The Real Estate M&A and Private Equity Review: South Korea
Overview of the market
Since the enactment of the Real Estate Investment Trust Act (the REIT Act) in 2001 and the introduction of the real estate fund (REF) as an investment vehicle pursuant to the Indirect Investment Asset Management Business Act (which was later merged into the Financial Services and Capital Markets Act (FSCMA)) in 2004, commercial real estate transactions have migrated from traditional models to investment vehicle-oriented models. REFs, as well as real estate investment trusts (REITs), have been widely used for real estate investment and transactions and have become major players in the Korean commercial real estate market.
The tables below show that numbers and investment amounts of such investment vehicles have increased in recent years.
|December 2016||December 2017||December 2018||December 2019||December 2020|
|No. of REFs (private REFs)||878 (858)||1,175 (1,146)||1,506 (1,470)||1,933 (1,885)||2,116 (2,054)|
|Public offer (100 million won)||12,594||19,866||23,290||32,234||31,176|
|Private offer (100 million won)||444,349||578,179||732,174||951,146||1,082,829|
|Total (100 million won)||456,943||598,046||755,464||983,380||1,114,005|
Source: Korea Financial Investment Association.
|No. of REITs||169||193||219||248||282|
|Total equity (100 million won)||107,344||127,340||145,342||171,236||N/A|
|Total assets (100 million won)||250,225||342,262||432,360||489,788||613,000|
Source: Ministry of Land, Infrastructure and Transport, Korea Association of Real Estate Investment Trusts.
The real estate investment market in South Korea is mainly focused on office buildings located in the main business districts in Seoul. Traditionally, the main business districts of Seoul comprise the Central Business District (CBD), Gangnam Business District (GBD) and Yeoido Business District (YBD). Real estate investment is not limited to Seoul and, as explained in Section VI below, while there is a growing trend of investment in logistics and distribution centres located in Seoul metropolitan area, it is still helpful to classify and keep in mind the aforementioned major business districts in Seoul.
Recent market activity
Real estate investors choose one or more of the investment vehicles described in Section III below, depending on their needs and situations. Traditionally, relevant transactions occur in the form of transfer of ownership of real estate itself, and share deal, merger, spin-offs or hostile takeovers of investment vehicles are difficult to be found. Thus, considering such market practices and trends, the examples below describe recent major market activities in Korea without distinguishing whether they are real estate M&A transactions or private equity transactions:
In 2020, the transaction volume of the Korean commercial real estate market was approximately 17.5 trillion won, which is the largest that it has ever been, despite the covid-19 pandemic. In the same year, a number of prime office buildings were constructed in the three major business districts of Seoul (CBD, YBD and GBD), supplying a total of 716,567 metres squared – in particular, most new office buildings were concentrated in YBD, including Parc One (total floor area of approximately 360,000 metres squared) and Yeoido Post Office Building (total floor area of approximately 69,110 metres squared), which constituted more than 60 per cent of the total of newly supplied buildings, thereby resulting in a steep increase in vacancy rate within a short amount of time.
Moreover, in the first half of 2020, the transaction size of new leases was cut down to around a half compared with the same period of 2019 – largely influenced by covid-19. However, the lease market was soon revitalised during the second half of 2020. Regarding YBD, LG Energy Solution Co., Ltd., a fast-growing battery manufacturer, leased 12 floors of Parc One, and Yeoido Post Office Building also rented out several floors to large-sized securities companies. As a consequence, despite a large increase in supply and increased numbers of people working from home caused by covid-19, an average rent for prime-level office buildings in central Seoul rose by up to 1.9 per cent compared with the last year.
In the case of retail business, covid-19 caused a rapid drop in the sales turnover of offline stores while a vacancy rate increased. However, the suburb areas continue to be developed by constructing large-sized shopping malls and outlet malls. In 2020, Hyundai Premium Outline Namyangju Space One (total floor area of approximately 130,115 metres squared) and Shinsaegae Starfield Ansung were newly opened.
