In this article, I want to tell you about a strategy to buy Korean real estate for very little money out-of-pocket. And just so you know, this is not a strategy that I profit from in any way (nor endorse). I'm just sharing knowledge that I learned from another member of the Seoul Real Estate Investing Meetup. As with any investment strategy, make sure you do your own due diligence and are following all local laws. And yes, this strategy can also be used by non-Koreans.
Okay, now that I've gotten that out of the way, let's start by defining traditional financing.
Traditional financing refers to borrowing money from the bank to buy a property.
For example, imagine there's a house you want to buy for $100,000. However, you only have $20,000. You might be able to go to the bank and ask for a loan for the other $80,000.
Traditional financing works great because you can usually get a good interest rate. Nowadays, interest rates are around 4% (or even lower in Korea).
However, often times you have to jump through many hoops to get a bank loan. You have to fill out paperwork. You have to qualify based on your income. And after four bank loans, it might be difficult for you to get more.
Also, it often takes a long time for the bank financing to come through. Sellers are usually looking to sell their house quickly and don't want to wait around to see if your bank loan will come through.
And maybe the most difficult obstacle to overcome is that you simply don't have the $20,000 for a down payment. Then what?
Enter creative financing.
Creative financing is a broad term that refers to different ways of finding the money needed to buy a house when you can't get a bank loan (or don't want to) for some reason.
One example of creative financing might be seller financing. In a seller finance deal, you basically promise to pay the seller a set amount over a certain number of years until the property is paid for. The seller acts as the "bank" in other words.
One advantage of seller financing is that you and the seller can negotiate directly and can set whatever terms you want.
Buying Korean property through creative financing
Here's how it works. In Korea, there are three ways to rent out a property:
- By charging a monthly rent (hereinafter weolse). For example, most one-room apartments in Korea require at least 10 times the monthly rent as an initial refundable deposit and a monthly rent. In Gangnam, that's usually around a deposit of $10,000 and a monthly rent of $700 in rent.
- By receiving a one-time deposit (hereinafter jeonse) that tenants will get back at the end of their contracts. The deposit is usually quite large. The owner of the apartment building then invests that money and basically whatever the owner earns off that investment is the equivalent of a monthly rent. For example, in Bundang, my sister-in-law was once asked by an apartment owner to pay about $500,000 to live in a three-bedroom place rent-free. (She passed and instead decided to buy an apartment in Yongin.)
- By using a combination of weolse and jeonse. In these cases, both the weolse and jeonse are a little less than what tenants would otherwise pay if they were to sign a weolse tenancy agreement (alone) or a jeonse tenancy agreement (alone). So, the higher the deposit the lower the monthly rent - typically a reduction in monthly rent of between $50 to $100 for every $10,000 a tenant puts down as additional deposit money.
However, with interest rates as low as they are, property owners would prefer to collect monthly rent rather than receive a large jeonse. That's because the landlord can't reinvest the jeonse in an investment that is both safe and returns enough to be worth it. Keep in mind that the owner must return the entire deposit when the tenant eventually moves out.
On the other hand, many Koreans would rather pay jeonse over weolse. Koreans are good savers and often get help from their family to put together the large jeonse deposits. Moreover, paying rent eats up a large part of a person's monthly income.
So, in this environment, we find that many apartment owners are interested in selling their apartments as they don't feel like they can get a good enough return on the jeonse deposit, and they can't easily rent out their places for weolse.
Here's where the opportunity to get creative comes into play.
There are certain markets where the jeonse demanded by owners is almost the same as the purchase price.
Remember, since jeonse is preferred by Korean apartment dwellers, this demand drives the jeonse up.
So, here's a scenario where you could end up purchasing a property for very little money:
Owner A wants to sell his apartment. He doesn't want to do jeonse, but he can't find a renter. He puts the property on the market for $50,000. While this figure is for illustration purposes, let's say the property is in Sokcho where property prices can go for as low as this, sometimes lower.
You make an offer on the apartment and put down a non-refundable deposit of 10% of the purchase price as earnest money. So, in this example, deposit would be $5,000.
Owner A accepts the offer of $50,000. You set a closing date before which you have to come up with the rest of the money. You try to set this date as far out as you possibly can. Maybe you both agree to close in three months, for example.
During that time, you market the property for a new tenant.
Now here's where the creative financing part comes in. You set the jeonse requirement at $45,000.
Let's say you find a tenant. Now, that tenant gives you the $45,000. You hand this over to the owner of the apartment along with $5,000 of your own earnest money.
You now own the apartment. You basically borrowed the money for the purchase from your tenant.
Okay, so you might be thinking:
"So what? You spent $50,000 for an apartment, which is a great deal, but you're not making any money from the apartment. And you're also indebted by $45,000. That doesn't sound that great."
Good points. And here's where you have to do your due diligence ahead of time and make sure you're employing this strategy in the right neighborhood.
You want to buy in a neighborhood that has shown steadily increasing property values, not huge swings up and down. You need to identify a steadily appreciating market.
In two years, when your tenant's jeonse deposit is due, you can now raise the jeonse. Let's say you raise it by $5,000 to $50,000.
Now, you return the $45,000 to your former tenant, you collect $50,000 from your new tenant, and you pay yourself back the $5,000 you originally put down. You now own a property outright with no money out of pocket.
That's the basic concept.
In two years, you rinse and repeat, and continue to ride the steady appreciating rates of return until you decide to bank your profit from the property's increased resale value.
Of course, as with all things, it's easier said than done.
Here are some factors you'll need to employ this strategy:
- A steadily appreciating area without wild swings in housing prices
- A market where the jeonse and purchase price are very close to each other
- The jeonse / house prices undergoes a downturn in which case you might not be able to return the jeonse.
- You're not able to find your initial tenant in which case you lose your original earnest money deposit. (Note: If the owner backs out of the deal after you've given the owner an earnest money deposit, the owner must repay you double the deposit.)
This is just one creative investing strategy that I learned about by attending our events. As I mentioned before, I've never used this strategy, and you should do your own due diligence to ensure you're complying with all the local laws and also consult with a real estate agent to hear more about the risks involved.
But as an investor, I love hearing about creative ways to do deals. Not only are you acquiring properties that can give you great returns, but you're also helping to solve problems - you're helping an owner sell a property the owner no longer wants, and you're able to provide jeonse housing for tenants who want it.
Check out the Part 1 of the Sokcho real estate investing series to learn more about this unique strategy.