The Real Estate Law Review: South Korea
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:
- 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;
- 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
- 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).
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 of the two most widely used types of investment vehicle in Korea, namely real estate fund (REF)2 and real estate investment trust (REIT).
The total amount of investments in REFs domestically 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 2019, the total amount invested in REFs domestically was approximately 45 trillion won, and the total amount invested both domestically and abroad was approximately 101 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). As of June 2021, there were a total of 2,214 REFs under management with combined net assets of 121 trillion won. The number of REFs and total amount of investments in REFs are 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). The year 2019 saw the creation of 50 new REITs; as of June 2021, there were 297 REITs in Korea with a total AUM of 70.2 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 growing significantly, driven by high interest by asset heavy conglomerates as well as support for the sector by the Korean government via regulatory reforms. As of June 2021, there were 13 publicly listed REITs in Korea (which is more than double the number of publicly listed REITS as compared to the end of 2018) with a total AUM of 7.5 trillion won.
Governmental approvals are generally not required for foreign persons to acquire real estate in Korea with the exception of land located in designated special areas (such as military protection areas). 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 that 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 via ordinary companies or vehicles with tax benefits such as an REF or a REIT.
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 among the investors is not subject to any cap on its maximum ownership.
Tax benefits currently available under the REF structure include:
- 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);
- dividend payment deduction for corporate income tax (no corporate income tax for the trust-type REF); and
- certain favourable treatment for property taxes as well as the aggregate real estate tax (see Section VII for a description of certain amendments affecting 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 are 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.
ii Institutional Private Fund
One of the changes introduced under the revised FSCMA, which went into effect on 21 October 2021, was to change the existing private equity fund (PEF) classification to an institutional private fund.
Under the PEF classification, only management participation type investment was possible, but the newly introduced institutional private fund can also invest in real estate, so institutional private funds are expected to be used as a real estate investment vehicle in the future.
An institutional private fund as compared to a REF:
- does not offer a tax exemption from the tripled acquisition tax rate imposed for acquisition of real estate located within the Seoul Metropolitan Area that is available to an REF3;3 and
- is more constrained in the range of investors that it can accept (i.e., institutional private fund investment is limited to institutional investors).
Nonetheless, because a related regulation that is connected to investor protection is relaxed compared to a general private fund, we anticipate that there will be room for utilisation of this type of investment vehicle depending on specific investment conditions (e.g., in the case of attracting institutional investors to set up a fund and investing in real estate loan bonds).
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). Owing 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 over 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:
- no single investor (together with its specially related persons) may own more than 50 per cent of the shares in a paper-REIT with exceptions for certain local pension plans;
- 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
- 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).
iv Project finance vehicle
A project finance vehicle (PFV) is an investment vehicle recognised by a Korean Corporate Income Tax Act and widely used for certain types of development projects that 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 as follows:
- formation of a PFV is relatively quick because governmental approval is not required (only filing with the local tax authority is required); and
- investors in the PFV can exercise a great degree of control over the operation and management of the PFV assets.
Key limitations are as follows:
- the PFV structure may be used only for large-scale development projects;
- a PFV has a limited life span; and
- there are some uncertainties regarding requirements for PFV qualifications.
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:
- the National Land Planning and Use Act (NLPUA), which regulates zoning and land use; and
- 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 and green) and, if applicable, sub-zoning designations (e.g., commercial areas may be subdivided into hub-commercial, general commercial, residential commercial and distribution commercial). A parcel of land may also receive other area-specific designations such as air-defence cooperation area, overcrowding restriction area and fire prevention area. 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 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 he or she 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:
- 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
- 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 in connection with the acquisition of real property for industrial purposes).
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.
Leases of business premises
The following two types of leases are most commonly used in Korea:
- a regular monthly lease similar to that found in many foreign jurisdictions; and
- 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, but strict criteria will apply to adjustment. 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.
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 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.
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:
- 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;
- publicly offered real estate funds; and
- a trustee operating a 'specific money trust' with 50 trustors or more.
Amendments to the Real Estate Investment Company Act were announced on 20 August 2019 and took effect as of 21 February 2020, and they were introduced to enhance the market's transparency for investors by increasing the amount of available information on REITs. Specifically, the amendments included newly introduced requirements whereby certain REITs designated by Presidential Decree are obligated to conduct and disclose credit assessments.
The Real Estate Investment Company Act was further amended on 22 December 2020, pursuant to which an asset management company is obligated to maintain business soundness and obtain approval if it intends to change any matters for which it has obtained licence approval, such as facility plan or shareholder composition.
