The real estate market is difficult to read, and so is home buying.
Today, the Bank of Korea raised the base rate from 2.50% to 2.75%, marking a 0.25 percentage point increase—the first hike in three and a half years. When news of a rate hike emerges, attention typically shifts to home prices. However, this decision is not solely focused on real estate. Consumer prices rose by 3.2% in June, and this year's growth rate is expected to exceed the May forecast of 2.6%. Additionally, factors such as exchange rate volatility, rising home prices in the metropolitan area, and increasing household debt are at play. The Bank of Korea stated in its monetary policy direction that it is necessary to remain vigilant regarding "high exchange rate volatility, the upward trend in metropolitan housing prices, and the expansion of household debt."
This raises a key question: How will this rate hike, which considers multiple objectives, affect the housing market? There is a significant gap between market perceptions and the actual events that are likely to unfold.
Rising interest rates won't immediately lower home prices.
The conventional wisdom is straightforward: when interest rates rise, borrowing costs increase, leading to fewer people taking out loans to buy homes, which should lower prices. However, in past periods of rate hikes, home prices did not immediately decline.
Excluding the current situation, the Bank of Korea has raised its key policy rate four times in the past 20 years: from 2005 to 2008, 2010 to 2011, 2017 to 2018, and 2021 to 2023. During the previous three rate hike periods, key home price indicators for the nation or Seoul continued to rise for an extended period. Central banks typically raise rates when the economy and asset prices are overheating. Initially, the existing upward momentum is stronger, and the impact of the rate hike becomes evident only after the increases accumulate. It is possible that home prices would have risen even more sharply had rates not been increased.
The most pronounced impact of rate hikes on price declines occurred during the previous rate hike period from 2021 to early 2023. The Bank of Korea raised the base rate by 2.25 percentage points in 2022 alone. As the cumulative impact of the hikes took effect and expectations for price increases diminished, nationwide apartment prices fell by the largest margin since the Asian financial crisis, according to KB Real Estate. The issue is not that interest rates lack power, but rather that the speed and cumulative effect of the increases are crucial.
This latest hike is 0.25 percentage points. Areas in Seoul, particularly key districts like Gangnam, are particularly insensitive to such an increase. Apartment prices in these areas have already surpassed levels manageable through mortgage loans, and there are multiple regulations constraining both the borrowing limits for borrowers and the loans banks can provide.
As a result, the proportion of self-funding, such as cash or proceeds from stock sales, has increased. An analysis by Kim Jong-yang's office, a member of the ruling People Power Party, of data from the Ministry of Land, Infrastructure and Transport revealed that 3.7255 trillion won from stock and bond sales was used for home purchases from January to April this year. Of this amount, 65.5%, or 2.4396 trillion won, was directed to Seoul, with about 1 trillion won concentrated in the three districts of Gangnam.
Of course, this buying trend is not entirely unrelated to interest rates. Rates indirectly influence stock and bond prices, deposit interest, and demand for refinancing. However, a 0.25 percentage point increase alone is unlikely to reverse existing expectations for price increases, as these channels are slow and weak.
That said, the market does not remain completely unresponsive. When interest rates rise, transactions tend to decrease before prices do, affecting buyers who rely heavily on loans and the outer and mid-priced markets first. Even if asking prices in key areas of Seoul remain stable, transaction volumes and buyer demographics may change.
Additionally, there is a supply shortage. The number of new apartment completions in Seoul from January to May this year fell by over 40% compared to the same period last year. As long as the perception of a shortage of new homes persists, the dampening effect of interest rates will inevitably weaken.
Interest rates are already increasing.
This does not mean that interest rates have no impact on home prices. According to an analysis by the Korea Research Institute for Human Settlements based on the Korea Real Estate Agency's apartment sales price index, the contribution of the base rate has generally been the highest at 50-60% across all periods. However, this does not imply that interest rates alone determine half of home prices. It means that among the various factors analyzed, the influence of interest rates was the strongest. This influence also varies depending on how quickly and to what level rates rise, rather than just a single increase.
