The Land Ministry will adopt a scheme to cap presale prices of apartments to be built on private land.
The upcoming step is regarded as the strongest measure ever taken by the government to clamp down on housing prices. Thirty-one “overheated speculative areas,” including all parts of Seoul, are expected to be subject to the measure.
In South Korea, when residents reconstruct their decrepit apartments, they usually build more units than they had before. They sell the added units to the public before new apartments are built in order to lessen the burden of reconstruction costs.
In effect, the ministry plans to make it mandatory to sell those extra units more cheaply than the market prices of nearby apartments. This will increase the financial burden on residents seeking to rebuild their apartments, so it becomes more likely that they will postpone or suspend their reconstruction projects. The same is true of redevelopment projects.
Price ceilings are an extreme policy that distorts the market mechanism of supply and demand. Adverse effects are unavoidable.
The government seems to believe that if presale prices of added apartment units are pulled down forcibly below those of nearby apartments, their prices will fall to the level of presale prices. On the contrary, the opposite will likely occur. Over time, the artificially suppressed prices of newly built apartments will rise up to or above those of neighboring ones.
Price caps have been enforced three times since 1977, and each time there was an unpleasant aftermath. The supply of new apartments contracted, sending housing prices and rental deposits sky-high.
The scheme was adopted in 2007 under the Roh Moo-hyun administration but effectively scrapped in 2015 under the Park Geun-hye government.
New apartment permits issued for four years from 2007, when the price cap took effect, decreased 24.3 percent from the previous four years.
The system also caused overheated competition for presale units, and unit winners selected through a raffle reaped huge profits by selling them at market prices later. The fairness of the policy is debatable.
As a countermeasure, the ministry plans to extend the period during which new homes must be owned before they can be sold, but it is questionable if this will work as intended.
In September last year, the government tightened mortgage-lending rules for overheated speculative areas, and as a consequence new apartments tend to be presold to wealthy people with plenty of cash. These people will feel less burdened by long-term apartment ownership. The countermeasure will be of little help to ordinary people and low-income people.
On the one hand, the scheme will put the brakes on reconstruction and redevelopment projects, causing a shortage of new apartments, particularly in popular residential areas such as Seoul’s Gangnam district.
On the other, the system will further raise the scarcity value of recently reconstructed apartments in the vicinity of old apartments yet to be rebuilt. Demand is already high for existing new apartments throughout Seoul, and not just in Gangnam. Their prices will ascend higher.
The engine of the Korean economy is sputtering. Production, investment and employment have been on a simultaneous decline. The US-China trade war and Korea-Japan conflicts are escalating.
In this situation, attempts to suppress reconstruction and redevelopment will likely dampen the construction business. Construction is a highly effective industry in inducing production and employment in other sectors.
The biggest problem with this approach is that it disables market mechanisms.
If the new apartments were built on government land, few would raise issues with artificial price-setting to stabilize housing prices.
But when it comes to apartments on private land, a different approach must be taken. Prices can be set most efficiently through the workings of the market.
A price cap is effectively a message to the market that it should give up expecting new apartments to be supplied through reconstruction and redevelopment. This policy has already been shown to be a failure. If a misguided policy is tried again, the same aftereffects will be repeated.
If the government wants to curb apartment prices in Gangnam in particular, it ought to increase supply by facilitating reconstruction, not by trying to suppress demand, and preferably in the most preferred areas or at least in central areas of the capital. Building a new town in a location where not many people want to live is less effective.
Prices may rise at first, but they will eventually be stabilized through the “invisible hand” of the market. This is the optimal way to solve the problem.