As described in part above, the revised FSCMA, which came into effect on 21 October 2021, abolished the classification criteria for PEFs, which were previously divided into management participation-type PEFs and professional investment-type PEFs (hedge funds). Management regulations were unified and vehicle classifications reorganised into institutional PEFs and general private funds based on the investor type.
Investors eligible to invest in institutional PEFs are non-individuals, including a certain range of professional investors and other investors with expertise or risk-taking ability, and the scope is specifically stipulated in the Enforcement Decree of the FSCMA.
Regulations for general private funds were also reinforced to protect investors by requiring distributors, trustees and comprehensive financial investment companies to check and monitor the management of funds.
iii Local Tax Act
Amendments to the Enforcement Decree of the Local Tax Act were promulgated on 2 June 2020, eliminating the hitherto reduced property tax rate on land and the aggregate real estate tax exemption previously available to private REFs and REITs (subject to certain transitional rates and exceptions) compared to an incremental tax rate of up to 0.48 per cent for regular companies. 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 (in contrast to an incremental tax rate of up to 0.84 per cent for regular companies), private REFs and REITs will be subject to the same tax rates as regular companies.
iv Commercial Building Lease Protection Act
On 16 October 2018, certain amendments to the Commercial Building Lease Protection Act (CBLPA) became effective, which provided stronger protection for tenants regarding the renewal of lease term and goodwill. Tenants' right to demand lease renewal was increased from five years to 10 years (the period includes the renewal term), while tenants' exercisable period for collection of goodwill was increased from three to six months prior to the end of the lease term. The first aforementioned amendment applied only to leases newly executed or renewed after the effective date of the amendments, but the latter aforementioned amendment applied to all existing leases regardless of their execution dates.
On 29 September 2020, further amendments to the CBLPA adopted for the purpose of protecting commercial tenants whose businesses were disrupted by the covid-19 pandemic became effective. Prior to promulgation of the amendments, if the aggregate amount of outstanding and unpaid rents by a tenant was equal to or greater than three months' rent, the landlord had the right to, among other things, reject a tenant's request for renewal of a lease or terminate the lease (collectively, the Landlord's Rights) or both. The new amendments provided that, from the effective date of the amendments until 29 March 2021 (the Grace Period) a landlord could not exercise any Landlord's Rights that were triggered by unpaid rents that arose during the Grace Period. The amendments do not prohibit the landlord from exercising its other rights under Korean law arising from unpaid rent, such as the right to receive damages for the delayed rent and the right to deduct the overdue rent from the tenant's security deposit.
Outlook and conclusions
Overall domestic Korean transactions began to recover from the second half of 2021, and the domestic market is now in a state of high volume and fierce competition. South Korea was one of Asia-Pacific's most active markets in 2021; seven of the past eight quarters have set new records for investment volumes, while pricing has increased 20 per cent over the past year.
As the impact of the covid-19 pandemic continued through 2021, we have seen impacts differ significantly between sectors. There has been a strong focus on logistics facility and office building investment. The hotel and retail sector continues to struggle and, over the past 18 months, numerous hotels have been put up for sale in connection with corporate and portfolio restructurings and the market has seen numerous conversions of hotels into office or residential developments. There has been continued growth in data centre investment, but continued growth of opportunities has been somewhat constrained by limitations on the amount of available land for these types of projects. We expect that electricity impact assessment regulations are likely to be introduced by the government in the near future.
Residential housing prices have risen significantly, particularly in Seoul; the government continues to implement policies (regulations) in an attempt to prevent overheating of the market, making it difficult for institutions to invest heavily in this industry (excluding construction).
Asset management companies for domestic funds and REITs are very active in the real estate sector, and investment via public traded REITs and public offering funds are a growing investment trend.
Outbound investment has also picked up sharply, with a focus on logistics and data centres, including pre-purchase and development stage logistics investments. We have also seen some additional diversification in deal structuring with these types of target investments, including formation of new blind funds to pool funds for such investments, as well as investments into third party blind funds managed by third party managers.
The direction of the real estate sector in the coming year will be impacted by the type of policy decisions made by the government in the face of the continued pandemic as well as macroeconomic factors, such as market liquidity and global and domestic interest rates.
1 Jin Ho Song, Sang Min Lee and Ik-Hyun Kwun are senior attorneys and David H Pyun is a senior 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.
3 Certain tax benefits are recognised for an institutional private fund (e.g., exemption of corporate income tax subject to certain specified conditions).