Major surgery for PF business that relied on debt… If you don’t have enough capital, you won’t get a loan.

The government will increase the capital ratio of real estate project financing (PF) projects, which is around 3%, to 20% by 2028. If a landowner invests land and buildings in kind in a REIT (real estate investment company), the payment of capital gains tax is delayed until the real estate is sold and profits are realized. By combining the ‘carrot’ of tax benefits and the ‘stick’ of requiring more loan loss reserves the lower the equity capital ratio, we are working to improve the ‘low capital and high guarantee practices’ that are ills in the development industry.

▶ Refer to page A1, page 4 of this magazine’s September 4 issue.

The government held an economic ministerial meeting on the 14th and announced the ‘Real Estate PF System Improvement Plan’ containing these contents. Real estate PF is a financial technique that raises funds using future profits generated from development projects as collateral. Domestic PF is worth 230 trillion won (as of the end of last year).

So far, PF projects have been structured in an abnormal manner, with up to 40% of the land cost being received as a high-interest loan due to a low equity capital ratio, and banks relying on guarantees (commitment to completion of responsibility) from construction companies and trust companies to lend, rather than properly evaluating the business feasibility.

The key to improving the PF system is to increase the equity capital ratio by encouraging land owners to invest land and buildings in kind in REITs. Currently, individuals and companies must pay corporate tax and transfer tax when investing their land in PF, but it has been decided to defer taxation by revising the Special Taxation Act next year. The government also decided to provide incentives such as relaxation of floor area ratio and public contribution to PF projects with high capital ratio.

Businesses with a low capital ratio raise the loan threshold. It was decided to differentiate the capital and loan loss allowance ratios that banks, insurance companies, and securities companies must build up when making PF loans according to the PF business capital ratio. PF business feasibility evaluation by a professional evaluation agency is mandatory, and evaluation standards and procedures are also established. Through this, we plan to foster developers into comprehensive developers who are in charge of not only development but also operation, like developed countries such as the United States and Japan.

Minister of Land, Infrastructure and Transport Park Sang-woo said, “We will support PF projects to transition from a high-interest loan structure to a capital investment method,” and added, “We will also quickly establish a ‘PF integrated information system’ to systematically monitor PF projects across the country.”

Decided to increase capital ratio to 20% by 2028
To reduce dependence on bridge loans… Encourage land owners to participate in PF projects

Due to the rise in interest rates that began in 2021, the inflation that occurred after the war between Russia and Ukraine, and the project financing (PF) insolvency from Legoland, the PF business site has been acting as a detonator that suppresses the real estate market. This led to a series of bankruptcies among construction companies and widespread losses in the financial sector. Restructuring of insolvent PF business sites is still in progress. A consensus has been formed between the government and industry that fundamental measures are needed. This is the background of the government’s announcement on the 14th of a plan to improve the system of PF projects with a chronic ‘low capital, high guarantee’ structure.

○Induce capital ratio of 20% by 2028

95% of the domestic implementation industry is small businesses with annual sales of less than 10 billion won. The government has released a blueprint to strengthen business stability by increasing the developer’s capital ratio to 20% by 2028 and fundamentally change the profit structure.

First, landowners are encouraged to increase their equity capital ratio by investing land and buildings in kind in REITs (real estate investment companies). These businesses are granted special urban regulations, such as raising the floor area ratio and easing public contributions. By revising the Special Taxation Act, corporate tax and capital gains tax will be deferred if land is invested in a PF project. Regardless of the equity capital ratio, the PF guarantee fee is the same and is also discounted the higher the ratio.

We also plan to prepare a plan to improve the responsibility completion system that transfers risks to construction companies and trust companies. The Ministry of Land, Infrastructure and Transport decided to establish a ‘PF integrated information system’ to inspect the entire PF market at a glance.

We plan to reduce inefficient operations such as vacancies by diversifying the profit structure of the development industry, which was focused only on sales income, into rental operations. REITs with stable equity capital are given priority to purchase public housing land with good location conditions. We will support the development of landmark commercial facilities in the region by first supplying prime land, such as the 3rd new city in the metropolitan area, to REITs. Specialized developments such as healthcare REITs are also encouraged by providing incentives. If necessary, public entities such as LH (Korea Land and Housing Corporation) participate through equity investment to help ensure business stability.

In the long term, we will improve the structure of the real estate development market by fostering comprehensive developers with rental operation know-how. In order to select excellent development companies, we develop performance evaluation indicators like construction companies. Kim Seung-beom, head of the Real Estate Investment System Division at the Ministry of Land, Infrastructure and Transport, said, “Our goal is to foster a comprehensive real estate company capable of development, operation, and financing in the form of short-term and small-scale implementation that only pursues sales profits.” He added, “By revitalizing REITs, we will also provide opportunities for public participation in quality businesses. “It will be effective,” he explained.

○Raising the loan threshold… Prevent potential failure in advance

In the future, the government will use a capital ratio of 20% as the standard and require financial companies to apply higher risk weights and provisions than the current level to PF business loans lower than this. As the risk weight increases, the Bank for International Settlements (BIS) capital ratio, which is an indicator of soundness, falls. If you accumulate a lot of provisions, profits decrease accordingly. The government’s intention is to create a structure in which PFs with high equity capital ratios can more easily receive loans.

Currently, the risk weight for PF loans is 150% for banks and 100% for second-tier financial institutions. For example, if a bank lends 10 billion won to a PF business, it is considered to have lent 15 billion won when calculating the BIS capital ratio. Financial authorities are also considering a plan to grade PFs according to their capital ratios and differentiate risk weights for each grade.

Provision for loan losses is an expense that financial companies must reserve in advance in case of insolvency such as delinquency. Even normal businesses must accumulate between 0.9% (bank) and 2% (savings bank) of the loan amount. The Financial Services Commission proposed a plan to differentiate the PF capital ratio by maintaining 0.9% if the PF capital ratio is 20% and applying 0.7% if it is 30%.

The financial authorities also decided to look into ways to restrict lending to PF businesses with equity capital ratios below a certain level, similar to savings banks, such as mutual finance, capital, and Saemaeul Geumgo. Mutual finance is a measure to complement the lack of risk weight regulation, unlike other industries.

Reporter Kang Hyeon-woo/Yoo Oh-sang hkang@hankyung.com