[The Era of Urban Maintenance Trusts③] Ambiguous Maintenance Project Trusts, "Professionalism and Capital Adequacy Must Be Carefully Examined"

Trust Method Urban Renewal Occupies Only 4%
Operating Profit Stagnates Due to Increased Operating Costs Despite Revenue Growth
Contingent Liabilities May Materialize Due to Real Estate Market Downturn

The trust method has been gaining attention following the reconstruction case of Dunchon Jugong. However, a thorough review of the capital status of real estate trust companies and the trust method is necessary. The photo shows the halted construction site of the Dunchon Jugong reconstruction complex in Gangdong-gu, Seoul. Photo by Hyunmin Kim kimhyun81@

[Asia Economy Reporters Chawan-yong and Ryu Tae-min] The government has decided to promote policies to activate the trust method to facilitate smooth progress in maintenance projects (redevelopment and reconstruction). The market is somewhat accepting this, especially after witnessing the suspension of construction work in the Dunchon Jugong redevelopment project. The real estate trust industry is enthusiastic. Preparations are already underway, including expanding maintenance project organizations and large-scale recruitment.

However, the trust method still has a weak foundation in the urban maintenance market. Since the 2016 amendment of the "Urban and Residential Environment Maintenance Act" (Urban Maintenance Act), real estate trust companies have been allowed to enter maintenance projects, so their experience is only six years. Their project order volume is minimal, accounting for only 4% of the entire urban maintenance market share. There have also been cases where projects were canceled due to problems during implementation. In short, it means the method is not yet fully verified. Additionally, the boundaries of the trust method are ambiguous, so members participating in trust-based maintenance projects need to carefully review the capital status of the real estate trust company and the trust method itself.

Borrowing Type Led by Non-Financial Sector, Completion Guarantee Type Led by Financial Sector

As of September 2022, there are 14 domestic real estate trust companies, categorized by capital strength and major shareholders into △financial trust companies (KB Real Estate Trust, Hana Asset Trust, Shinhan Asset Trust, Woori Asset Trust, Kyobo Asset Trust, Daishin Asset Trust, Han투 Real Estate Trust, Shin Young Real Estate Trust) △large non-financial trust companies (Korea Land Trust, Korea Asset Trust, Koramco Asset Trust, Daehan Land Trust) △small non-financial trust companies (Mugunghwa Trust, Korea Trust).

These trust companies each offer trust products that focus on their respective strengths. Broadly, trust-based maintenance projects fall under land trust (development trust). Land trust is a product where the trustee receives assets such as land from the trustor and returns profits to the trustor through real estate development activities such as permits, construction, sales, and occupancy.

Land trusts are further divided into borrowing type and management type depending on whether project financing is involved. Borrowing type land trust is a product where the real estate owner transfers ownership to the trust company, which then combines the owner's opinions, company funds, and expertise to effectively develop and manage the real estate.

From the trust company's perspective, there is a burden of project financing, and if sales do not go well, there is a risk of losing the invested project funds. However, trust fees are higher than other trust products, and interest income is generated on the financed project funds. Korea Land Trust and Korea Asset Trust are leading in traditional borrowing type land trusts.

Of course, there is also a trust method for maintenance projects. This is a type of development trust where the trust company receives assets such as land from owners or associations in maintenance zones and promotes reconstruction or redevelopment projects. It is divided into a sole implementer method, where the trust company acts as the sole developer, and a project agent method, where the trust company implements the project on behalf of an existing project implementer (association). Broadly, it can be considered part of the borrowing type land trust category. Mugunghwa Trust shows strength in this trust type.

There is also a completion guarantee type management development trust, a variation of the management type land trust. This product was created after the 2016 amendment of the Urban Maintenance Act allowed trust-based reconstruction. In addition to general management type land trust, the trust company provides credit enhancement by securing a completion guarantee from the construction company for project financing (PF) loans. The completion guarantee means the construction company promises to complete the building responsibly. The construction company cannot stop work due to the developer's bankruptcy, delayed payment, or complaints, and is obligated to complete construction within the scheduled period.

From the trust company's perspective, bearing this risk provides an incentive by earning higher trust fees compared to general management type land trusts. However, if the trust company has to fulfill the completion guarantee itself, it can suffer significant losses, so risk management is crucial. Financial trust companies such as KB Real Estate Trust and Hana Asset Trust are leading the market in the completion guarantee type management development trust.

Contingent Liability Risks... Need to Monitor Capital Adequacy

The real estate trust industry has recorded good performance in recent years, supported by a favorable real estate market. However, since last year, competition in the borrowing type land trust sector has intensified, causing slight declines in performance for Korea Asset Trust and Korea Land Trust, which had led this sector.

According to the Financial Supervisory Service, the cumulative sales of 14 real estate trust companies last year amounted to 1.605 trillion KRW, an increase of 242.7 billion KRW from the previous year (1.3623 trillion KRW). Operating profit was 834.7 billion KRW, and net profit was 637.8 billion KRW, increasing by 126.4 billion KRW and 103.6 billion KRW respectively compared to the previous year.

However, the average operating profit margin of real estate trust companies last year was 52%, similar to 51.9% in 2020. This is because operating expenses also increased along with sales. Last year's operating expense growth rate was 17.8%, close to the sales growth rate of 17.82%.

This year, the situation is unfavorable. Amid growing concerns about a real estate market downturn, the trust industry is also being affected. In particular, even the completion guarantee type management development trust business, which was considered to have relatively low risk sensitivity, is expected to be impacted by the real estate market decline.

According to Korea Credit Rating's "Real Estate Trust Industry Peer Report," the macro environment for the real estate trust industry has turned unfavorable this year. It also analyzed that quantitative and qualitative risks have increased even in the completion guarantee type management development trust business, which was considered to have relatively low risk sensitivity compared to borrowing type land trusts.

Yoon-gi Yeo, Senior Researcher at Korea Credit Rating, predicted, "Contingent liabilities may materialize due to the real estate market downturn, so monitoring whether capital adequacy deteriorates is necessary."

As of September this year, among the three credit rating agencies (Korea Credit Rating, Korea Enterprise Rating, NICE Credit Rating), KB Real Estate Trust (A2+) was rated the highest in credit rating. Following were Koramco Asset Trust (A2), Hana Asset, Shinhan Asset, and Korea Land Trust (A), all receiving stable or higher credit ratings. Woori Asset, Kyobo Asset, Daishin Asset, and Korea Asset Trust were rated A- with positive credit outlooks.