I INTRODUCTION TO THE LEGAL FRAMEWORK
With respect to ownership of real estate, Korean law only recognises complete ownership, which is similar to the common law concept of a fee simple absolute. Korean law does not recognise partial estates, such as life estates (ownership lasting only during a certain person's lifetime), conditional estates (ownership lasting only so long as certain conditions remain satisfied) and future interests (i.e., ownership arising only upon the occurrence of a future contingency). Leasehold interests, superficies rights (the right to use land without ownership) and certain easements are also recognised under Korean law.
In Korea, real estate may be held by sole ownership or by tenancy in common, where two or more persons own an undivided interest (which may or may not be equal) in real estate with no right of survivorship. Joint tenancy (where two or more persons own an undivided and equal right to enjoy the property during their lives, with the right of survivorship) and tenancy in the entirety (where the joint tenancy is between a husband and a wife) are not recognised under Korean law. Depending on the relationship among the joint owners, tenancies in common can be divided into: (1) gongyu, where the joint owners are not related and each owner has full right to dispose of its ownership interest independently from the other owners; (2) hapyu, where joint owners own the real property as a partnership such that until the partnership is dissolved, the real property, as well as interests in the partnership, can only be transferred with the consent of all of the owners; and (3) chongyu, where real property is owned by an association such as a religious organisation and disposition requires the consent of the requisite proportion of the members of the organisation).
In Korea, a separate title registry exists for land and buildings, which constitute separate real estate. Title registries are maintained by the court registrar. In addition, the local government maintains a separate ledger (containing detailed descriptions of the real property) for land and buildings.
Registration in the title registry is generally required to perfect real estate title transfers (except for transfers arising by operation of law). Registration of title constitutes prima facie evidence of valid title. The order of priority among different interests in real estate (including security interests) is generally determined by the order of registration in the title registry.
The Korean title registry involves 'registration' of interests, rather than 'recording' of interests. Thus, while the information shown in the title registry is public information, the underlying documents creating such interests, which are required to be submitted to the court registry in connection with the registration, are generally not publicly available (except trust agreements).
There is no state guaranty of title. Title insurance is available but has not been widely used due to the fact that title registration generally constitutes prima facie evidence of valid title.
Real estate transactions are mainly governed by the Civil Code, Commercial Code, Real Estate Registration Act (creation and maintenance of title registries), Act on Real Estate Transaction Report, Etc. (procedures for reports and approvals on real estate acquisitions including by foreigners), National Land Planning and Use Act (zoning and land use) and Building Code (construction and building use).
Depending on the particular transaction, certain additional laws may apply, such as the Industrial Complex Act (development and use of industrial complexes and establishment of factories) and Act on Free Economic Zone (tax benefits to qualified investors in real estate located in free economic zones).
II OVERVIEW OF REAL ESTATE ACTIVITY
The Korean real estate investment market has continued to demonstrate strong growth. Foreign investors continue to actively invest in Korea's commercial real estate market, driven by relatively higher investment yields as compared to other mature Asian markets, low volatility and comparatively favourable interest rates. These trends are reflected in the continued investment growth in the two most widely used types of investment vehicles in Korea, real estate funds (REFs)2 and real estate investment trusts (REITs).
The total amount of investments in REFs was over 7 trillion won in September 2008, just before the global credit crisis. That amount steadily grew to 11 trillion won by December 2010 and more than doubled in the span of the next five years, reaching 23 trillion won by December 2015. In December 2018, the total amount invested in REFs was approximately 36 trillion won, over 98 per cent of which was invested into private real estate funds (i.e., funds offered privately to a limited number of institutional investors such as pension plans, financial institutions and foreign private equity funds). The total amount of investments in REFs is expected to continue to grow.
In addition to REFs, the Korean REIT market has continued to demonstrate strong growth, with a compound annual growth rate of almost 30 per cent between 2012 and 2018 in terms of assets under management (AUM). 2018 saw the creation of 32 new REITs; as of September 2019, there are 232 REITs in Korea with a total AUM of 46.8 trillion won. The use of REITs as a real estate investment vehicle in the residential sector has soared since 2014, and there has been a continued growth of REIT investments in office buildings, retail properties, and mixed use properties.
