The Real Estate M&A and Private Equity Review: South Korea
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:
Belle-Essence Hotel Site Development Project: the recent real estate development project with the largest transaction amount is the transaction for development of the former Belle-Essence Hotel Seoul site located in GBD. In July 2018, McKin237 PFV, the owner of the site, executed an agreement with IGIS Asset Management to sell the site and all other assets that are under development for 2 trillion won. For this project, IGIS Asset Management plans to form a private placement REF and develop two buildings (with a total floor area of 239,000 metres squared) comprised of a hotel, offices and shops, which will be completed in 2020. It is known that Kohlberg Kravis Roberts (KKR), the Korean National Pension Service, invested in this fund.
Centropolis Building: Centropolis (total floor area of 134,310 metres squared), located in Gongpyeong-dong in CBD, was developed by the real estate developer CT Core Co, Ltd and sold to LB Asset Management in July 2018, shortly after the completion of construction. It was reported that M&G Real Estate, a UK real estate investor, and the Korea Teachers' Credit Union (KTCU) invested in this fund. The transaction amount was 1.12 trillion won, which is the highest amount for an office building, and it was the first time in Korea that an office building was sold for more than 1 trillion won.
Seoul Square Building: Seoul Square Building, located right in front of the Seoul Station, was purchased by NH Investment Security for 980 billion won in March 2019. This transaction is ranked second after the Centropolis in the history of the Korean real estate market. The amount of equity investment was 410 billion won. NH Investment security and ARA Korea Asset Management, a Singapore-based real estate asset management firm, invested in equity with a plan to sell it down to domestic institutional investors. The remaining amount will be procured by debt financing.
K Twin Tower: these twin buildings (16 floors; total floor area of 83,878 metres squared), located in CBD and constructed in 2012, was sold at the price of 710 billion won. It was recorded as the office building transaction with the highest transaction amount of 28.1 million won for 1 pyung2 (for Centropolis, which ranked first with the highest total transaction amount, the sale price for 1 pyung was about 27 million won). The K Twin Tower was purchased by Vestas Asset Management in 2014 at the price of about 500 billion won, and the relevant fund was invested by KKR, Lim Advisors (a Hong Kong-based asset management firm) and the KTCU. In the March 2018 transaction, KB Investment Security purchased a great portion of the equity at the price of 310 billion won, which will be sold down later, and Samsung Life Insurance and Samsung Fire & Marine Insurance provided acquisition financing that was valued at about 400 billion won.
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. For instance, Shinhan Alpha REITs, established and managed by Shinhan Financial Group (one of the major banking and financial service institutions in South Korea) was listed in August 2018. It started with one building but later acquired two additional buildings as its underlying assets, and was recently selected as a preferred bidder for acquisition of another building. Also, the Lotte REITs, introduced by Lotte Group, which is one of the retail giants in Korea and holds four Lotte Department Stores, four Lotte Marts and two Lotte Outlets, completed the listing of all of its common shares in October 2019. The NH Prime REIT, which does not directly own any real estate but holds the equities of three REFs and one REIT, the real properties of which are located in the main business districts in Seoul, completed the listing of its common shares in December 2020.
Real estate companies and firms
Apart from 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 to 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. Also, 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
Further, 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 is 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.
On the other hand, 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 due diligence, valuation, etc.
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. Also, 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, how the parties will cooperate, etc.
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, in order 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 is 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.
Real estate transactions relating to logistics centres are expected to grow. The value of real estate transactions was approximately 8.19 trillion won in the first quarter of 2020, of which transactions involving logistics centres accounted for about 22 per cent with a total value of 1.83 trillion won. The largest deal in the first quarter was KKR's sale of BLK Pyeongtaek Logistics Centre to a domestic real estate fund established and managed by Pebblestone Asset Management for 197 billion won. BLK Pyeongtaek Logistics Centre is a newly developed multi-tenant logistics facility located at Pyeongtaek port, one of the largest ports and quite close to Seoul metropolitan area. Investments in logistics centres are expected to grow owing to the increasing demand for e-commerce and online shopping and related delivery services.
As it is expected that there will be an increasing supply of new large-sized offices while the demand for such offices will shrink, it will be interesting to see what changes will occur to the Korean real estate market. For example, Parc One (total floor area of about 360,000 metres squared) will be opened in YBD, and Gate Tower (total floor area of 85,000 metres squared) and SG Tower (total floor area of 125,000 metres squared) will be opened in CBD. After its first launching in Korea in 2016, WeWork opened 18 locations within a short period of time, and most of them are located in Seoul's main business districts such as CBD, GBD and YBD. Because of the growing business of WeWork and domestic co-work office providers, the vacancy rate for office buildings in major business districts could be kept low. However, considering the unexpectedly high level of rents and recent active utilisation of the system for working from home caused by covid-19, it has been questioned whether the co-work office business will continue to grow going forward. Accordingly, WeWork, together with internal issues, is now considering downsizing its business in Korean market. In fact, WeWork is currently negotiating with a REF, the owner of Jongro Tower located in CBD, for termination of its lease. As a consequence, it is anticipated that the vacancy rate for office buildings in major business districts will rise and the profits of investment vehicles that own the relevant buildings will shrink.
On the other hand, public-offering REITs are expected to continue. Owing to the recent instability in both domestic and global stock markets, individual investors have begun to have interest in the real estate market (REITs in particular) as an alternative investment outlet. Furthermore, the MOLIT also announced its policy goal in September 2019 to promote investment in public-offering REITs. In particular, while existing REFs and REITs were arranged through private placement among institutional or sophisticated investors, public offering of REITs has the advantage of being open to small individual investors.
Currently, there are five public-offering REITs that are listed in the Korean market, and five additional public-offering REITs with a size of 100 billion won are preparing to be listed in 2020. The underlying assets of these public offerings of REITs have been more diversified to include not only office buildings but also gas stations, hotels, rental houses and buildings located overseas.
1 Junghoon Yoo is a partner and Jee-Hyun (Julia) Kim is an associate and US attorney at EJE Law.
2 In Korea, the metric system of measurement is officially used, but for real estate transactions, the unique unit 'pyung' (which is equivalent to approximately 3.3 metres squared) has been traditionally used.