Furthermore, an increase in single households and a growth of online shopping malls accelerated by covid-19 caused continuing growth of logistics and distribution centres and approximately 1,750,000 metres squared of logistics and distribution centres (constituting 27 transactions with the transaction volume of 2,340 trillion won in total), which is the largest volume of supply in history, were supplied in Seoul Metropolitan Area.
Real estate companies and firms
In addition to the general forms of corporations: joint-stock corporation and limited liability company under the Korean Commercial Code (KCC), there are certain special forms of real estate investment vehicles under Korean law – specifically, REIT, REF and Project Financing Vehicle (PFV).
In essence, REITs require public offering, but under certain exceptions, they can be established and operated privately. REF also has both public-offering funds and private-placement funds. Accordingly, this chapter will not distinguish between publicly traded REITs, real estate operating companies and real estate private equity firms, but instead will explain each type of investment vehicle recognised under Korean law.
REITs are established and regulated by the REIT Act and are principally regulated and supervised by the Ministry of Land, Infrastructure and Transportation (MOLIT). However, as the legal form of a REIT is a joint-stock corporation under Korean law, matters that are not specifically provided in the REIT Act will be governed by the KCC and matters relating to public offering and listing will be governed by the FSCMA.
Depending on the operation methods, REITs can be classified into:
- self-managed REITs;
- REITs managed by an asset management company; and
- corporate restructuring REITs (CR-REITs).
Among those, CR-REITs are used solely for the special purpose of corporate restructuring, and are explained further in Section V, below. A REIT that is managed by an asset management company is a paper company and its asset management are handled by a separate asset management company. Self-managed REITs are operated in the same way as ordinary corporations; in other words, business decisions are made by the board of directors and at shareholders' meetings but are subject to more legal restrictions compared with REITs managed by an asset management company. For example, self-managed REITs are required to have more than five asset management professionals working there. For this reason, self-managed REITs are less preferred by the investors.
To establish an REIT, a business approval issued by the MOLIT is required. In addition, REITs are subject to the following restrictions under the REIT Act:
- a minimum capital requirement of 5 billion won;
- the REIT shall offer at least 30 per cent of its shares to the general public within six months of obtaining business approval from the MOLIT;
- the REIT shall not have any single shareholder that owns more than 50 per cent (with certain exceptions);
- the REIT shall become a listed company if it meets the qualifications of a listed company under the FSCMA; and
- the REIT shall distribute not less than 90 per cent of its distributable income to its shareholders
Furthermore, assets of REITs must be invested and operated through:
- acquisition, management, improvement and disposition of real estate;
- real estate development business;
- real estate lease;
- sale and purchase of certain security;
- deposit in financial institutions;
- acquisition, management and disposition of legal rights to use real estate, such as surface right, leasehold right; or
- acquisition, management and disposition of beneficiary rights to real estate trust.
In this regard, the following restrictions are applicable:
- at least 70 per cent of the assets shall be invested in real estate;
- regarding requirements for real estate development projects invested: the investment ratio shall be set by shareholders' resolution and the business plan is required to be confirmed by a licensed real investment consulting service company; and
- there shall be prohibition against disposition of real estate for a specific time period stipulated in the articles of incorporation, not exceeding one year for domestic real estate or five years for foreign real estate.
REITs have become popular in projects involving the development of multipurpose buildings having both residential and commercial units, such as hotels, department stores, supermarkets and retail stores.
REFs are collective investment vehicles governed by the FSCMA. REFs may be structured in the form of a trust, a corporation or an association. The most common type of REF formed by investors is the trust-type REF. While there are no substantial differences among these types of REFs in terms of benefits or advantages, a trust-type REF is preferred by investors because it is relatively easier or simple to form a trust-type REF compared to other types of REF. Unlike REITs, REFs are not subject to certain legal requirements such as public offering or listing, dividend distribution and maximum ownership caps on single investors. As such, REFs are currently the most popular investment vehicles used by real estate investors in Korea.
To establish a REF, at least two or more persons are required and the establishment of a REF must be registered with the Financial Services Commission (FSC).
A REF is required to manage its assets through an asset management company with equity of 2 billion won or more and with five or more asset management professionals. As REFs were initially permitted as an indirect investment or collective investment vehicle, investors are prohibited from directly making decisions on matters relating to the management of assets owned by a REF.
