Since my in-laws, seasoned real estate investors in Korea, have stayed at my apartment in Canada for last several months, I picked up a few things about unique Korean housing rental system: Jeonse. I figured it’d be a good topic to share in my blog as this unique system might provide us a decent investment opportunity.
In Korea, there are two housing rental systems which tenants can choose: Wolse and Jeonse.
Wolse requires an initial deposit (about 20% of housing value) and a monthly rent. Though initial deposit is larger than what’s typically required in Canada (typically equal to 2 month rent), Canadian should be familiar with the system.
Jeonse requires a deposit (typically 2 years), typically ranging about 70%-80% of the housing value. The deposit is provided to the landlord with no interest. The tenant gets back the deposit when they decide to move out. Since the deposit is such a large sum, the tenant typically borrows money from the bank to pay for it.
What’s so interesting about Jeonse?
1. It’s just like an interest free loan for an investor
What’s interesting about Jeonse is that, the landlord (an investor) can buy a property using the Jeonse.
Say the house price is $200k and Jeonse is $160K (80% of the housing value). An investor can buy the house by only putting $40K. If the housing price goes up to $220K (10% appreciation) and the investor sells it, they would make $20K profit out of $40K initial investment, which translates to 50% return.
Since Jeonse is an interest-free deposit, it’s just like a free-interest loan from an investor’s prospective. In other words, Jeonse allows an investor to take a leverage (about x5) without any charges.
2. Limited downside risk for an investor
What makes Jeonse very different from a regular bank loan, based on my understanding, is that Jeonse is typically non-recourse whereas bank loans are recourse. Say the house price is $200k, Jeonse is $160K and an investor puts $40K to buy it. After two years, house price drops to $100k and investor does not have $160K to pay Jeonse back. In this case, the house ownership would be transferred to the tenant from the investor. Even though the housing price went down by $100K, the investor would only lose $40K, which is the initial investment. The tenant bears the rest of loss, which is $60K. Jeonse is designed oddly favorable for an investor. The tenant bears majority of the downside risk while the investor enjoys all the upside potential.
From my understanding, investing in a house using the Jeonse system in Korea is just like buying a long-term call option on the house. The downside risk is limited to the invested capital, while the return is leveraged by the borrowed money with no interest. I’m currently under discussion with my in-laws to explore potential investment properties to take advantage of this unique rental system.