While the majority of REITs in Korea are private REITs, the publicly listed REIT market is also expected to grow, driven by high interest in listing by asset heavy conglomerates as well as support for the sector by the Korean government via regulatory reforms.
III FOREIGN INVESTMENT
Governmental approvals are generally not required for foreign persons to acquire real estate in Korea. However, under the Act on Real Estate Transaction Report, Etc., acquisition by a foreign person of land located in Korea, either directly or indirectly through a company the majority interests of which are owned by a foreign person, must be reported to the local government. In lieu of filing such report on acquisition by foreign persons, a foreign purchaser may file a real estate transaction report pursuant to the same act (i.e., Act on Real Estate Transaction Report, Etc.), which is required to be filed in connection with all real estate acquisitions in any event.
Certain tax incentives may also be available in connection with certain foreign investments made in certain designated foreign investment zones or to certain foreign invested enterprises which provide certain qualified high-level technology.
While direct acquisition is also possible, foreign companies generally acquire real estate in Korea through special purpose vehicles, whether it be via ordinary companies or vehicles with tax benefits such as an REF or a REIT.
IV STRUCTURING THE INVESTMENT
Korean law provides flexibility as well as certain tax benefits for various investment structures. The following are investment structures commonly used in real estate investments in Korea:
REFs have become the investment vehicle most frequently used for collective Korean real estate investments. Among the various types of REFs recognised by the Financial Investment Services and Capital Markets Act (FSCMA), the trust-type REF has been commonly used due to the relative ease with which a trust-type REF can be established, since the structure does not involve the incorporation of an entity. The company-type REF is another form that is often considered, especially among foreign investors. REFs should have at least two or more investors (with certain required minimum investment amounts) while a single investor amongst the investors is not subject to any cap on its maximum ownership. Tax benefits currently available under the REF structure include: (1) no otherwise applicable tripled acquisition tax rate (i.e., the registration tax component of the acquisition tax) imposed for acquisition of real estate located within the Seoul Metropolitan Area (however, REFs will still be subject to the heavy acquisition tax if the percentage of its investments in real estate does not exceed 80 per cent of its assets); (2) dividend payment deduction for corporate income tax (no corporate income tax for the trust-type REF); and (3) certain favourable treatment for property taxes as well as the aggregate real estate tax (see Section VII for certain proposed amendments effecting REF tax treatment). One notable feature of the REF structure is that, because the FSCMA's intent was to provide tax benefits to passive investors in an REF, investors by statute have only a limited amount of control over the day-to-day management and operation of REF assets, which management and operation is instead required to be undertaken by a licensed asset management company (AMC). REFs are also subject to a one-year mandatory holding period before it can dispose of its assets, with certain limited exceptions.
REITs are also a commonly used investment vehicle for real estate investment in Korea. There are three types of REITs: K-REITs, paper REITs, and corporate restructuring -REITs (CR-REITs). Due to the comparatively non-favourable tax treatment of K-REITs and stringent requirements for internal management, K-REITs are not widely used by foreign investors.
A paper-REIT is a special purpose company and thus required to assign management functions to an AMC, a business trustee and a custodian. The custodian as trustee of a paper-REIT holds the title to the assets. One of the advantages of a paper-REIT compared to the CR-REIT is that development projects are possible up to 30 per cent of total assets of a paper-REIT when they meet the listing requirement described below. Some of the downsides of a paper-REIT include: (1) no single investor (together with its specially related persons) may own more than 40 per cent of the shares in a paper-REIT with exceptions for certain local pension plans; (2) at least 30 per cent of the shares in a paper-REIT must be publicly offered within a stipulated period of time with exceptions for certain local pension plans; and (3) a paper-REIT should go public when it satisfies relevant IPO regulations. Due to these disadvantages, this structure may not be available to an investor (without involving investment by pension plans) intending to acquire title via the REIT structure and hold a majority stake of such REIT. Tax benefits of a paper-REIT are similar to that of an REF (see above) in most material respects.