Moreover, at least 50 per cent of the assets must be invested in real estate. A REF must invest in:
- real estate;
- derivative products based on real estate;
- loan to corporation related to real estate development;
- development, management, improvement, lease or operation of real estate; or
- securities relating to real estate.
However, when investing in real estate development, a REF must obtain confirmation on its business plan from an independent appraisal company. Further, if a REF acquires domestic real estate, it must hold and maintain ownership thereof for at least one year.
A PFV is one of the forms of investment vehicle used for real estate development projects. It is difficult, however, to ascertain accurate data and information relating to PFVs as they are only registered with local tax offices in the relevant jurisdictions, instead of being governed by a single central agency, namely, the National Tax Service.
A PFV is established as a joint-stock corporation under the KCC for the purpose of engaging in the business of facility investment, social indirect capital facility investment, development of resources, or any other specially designated business that requires a considerable investment of time and capital and distribution of earnings to its shareholders. A PFV is a paper company and must not have any employees or full-time officers or directors. It is based on the Corporate Income Tax Act and enjoys certain tax benefits, namely, exemption from corporate income tax if it distributes 90 per cent or more of its distributable income as dividends.
PFVs have been widely embraced by investors because they only require a report to the relevant tax office in addition to general incorporation process; and they are not subject to other reporting requirements (while the asset management company of a REF has reporting obligations to the FSC and REITs are required to submit a quarterly business report to the MOLIT). In addition, PFVs are attractive among investors as their participation in the decision-making process concerning investment is permitted.
However, the applicable law requires that a PFV must be established for the specific purpose of development business, but it is interpreted that such development business does not include ownership, operation or lease of real estate. As such, a PFV is established mainly for real estate development business and, when its development business ends, the PFV generally sells off the real estate and distributes the profits from such sale to investors.
i Legal frameworks and deal structures
Although there was a transaction in 2016 where Blackstone purchased its first real estate in Korea (Capital Tower, located in GBD) by purchasing beneficiary rights of the REF who owned said real estate, the most commonly used method in real estate transactions in the Korean market is having an investment vehicle to acquire ownership of real estate and pay the proceeds to the previous owner in cash. While sale and purchase of beneficiary rights of REFs or stock of REITs are permissible under the relevant laws, they are not widely used in practice.
For real estate transactions through investment vehicles, the bidding process is not legally required and there are many cases where transactions are concluded through private negotiations. In many cases, the bidding process can be completely public and is offered to a limited number of potential investors, which satisfies certain standards set by the seller. By doing so, a transaction involving conditions that are consistent with the parties' needs can occur. For example, in the case of the sale of the K Twin Tower, mentioned above, the seller placed priority on the speedy conclusion of the transaction, and as a result KB Investment Security decided to undertake most of the equity for the time being and sell it down later.
Ordinarily, the seller selects a real estate consulting company, accounting firm and law firm as its advisers to proceed with the sale of its real estate, and in response the buyer also has a similar group of advisers who can take charge of such processes as due diligence and valuation.
In addition to the general provisions of the Civil Code on real property, REFs are subject to the FSCMA and the KCC (in the case of corporation-type REFs) whereas REITs are subject to the REIT Act and the KCC.
Decisions on the acquisition and disposition of real estate owned by a REF are made by the asset management company, and fund investors cannot be involved in this decision-making process. The asset management company has the fiduciary duties under the FSCMA, and is required to report and disclose important matters (such as the acquisition and disposition of real estate) to the FSC. In practice, such filing of a fund is done through the Electronic Filing Service (http://dis.kofia.or.kr) provided by the Korean Financial Investment Association.
For matters relating to the acquisition and disposition of real estate, resolutions by the board of directors and the shareholders' meeting are required. For important matters such as the acquisition and disposition of real estate, a REIT must report to and file with the MOLIT and FSC in accordance with the REIT Act. In practice, filing of a REIT is done through the REITs Information System (http://reits.molit.go.kr) provided by the MOLIT.
ii Acquisition agreement terms
The conditions that are normally included in an agreement for an ordinary M&A transaction need to be included.
