KDI Report:
"The Effects of Capital Expansion in Real Estate PF and Policy Improvement Measures"
An analysis has found that a higher equity ratio in real estate project financing (PF) reduces both pre-sale risk and the likelihood of insolvency, while also lowering project costs. However, there are concerns that the difficulty of raising large amounts of equity capital could shrink development activity, highlighting the need for more sophisticated policy measures.
According to the Korea Development Institute (KDI) report, "The Effects of Capital Expansion in Real Estate PF and Policy Improvement Measures," released on September 22, if a developer’s equity ratio increases from the current 3% to 20%, the 'exit pre-sale rate' for residential projects drops by about 13 percentage points. This analysis, based on approximately 800 projects carried out between 2013 and 2025, shows that risk is significantly mitigated from the average pre-sale rate of 60%.
KDI noted that since the 2022 Legoland incident, PF has become a source of instability for both the construction and financial sectors. Following the workout of Taeyoung Construction, companies such as Shindongah Construction and Sambu Construction filed for court receivership, and two-thirds of real estate trust companies fell into the red. Delinquency rates for securities firms and savings banks, which handled a large volume of PF loans, soared to 26% and 8%, respectively.
Domestic developers typically invest only about 3% of total project costs, relying on construction company guarantees to secure large-scale loans. This structure means that when a shock occurs, the developer collapses first, spreading risk to construction firms and financial institutions. This contrasts with major overseas markets, where 20% to 40% equity is invested.
The report also found that increasing a developer’s equity capital can reduce overall project costs. Raising the equity ratio by 17 percentage points cut total project costs by 7.2%, from an average of 310.8 billion won to 288.3 billion won. For residential projects, the decrease was 11.1%. Construction costs fell by 6.4%, mainly because increased equity reduced the need for construction company guarantees, thereby lowering the 'guarantee premium.' Financial costs dropped by 12.6%, and other expenses such as trust fees, pre-sale guarantee fees, and registration fees also decreased.
However, since equity capital is harder to raise than loans, excessive requirements could lead to a contraction in development activity. KDI stressed the need for a sophisticated policy mix that combines regulation and support measures. The institute recommended that the government’s planned cap on PF loans by financial institutions should not be applied uniformly to all projects, but rather targeted at those with low equity ratios.
There was also a suggestion to include non-redeemable preferred shares as eligible equity capital to incentivize equity investment. The report pointed out that the capital gains tax deferral system for in-kind land contributions should be made permanent, not temporary. Since land accounts for 26% of total project costs, activating such contributions would have a significant effect on expanding equity capital.
The regulatory gap surrounding Project Finance Vehicles (PFVs), which are widely used in large-scale projects, was also highlighted as an issue. PFVs enjoy double taxation relief but are not subject to prudential regulations or supervision, resulting in equity ratios remaining at around 3%. PFVs are highly favored, being used in 58% of projects worth over 1 trillion won.
The report stated, "PFVs are effectively being exploited as a means for large-scale development projects with minimal capital," and recommended, "Prudential regulations and supervision similar to those for project real estate investment trusts (REITs) should be gradually introduced."
KDI assessed that this analysis is significant as the first empirical evidence supporting improvements to the real estate PF structure. Hwang Soonjoo, Senior Research Fellow at KDI, commented, "While increasing equity capital reduces risk and costs, excessive regulation could shrink development activity. Strengthening regulations, expanding support measures, and institutional improvements should be balanced."
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