CR-REITs are restricted in that they are only permitted to invest in real estate assets sold by companies undergoing corporate debt restructuring (i.e., the seller should use the proceeds from the sale to repay its debt).
iii Project finance vehicle (PFV)
A PFV is an investment vehicle recognised by a Korean Corporate Income Tax Act and widely used for certain types of development projects which require a substantial amount of investment funds. A PFV is a paper company without having any full-time employees; thus a PFV should delegate its day-to-day asset management activities to an asset management company (which is not required to be licensed and, instead, needs to own a prescribed equity stake in the PFV). In the PFV structure, one or more financial institutions must hold at least 5 per cent of the equity interest in the PFV. In addition to various tax benefits, the key advantages of the PFV structure are that (1) formation of a PFV is relatively quick because governmental approval is not required (only filing with the local tax authority is required); and (2) investors in the PFV can exercise a great degree of control over the operation and management of the PFV assets. Key limitations are that (1) the PFV structure may be used only for large scale development projects; (2) a PFV has a limited life span; and (3) there are some uncertainties regarding requirements for PFV qualifications.
V REAL ESTATE OWNERSHIP
The Ministry of Land, Infrastructure and Transport devises a basic land use plan at the national level. Local governments are responsible for establishing more detailed land use plans at the local level.
The main laws governing land use include (1) the National Land Planning and Use Act (NLPUA), which regulates zoning and land use and (2) the Building Code, which regulates construction and building use. Under the NLPUA, every parcel of land receives one or more zoning (e.g., residential, commercial, industrial, green, etc.) and if applicable, sub-zoning designations (e.g., commercial areas may be subdivided into hub-commercial, general commercial, residential commercial, distribution commercial, etc.). A parcel of land may also receive other area-specific designations such as air-defence cooperation area, overcrowding restriction area, fire prevention area, etc. In addition, each parcel of land also has a specific land usage designation, such as building site, factory site, farmland site and forest site. Furthermore, under the Building Code, every building has a registered purpose of use, which should be complied with by the user of the building. The above designations determine the permitted use of a particular parcel of real estate.
Other specific laws may apply for certain types of development, such as development of industrial, logistics and residential complexes and redevelopment of destroyed city areas.
Under the Framework Act on Environmental Policy (FAEP), a polluter is generally responsible for remediation of and compensation for damage arising from environmental pollution caused by it. The FAEP is a strict liability statute. Accordingly, if one is shown to have caused pollution, which in turn is shown to have caused damage, the person will be liable whether or not it was negligent or otherwise at fault.
Furthermore, under the Soil Environment Preservation Act, with respect to soil contamination liability, certain persons, including owners, occupants and operators of certain facilities likely to cause soil contamination at the time of the soil contamination and acquirers of such facilities or even just the land under such facilities, are deemed to be polluters and may be held strictly liable for such contamination.
A lessee of real property (who is not operating the facilities) may also be liable under general tort theories for damages caused by contamination of land, even if the contamination existed prior to its occupation of the land.
In connection with the acquisition of real property, a purchaser is required to: (1) pay an acquisition tax (including surtax) at the rate of 4.6 per cent of the purchase price (or 9.4 per cent, if the real estate is in the Seoul Metropolitan Area and acquired by the head office or a branch office); and (2) purchase national housing bonds issued by the government in an amount equal to around 5 per cent of the government-posted standard value for land, and for non-residential buildings, around 2 per cent of the government-posted standard value (foreign invested entities are exempt from this national bond purchase requirement).
The seller must collect from the purchaser a 10 per cent VAT on the purchase price of a building for remittance to the tax authorities. VAT is not charged if the buildings are transferred as part of a comprehensive business transfer.
iv Finance and security
A mortgage over real estate is the most common form of security used to secure a real estate loan. A mortgage interest must be registered in the applicable title registry in order to be enforceable against third parties. Once registered, the mortgage holder has priority over subsequently registered security interests over the property. A lender may also require a pledge of the borrower's rights and claims to all revenues generated from the property.
