Apartments or stocks?

Peter S. Kim

Since January, the Korean government, led by the key regulator Financial Supervisory Service (FSS), has been determinedly pursuing the Corporate Value-Up Program (CVP) under the broad capital market revitalization initiatives inspired by the Japanese version from the Tokyo Stock Exchange (TSE). A key concern has been that Korea's program is merely a short-term election ploy orchestrated by the ruling party to win the all-important general election in April. However, since that heavy loss, the CVP has continued to be debated on both sides of the aisle, suggesting that it is more than an election theme. I have maintained that the prospect of Korea following Japan into its own "lost decades" makes this an urgent issue for all Koreans, regardless of income class. And whenever Korea's income gap issue is discussed, it inevitably involves residential property.

A taxation regime to make financial products more attractive is long overdue for a developed nation thus far obsessed with residential property. Earlier this month, left-wing lawmakers surprisingly opened the door for further debate on the taxation of inheritance, capital gains and dividends. In the past, the left-wing's election win would have put any concessions on taxation for the middle class to rest. Whether this is just part of negotiation strategies by parliament members remains to be seen, but just the fact that the opposition party is willing to leave wriggle room on the divisive issues is encouraging. Hence, I believe there is potential for the two sides to find common ground on the CVP progress – with some compromises.

The ruling People Power Party's biggest debate with the opposition Democratic Party of Korea could be related to the residential property market, which is an issue of utmost importance to the opposition. Like many other parts of the world, working-class backlash emanates from increasingly easier monetary conditions that have primarily benefitted the upper class. While the income gap may have remained stable, the wealth gap has widened, with lower interest rates boosting assets, both real and financial, owned by the middle class. In Korea, most household assets are concentrated around residential property, which is a political issue that divides the two main parties.

With almost 75 percent of household assets allocated to residential property, Korean individuals are one of the most concentrated owners in the world. As a result, Koreans' financial asset holdings are lower than those of most economies. If we compare the performance of the Korean stock market to residential property, it is clear that Korean households have been the smart money, with returns for property in Seoul more than double that of stock market over the past 20 years. The returns are even greater for southern Seoul (Gangnam) apartments, which have handily beaten every other investment asset. It is no wonder that the "Korean Dream" is to own a Gangnam apartment and that it remains a focal point of financial planning by Koreans.

Furthermore, rising household debt is directly linked to the obsession with property; around 80 percent of Korea's household debt is allocated for jeonse, or the key money system used in lieu of monthly rent. In an effort to control ballooning household debt and speculative investments in certain parts of the property market, Korean authorities have spent the past decade clamping down on property owners, especially those who own more than one home. However, the layers of restrictive measures have not been effective as real estate has easily outpaced equities – and with much lower volatility. The Korean government's key miscalculation was focusing on punishing property owners rather than making other investments more attractive. For the first time, the policy focus is shifting to making financial products more attractive relative to property. The CVP is the first such measure to educate and shift individual investors' attention to long-term investment alternatives other than property. Dividends are the first such offering in the paradigm shift for everyday Koreans.

Looking ahead to the next decade, Korean property no longer seems to present a rosy prospect as an aging population takes its toll. Like Japan more than thirty years ago, a decline in the property market in line with a declining population is inevitable. The good news is that household debt could be on the cusp of deleveraging on its own. And despite some concerns about a potential "disorderly" unwinding of household debt (and hence, the property market), I think the possibility is limited considering Korean banks' conservative mortgage lending practices. While property prices in certain parts of Seoul may resemble some bubbly features, the nationwide price trend and even greater Seoul price movements do not indicate a bubble about to burst.

Nonetheless, the smooth transition from property to financial products is a critical underlying mission for the Korean economy and the financial market. For the better part of the past few years, Korean retail investors have been known for momentum trading, focusing on U.S. stocks and cryptocurrencies. However, going forward, the untapped investors will not be theme-driven investors but rather long-term yield-focused investors; they will be the key to the property-to-equities transition. To attract this bigger and long-term fund flow will require structural reform. The taxation reforms currently being discussed by the two main political parties are the first step in determining whether the transition to capital markets from the property market will take years or decades.

Peter S. Kim is managing director at the KB Financial Group.