of late, especially since the middle of the last decade, house prices have stopped rising. The market is now normalising and rents that drive values are taking hold and tying values to more normal returns. The process will continue further as the Koreans move inexorably towards a market where house prices are tied to household incomes and driven by rental returns.

The housing market in any modern economy is an important pillar. It is a store of household wealth and when it stalls or falls it has an impact, sometimes an outsized impact, on the economy.

In the United States, house prices went up (and was allowed to go up by design or mistaken notions) against governing fundamentals and are now on a downward trajectory to the detriment of the economy at large and the global economy. A recent article in the Wall Street Journal shows the pre-bubble average house price increase from 1988 to 2000 to be 3.6% per annum and it shot up to 10.4% per annum between 2000 and 2007, outstripping average household income increase.

The US Bureau recently revealed that median household income in the United States in 2010 fell to US$49,445, the lowest in more than a decade. In Malaysia, our country-wide compounded annual average house-price increase in the period 2000 to 2009 was about 5%, running neck to neck with household-income increases.

Regulators are obliged to cast a watchful eye on the housing market and know the driving fundamentals, and where and when needed, nudge the market through astute policy intervention.

Post 2008 Global Financial Crisis, most countries in the region, including ours, have taken policy measures targeted at the housing market as against mainly broad brush monetary policy measures of the past, to stamp out excessive speculation and keep the market tied or running not too far from underlying fundamentals. This no doubt requires constant monitoring of the market, and in particular, before and after any policy implementation.

On a broader perspective, the market should be allowed to function as a free market and any intervention kept to a minimum and only to iron out free market imperfections.

Elvin Fernandez believes in the free market and timely nudging by policy makers and key market participants to iron out any, and only where needed, imperfections in the system.

By The Star (by Elvin Fernandez)

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