A security-purpose trust is also commonly used in real estate financing transactions. A security-purpose trust must also be registered in the relevant title registry in order to be enforceable. Under the security-purpose trust structure, the borrower transfers legal ownership of the property to a trustee entrusted with the management of the property for the benefit of the trust beneficiaries (typically the beneficiaries will be the lenders and the borrower, as the most subordinate beneficial interest holder) until repayment of the loan. Upon repayment, the trust will be terminated and the entrustment will be deregistered, whereupon title to the property will revert back the borrower.
VI LEASES OF BUSINESS PREMISES
The following two types of leases are most commonly used in Korea: (1) a regular monthly lease similar to that found in many foreign jurisdictions and (2) a cheonsei, which is a lease form unique to Korea. Under a cheonsei, the tenant remits a fairly large lump sum key money deposit to the landlord at the outset of the lease in exchange for a reduction, or even a complete elimination, of periodic rental payments. At the end of the cheonsei term, the landlord must return the principal amount of the key money deposit (but not periodic rental payments, if any) to the tenant. The landlord is not required to account to the tenant for the use of the key money deposit during the term of the cheonsei and any interest earned thereon belongs to the landlord. The key money is essentially an interest free loan made to the landlord.
Parties can contractually decide and agree upon the lease terms, except for certain mandatory provisions designed to protect tenants. In addition, certain commercial leases (Protected Commercial Leases) and residential leases are protected under the Commercial Building Lease Protection Act and the Housing Lease Protection Act, respectively.
There is no legal restriction on rent levels, which are subject to negotiation between the parties. Parties generally agree upon a mechanism for periodic rent adjustment, either based on a fixed rate of increase or by reference to an index such as the consumer price index or rate of inflation. Under the Civil Code, either the landlord or the tenant can request a rent adjustment if existing rent levels become inappropriate due to changes in the amount of public charges or other changes in economic situation. Protected Commercial Leases are subject to a 5 per cent cap on annual rent increases in cases where a landlord requests such rent adjustment due to economic changes.
The extension of lease term is subject to negotiation between the parties. Unless expressly agreed in the lease, a tenant does not have a unilateral right to renew its lease at the end of the lease term. However, if a tenant under a Protected Commercial Leases requests renewal, the landlord may not refuse unless it has a justifiable reason or the total lease term of such tenant has exceeded 10 years (increased from five years to 10 years in 2018.
Leasehold interests are created contractually. However, a leasehold contract does not, in itself, secure the return of the deposit on expiry or termination of the lease. In addition, the contract does not guarantee the use of the leased premises for the entire lease term if certain adverse events take place (such as the transfer of the property by the landlord) while protected commercial leases provide for automatic assumption by new owners. To protect these rights, a tenant may, with the consent of the landlord, register its interests by way of a leasehold or a kun-mortgage in the applicable title registry. Upon registration, these interests will secure the tenant's right to a return of the deposit or use of the premises for the full lease term, or both, depending on the type of right registered.
VII DEVELOPMENTS IN PRACTICE
i Amendments to the Real Estate Investment Company Act
As of 30 December 2016, AMCs became allowed to act as an AMC for REITs in addition to REFs upon obtaining a licence. AMCs qualified for private or public REFs can apply for a licence to act as an AMC of a REIT, provided that the subject AMC has paid-in capital of at least 7 billion won. However, AMC employees responsible for the investment and management of REIT assets may only engage in REIT-related duties. Furthermore, the respective divisions within an AMC performing both REF- and REIT-related functions must be independent with separately kept accounting.
Exemption from public offering obligations for REITS was also modified in amendments that became effective on 15 November 2018. The amendments increased the existing minimum investment threshold to exempt a REIT from the public offering requirement when the National Pension Service or any other investors designated by Presidential Decree subscribe to 50 per cent or more of the total number of shares issued by a REIT (which was increased from the previous threshold of 30 per cent). The amendments also broaden the scope of the types of investors that will enable a REIT to qualify for this public offering exemption. These broadened categories include: (1) professional investors (e.g., financial institutions and listed companies) that invest in a REIT and with respect to each of whom 70/100 or more of its total assets comprise equity interest or debt securities in publicly offered REITs or equity interest or debt securities in a CR-REIT; (2) publicly offered real estate funds; and (3) a trustee operating a 'specific money trust' with 50 trustors or more.
