SEOUL: A lengthy property market slump and low interest rates are threatening the future of a uniquely South Korean home lease system that traces its roots back to the 19th century.

“Jeonse” contracts have been a mainstay of the South’s housing market for decades, offering tenants the enticing, and at first sight startling prospect of not actually paying rent.

Instead, the tenant forks out a hefty, up-front deposit – typically around 40% of the property’s value – which is then refunded in its entirety, or renewed, after two years.

At its peak in the mid-1990s, two-thirds of all housing rents and leases in South Korea were using the jeonse system.

The benefit for landlords was a large capital sum they could invest in high-yield opportunities that were plentiful during the country’s rapid industrialisation in the 1970s and 80s, when banks often offered double-digit interest rates.

Those investment opportunities included financing second or third properties purchased as a speculative investment on the back of fast-rising housing prices.

Landlords could return the deposit at the end of a contract and keep profits, or find a replacement jeonse tenant who effectively pays the deposit of the departing tenant when their contract begins.

The system was also a boon for first-time home buyers at a time when mortgages were hard to come by because of government policies that pushed banks to lend to manufacturing firms at the heart of the country’s export-driven growth model.

Typically, a property occupied by a jeonse tenant was traded at a price excluding the up-front deposit.

So buyers could get a home at the fraction of its cost, although they would eventually have to pay the departing tenant’s deposit before taking up residence themselves. “Essentially, the jeonse deposit played the role of a bank loan, which the home buyers could pay back in the future when they amassed enough savings and were ready to actually move in,” said Kwon Joo-An, analyst at Seoul-based Korea Housing Institute.

But some didn’t bother to move in.

Speculators would snap up several jeonse-leased houses at discount prices and then sell them at a huge profit, riding on and further fanning a real estate price surge.

In 1978, property prices soared 49% across the country, 79% in six main cities and a stunning 136% in the capital Seoul alone.

“Back then, jeonse was also a popular way to increase personal wealth,” said Kwon.

“That’s what sustained the jeonse system for decades – the belief that property prices would just keep rising.”

Speculation and property price inflation became a major challenge for policy makers, and successive administrations introduced measures to cool things down, but to limited effect.

In the end, it was brought to heel by changing market conditions brought about by a multitude of socio-economic factors – ranging from an ageing population to the global slowdown.

Since 2008, both interest rates and property prices have fallen – seriously undermining the twin foundations that sustained the jeonse system.

The low rates negatively impact a key benefit for the landlord – investing the jeonse capital sum at a high-level of return.

With investment opportunities limited, landlords began switching from an under-performing jeonse to a monthly rental system more familiar to the rest of the world.

Rentals accounted for around 30% of leases in 1995, but that share had risen to 50% by 2010, and is believed to have increased further in the years since then. – AFP