An analysis by a state-run research institute found that in a real estate project financing (PF) structure, expanding a developer's equity from the current 3% to around 20% would significantly reduce presale risk and also cut project costs.
Hwang Sun-joo, senior research fellow at the Korea Development Institute (KDI), presented this analysis in a report released on the 22nd titled "Effects of capital expansion in real estate PF and policy improvement measures."
Currently, in most domestic PF deals, developers contribute only around 3% of total project costs as equity, relying on loans from financial institutions backed by construction company guarantees for the rest. Because of this, when interest rates rise or the economy slows, project viability can deteriorate rapidly, with risks cascading to construction firms and financial companies, a concern that has been consistently raised. To address this vulnerability, the government has been pursuing measures since last year to raise the equity ratio to around 20%.
Hwang said that expanding equity does in fact help mitigate risk. An analysis of about 800 PF business sites from 2013 to this year found that if the equity ratio is raised to 20%, the "exit presale rate" for residential projects drops by an average of 13 percentage points. The exit presale rate is the minimum presale rate needed to repay PF loans; a lower figure means that even if presales underperform somewhat, project stability can be maintained.
The effect of reducing total project costs was also confirmed. The average total project cost across all business sites falls about 7.2%, from 310.8 billion won to 288.3 billion won, if equity is expanded to 20%. In particular, residential projects see a larger reduction, down 11.1% from 315.1 billion won to 280.1 billion won. This is attributed to lower expenses to secure guarantees from high-credit construction firms as equity increases, along with reduced financing costs due to smaller loan sizes.
However, the report cautioned that excessively demanding capital expansion could dampen development and stressed the need to refine the system. Specifically, it proposed: ▲ limiting aggregate caps on PF loans by financial institutions to business sites with low equity rather than applying them to all business sites ▲ recognizing non-redeemable preferred shares as eligible equity to broaden participation in equity investment ▲ converting the system that defers capital gains tax payments for in-kind contributions of land from a temporary to a permanent measure.
It also cited a regulatory gap for PFVs, a conduit vehicle (SPV) widely used in current PF projects, as a problem. While project REITs and real estate funds have equity requirements of at least 33% and 20%, respectively, PFVs have no such regulation, leaving their equity ratios at 3%, the report noted. Hwang said, "PFVs also need prudential regulation and supervision at levels comparable to other conduit vehicles."