Amendments to the Real Estate Investment Company Act announced on 20 August 2019 will take effect as of 21 February 2020. The amendments were introduced to enhance the market's transparency for investors by increasing the amount of available information on REITs; specifically, the amendments include newly introduced requirements whereby certain REITs designated by Presidential Decree are obligated to conduct and disclose credit assessments.
Amendments to the FSCMA adopted in 2015 recognised and created the 'professional qualified investors fund' (PQIF) as a new category of collective investment vehicles. The PQIF encompasses all collective investment vehicles marketed solely to qualified investors, whether for investment in real estate or other financial products. Prior to the 2015 amendments, collective investment vehicles established under the FSCMA for purposes of investing in real estate were referred to as a 'real estate fund' (i.e., REF).
A PQIF has certain eligibility requirements for investors that are certain institutional investors as specified under the law or are listed companies. Other than these institutional investors or listed companies, an investor must invest a minimum of 300 million won (or 100 million won if the PQIF has a loan-to-value ratio (LTV) of 200 per cent or less) to be an eligible investor.
As a recent development, on 14 November 2019, the Financial Services Commission (FSS) announced its plans to implement systematic improvements for protection of investors. The FSS plans to increase the minimum required investment amounts in a PQIF (i.e., REF) from the current 100 million won to 300 million won and for an LTV over 200 per cent, 500 million won respectively. The foregoing amendment plan has not yet been promulgated, and a clear promulgation or implementation date has not been indicated by the relevant authorities.
iii Local Tax Act
Amendments to the Enforcement Decree of the Local Tax Act were announced on 19 April 2019 (which has not yet been promulgated), eliminating the hitherto reduced property tax rate on land and the aggregate real estate tax exemption previously available to private REFs and REITs. Hence, while public REFs and REITs will continue to enjoy the reduced property tax of 0.24 per cent (additional 0.14 per cent for city areas) and no aggregate real estate tax, private REFs and REITs will be subject to the same tax rates as regular companies. The foregoing amendments have not yet been promulgated, and a clear promulgation or implementation date has not been indicated by the relevant authorities.
iv Commercial Building Lease Protection Act
On 16 October 2018, amendments to the Commercial Building Lease Protection Act became effective. The amendments provide stronger protection for tenants regarding the renewal of lease term and goodwill. Tenants' right to demand lease renewal has increased from five years to 10 years (the period includes the renewal term), while tenants' exercisable period for collection of goodwill has been increased from three to six months prior to the end of the lease term. The former amendment applies only to leases newly executed or renewed after the effective date of the amendments, but the latter applies to all existing leases regardless of their execution dates.
VIII OUTLOOK AND CONCLUSIONS
Logistics centres and warehousing facilities continue to be high demand in Korea. 2018 and 2019 saw active investments in these sectors, and both domestic and foreign investors continue to show much interest due to the potential for higher return as compared to office buildings. Online shopping trends are continuing to drive the demand for cold storage warehouses. Location continues to be the key factor in successful investment of logistics facilities, and logistics centres located in Seoul Metropolitan Area continue to be very popular with high occupancy rates.
Despite the original outlook for the Korean real estate market projected for 2018 and 2019, real estate investment turned out to be very active for both years. Office building transactions were higher in total transaction value than ever before, and 2018 and 2019 saw an increase in foreign investments from Europe and the US and a decrease in the number of Chinese investors.
There have been increasing interest in, and plans for public listing of, REFs and REITs as an additional means of fundraising and an exit strategy option for owners and investors. This trend is expected to continue, and the scope broadened to include public listings of construction companies and asset management companies.
1 Hyoung Soo Kwon and Jin Ho Song are senior attorneys and David H Pyun is a foreign attorney at Kim & Chang.
2 Although the official designation for this type of vehicle is now part of the broader 'professional qualified investors fund' concept, the term REF remains commonly used in Korea and in the real estate industry.