In South Korea, the transmission speed of housing loan rates is relatively fast. Many loans are variable-rate or hybrid loans that reset after a certain period, so when market rates rise, the burden on borrowers increases relatively quickly. This contrasts with the U.S., where long-term fixed-rate loans are more common, providing a buffer. While the force to lower home prices may be slow, the pressure to increase interest payments is rapid.
The market anticipated this rate hike months in advance, and bank bond and deposit rates have already risen. When the cost of borrowing for banks increases, the benchmark for variable-rate loans, known as COFIX, also rises, leading to higher mortgage rates.
In fact, the COFIX for new loans in June was 3.05%, surpassing 3% for the first time in 1 year and 5 months, and it has risen for three consecutive months since April. The upper limit of fixed-rate mortgage rates at the five major banks has also climbed to around 7%. The burden on variable-rate borrowers will increase further depending on when their loan rates are reset.
In numerical terms, according to data submitted by the Bank of Korea to the National Assembly, if housing-related loan rates rise by 0.25 percentage points, the annual interest burden for all borrowers will increase by approximately 1.8 trillion won. The average burden per borrower will rise from 5.843 million won to 6.139 million won, an increase of about 300,000 won.
In the market, some are questioning, "What impact can a 0.25 percentage point increase have?" While home prices may remain stable for now, the situation is already becoming tense for those repaying loans.
The burden falls on both homebuyers and builders.
The impact of rising interest rates is not limited to homebuyers; it also affects builders. This aspect is often overlooked in the market, but its consequences can be long-lasting.
Development projects for building homes often rely on loans to cover a significant portion of land and construction costs, known as project financing (PF). The developer initiates the project, while the construction company is tied to it through completion guarantees or warranties. When interest rates rise, the cost of borrowed funds increases, disrupting the financial calculations of the project.
Additionally, construction costs have also surged. The construction cost index, with 2020 set at 100, rose to the high 130s by May. As both financial costs and material and labor expenses rise, projects with lower profitability may not even break ground.
In 2023, the Korea Development Institute (KDI) estimated that the reduction in construction starts due to high interest rates could lower growth rates by 0.3 percentage points that year and by 0.4 to 0.5 percentage points the following year. Building fewer homes does not only result in losses for construction companies.
The issue comes full circle. One of the key reasons supporting home prices in Seoul is the shortage of new homes. However, when interest rates rise, the initiation of new home construction projects is delayed. While this may reduce current demand for home purchases, it could lead to a supply shortage in a few years. The interest rates intended to suppress home prices today could become a factor that reduces the supply of new homes that stabilize prices tomorrow.
This burden is felt most acutely in provincial areas. Among the 65,239 unsold units nationwide as of the end of May, 46,638 are located in provincial regions. The situation is even more severe for unsold units after completion, with 83% of the 29,350 units in provincial areas.
As unsold units accumulate, developers' cash flow diminishes, delaying construction and new projects. The longer projects are delayed, the more financial costs increase, leading to greater losses. Rate hikes exacerbate this vicious cycle.
While interest rates apply uniformly across the country, the center of overheating is concentrated in Seoul. In reality, key areas in Seoul are relatively insensitive to interest rates. The shock from rising rates tends to spread first to provincial areas and construction sites.
One interest rate hike cannot control home prices.
In summary, this rate hike alone is unlikely to change the direction of home prices in Seoul, but it will increase the interest burden on borrowers and make it more difficult to initiate projects in less profitable areas.
The base rate is a tool that considers inflation, growth, exchange rates, and financial stability. While the rising home prices in the metropolitan area and household debt were reasons for this decision, a single interest rate applied uniformly across the country cannot address the supply shortage in Seoul or the concentration of demand in key areas. To change the direction of prices, tax policies, loan regulations, and, most importantly, supply policies for new homes in Seoul must all work in tandem.
Therefore, today's rate hike should be interpreted as follows: it is premature to expect that this 0.25 percentage point increase will stabilize home prices in Seoul, just as it is hasty to worry that the market will collapse soon. The first areas to examine should be borrowers' bank accounts and construction sites.
* This article has been translated by AI.
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