In the event that both seller and buyer use acquisition financing, the release of any existing security right on the real estate subject to the transaction and creation of a new security right for the buyer's lender must be completed on the closing date, and thus the provisions stipulating the mechanism for the aforementioned conditions need to be included.
The conditions that are normally included in an agreement for an ordinary M&A transaction, as well as a covenant to cure any violation of law that has been identified through the due diligence, need to be included. Furthermore, it is common to include a provision setting forth the ways to deal with the existing tenant in the subject real estate, for example, who will procure the consent of the tenant on the change of landlord, as a result of the change in ownership of the subject real estate, and how the parties will cooperate.
Representations and warranties
Typical representation and warranties in real estate transactions are as follows:
- authorisation; enforceability;
- title; registration;
- government approval;
- no expropriation or encroachment;
- no encumbrances;
- no violation; compliance with zoning or planning;
- environment; no hazardous materials;
- no litigation or dispute; and
Any profits from the subject real estate (such as rents) and any costs pertaining thereto (such as utility fees) must be calculated and prorated to each of the buyer and the seller as of the closing date. Normally, the parties include a proration provision stipulating that such profits and costs accrued until the day before the closing date are borne by the seller, whereas such profits and costs accrued after midnight on the closing date are borne by the buyer.
On many occasions where both the seller and the buyer use investment vehicles, indemnification is deemed meaningless because the seller's investment vehicle will likely distribute income from the sales proceeds to investors and thus it no longer exists when the deal is closed.
Break fees and other deal protections
Article 565 of the Civil Code provides that when a deposit is made by the buyer to the seller at the time of entering into a sale contract, the seller may terminate such contract by paying the double the amount it received from the buyer. This Article is applicable only when there is no other agreement between the parties. Thus, to strengthen the binding effects of the contract, the parties may include a provision explicitly ruling out the application of the above Article or stipulating liquidated damages as break fees.
In ordinary transactions, each party bears its own taxes. For instance, any acquisition tax is borne by the buyer and any taxes imposed on the gain on transfer of the real estate are borne by the seller.
iii Hostile transactions
No hostile transactions by or against public real estate investment vehicles in Korea have been reported to date. Because transactions for the sale and purchase of real estate itself are common in the Korean market, it is rare to see any hostile transactions, such as M&A, for the acquisition of an investment vehicle.
iv Financing considerations
Like any general M&A transaction, equity financing and debt financing can be utilised in real estate transactions in Korea. Equity financing is carried by investors either paying investment funds into a REF and acquiring beneficiary rights, or paying share subscription money into a REIT and acquiring shares.
For debt financing, the limitation on the loan amount can be imposed depending on the type of investment vehicle:
- for REITs, it is up to double (or 10 times under certain exceptions) the amount of the net assets;
- for REFs, it is up to double the amount of the net assets; and
- for PFVs: no such limitation is imposed.
A typical security for real estate investors borrowing funds to acquire or develop real estate is a mortgage on the real estate, which can be created by a mortgage agreement between the lender and the borrower and registered in the real estate registry. If the debtor fails to pay back the loan, the creditor may enforce its security rights by requesting the court to arrange an auction to sell the real estate.
Another type of security that is typically used in real estate financing in Korea is a security trust, under which the real estate investor entrusts the real estate to a trustee (generally, a licensed trust company) for the purpose of debt security. In that case, the lender becomes a beneficiary and is granted a priority interest under such arrangement. The reasons why such a security trust is commonly used and sometimes preferred by investors are as follows. First, in the case of a mortgage, the mortgaged real estate must be disposed under the court procedures in accordance with the Civil Execution Act, whereas in the case of security trust, the disposition of the real estate can be agreed by and between the parties to the trust agreement and thus there is flexibility. Second, in the case of a security trust, the ownership and title of the real estate are transferred to the trust company, and therefore, even if the debtor goes into bankruptcy or dissolution proceedings, the real estate can be separated from such proceedings and remain subject to the creditor's exercise of rights.
v Tax considerations
When a person acquires real estate through a transaction in Korea, they must pay an acquisition tax at a rate of 4.6 per cent (inclusive of surtax) of the purchase price – in other words, the acquisition cost reported at the time of acquisition. Deemed acquisition tax applies to share deals involving a corporation holding real estate. In such transaction, deemed acquisition tax is imposed when a person becomes a majority shareholder of a company by acquiring more than 50 per cent of its shares. In such case, the majority shareholder is required to pay the deemed acquisition tax at 2.2 per cent (inclusive of surtax) for real estate held by the company in proportion to the majority shareholder's holding in the company, as if it has directly acquired such real estate.
If an investment vehicle such as an REIT or PFV distributes 90 per cent or more of its distributable income as dividends, the disbursed dividend amount may be deducted from the income calculated for the relevant business year for tax purposes. A REF is a pass-through entity and thus is not taxable.
vi Cross-border complications and solutions
Land acquisition reports and real estate transaction reports
Foreign investors who intend to acquire land in Korea are required to file a report with the local government within 60 days of the execution of relevant sale and purchase agreement. Foreign investors acquiring 50 per cent or more of shares in a land-owning company are required to file a report as well. This reporting requirement may be exempted if the foreign investor elects to file a general real estate transaction report with the local government in accordance with the Real Estate Transaction Report Act.
Foreign exchange transaction report
In the event that a non-resident foreign investor intends to acquire real estate in Korea, they are required to file a real estate acquisition report pursuant to the Foreign Exchange Transaction Act for the inflow of foreign currency. Nowadays, foreign investors tend not to acquire domestic real estate directly, but through investment vehicles. In such a case, where foreign investors invest in acquiring shares in investment vehicles instead of acquiring real estate in Korea, they are required to file a share acquisition report with a foreign exchange bank designated under the Foreign Exchange Transactions Act in advance with regard to the acquired shares.
Corporate real estate
Separation of corporate real estate from operating companies or monetisation of corporate real estate usually occurs for the financing or restructuring of financially distressed companies.
The ways in which such financing or restructuring can be carried out include establishment of CR-REITs as one of the types of REITs, and issuance of asset-backed securities or asset-backed commercial paper and financing by means of holding a mortgage on corporate real estate. Additionally, there is a sale and leaseback transaction in which a buy-back option can be granted.
CR-REIT is exempt from public offering requirements, a cap on the maximum ownership of a single shareholder and the restriction on disposition of acquired real estate within one year. However, it is subject to a 5 billion won minimum capital requirement, is required to invest 70 per cent or more of its assets in certain qualified CR-REIT assets (as defined in the relevant regulations) and is also required to manage its assets through an asset management company with equity of 7 billion won or more and with five or more asset management professionals.
In 2021, additional new offices, with a total floor area of 213,000 metres squared, are expected to be supplied to the Seoul office market, which is lower than the average supply volume of the last 10 years. The two major buildings that will be constructed this year are Centerfield Tower in GBD (total floor area of 171, 143 metres squared) and K-Square Citi (total floor area of 41,634 metres squared) in CBD.
With the growth of e-commerce, the development and supply of logistics and distribution centres will continue to expand; it is anticipated that approximately 1,750,000 metres squared in 2020 and around 2,000,000 metres squared in 2021 are to be supplied to the market. Owing to a rapid growth of the market for delivery of fresh food that is causing an increase in demand for low temperature logistics and distribution facilities, it is also anticipated that the supply of advanced logistics and distribution centres, which are in the form of either a mixture of existing warehouse and low temperature facilities or only the latter, will increase.
As mentioned in last year's chapter, a recent notable market trend in Korea is the utilisation of public-offering REITs. The listing rules were amended in December 2018 to facilitate the listing of public-offering REITs and the general public's access to real estate investment through REITs. Since then, a considerable number of new public-offering REITs were successfully listed in the Korean market. In 2020, a total of six public-offering REITs were listed in the Korean market and the newly-listed REITS are diversified with different types of investment assets such as gas station, logistics and distribution centres, and rental houses, whereas in 2020 the REITS were mainly focused on office buildings.
1 Junghoon Yoo is a partner and Jee-Hyun (Julia) Kim is an associate and US attorney at EJE Law.