South Korea uses a real estate system found nowhere else, in which tenants typically deposit between 60 to 80% of the property’s value as part of a two-year contract. This so-called jeonse system has the benefit of allowing tenants to live rent-free, while landlords can use the large deposits to engage in various financial activities.

But despite these advantages, a wave of fraud cases that have swept the country have underscored major flaws in jeonse practices, demonstrating tenants’ vulnerability to scammers and threatening to undermine a system that millions rely on for housing.

The issue has become a focal point of political wrangling, and while the South Korean government has proposed various solutions, each risks creating new problems that could put the state on the hook, harm creditors’ bottom line, or leave victims out in the cold.

Victims of a massive rental fraud case protesting outside the National Assembly on May 24, 2023 | Image: Jack Greenberg

JEONSE FRAUD

Fraud and landlord bankruptcy have emerged as significant concerns in the jeonse system. In 2022, jeonse-related disputes saw a startling increase, doubling from the previous year to $909 million (1.2 trillion won). Even more strikingly, fraud cases skyrocketed to 618, up from 187 reported in 2021.

Jeonse fraud can manifest in various forms and has recently been connected to a series of sophisticated scams, primarily involving “villas” — small apartment units in buildings usually five stories tall or less.

These fraudulent activities encompass kickbacks to brokers, builders and consultants, who assist in identifying potential properties, purchasing them and luring tenants. The acquired properties are often registered under multiple names before ultimately transferring ownership to a single individual, who typically possesses no personal assets.

These villas, which are custom-built and lack branding, pose a stark contrast to the standardized nature of apartment complexes. Despite equivalent public regulations governing both types of properties, market prices for villas are more opaque because they generate fewer transactions compared to large apartment complexes, resulting in limited public information about their prices and jeonse agreements.

One common scam involves fraudsters leasing apartments on a monthly basis, posing as the rightful landlord and then vanishing after signing jeonse contracts and collecting significant deposits from unsuspecting tenants.

A recent case from April highlighted a couple who changed their phone numbers and disappeared just before their tenants’ contracts expired. They left behind a staggering $4 million (5.4 billion won) in owed tenant deposits.

High-profile scams have rocked Seoul and Incheon, achieving particular notoriety through the deaths of three landlords involved in these fraudulent operations. The most notorious was a landlord named Kim, who held 1,139 properties under his name and died in Oct. 2022. Another landlord who owned 240 properties died in July 2021. 

A man named Shin was arrested in January along with 77 other suspects on allegations of orchestrating these frauds, including a scheme that allowed a landlord to amass 628 properties in just over three years. This landlord was subsequently apprehended in Dec. 2022.

In situations where the landlord passes away, the complexities of the jeonse system become even more evident. Deposit refund insurance does not automatically pay out unless an heir inherits the properties. The tenancy continues even after the landlord’s death, and to terminate a contract, tenants must notify the deceased landlord’s estate. But if the landlord has no estate, the tenants face a catch-22.

Prosecutors have vowed to seek maximum prison sentences and seize all illicit proceeds, and the ruling People Power Party (PPP) has stressed its commitment to intensify penalties for jeonse fraud by amending the Specific Economic Crimes Act, but a resolution remains elusive for the cash-strapped victims of these scams.

This grim reality has been linked to five suicides this year, most recently on May 24, a day before the National Assembly passed a temporary special law aimed at stabilizing residential housing for verified victims of jeonse fraud.

An older “villa” in South Korea, Feb. 8, 2020 | Image: Korea Pro

GOVERNMENT RESPONSE

In an effort to provide relief to victims of jeonse fraud, the South Korean government announced a suite of financial support measures at the end of April, including public mortgages for lower-income households, special long-term mortgages and eased lending rules.

However, these initiatives have not been without criticism. The main opposition Democratic Party (DP) has contended that these measures offer little to help victims recover their lost deposits or mitigate the distress caused by the fraud.

A special law to further aid victims is set to take effect, subject to Cabinet promulgation in early June. This legislation will apply to victims with a fixed date on their jeonse contract and whose residence is put up for auction during an ongoing fraud investigation.

However, this law does not cover all victims of jeonse fraud. Specifically, it omits pre-move-in and double-contract fraud victims, which has sparked demands for further amendments from those left unprotected.

The proposed law offers certain rights to eligible victims. These include the right to request a postponement of auctions on their current residences and, should an auction occur, the right to make a preferential purchase at an amount equal to the highest bid. Initial suggestions had proposed that victims be given the right of first refusal on their current residence.

However, “such a move contradicts existing legal principles, which give creditors priority over the lien,” Cho Joo-hyun, an emeritus professor of Konkuk University’s Department of Real Estate Science, told Korea Pro, referring to the right to keep possession of property belonging to another person until a debt owed by that person is discharged.

IN SEARCH OF A SOLUTION

The South Korean government faces a challenging task in mitigating the fallout of jeonse fraud.

Successful bids from the highest bidders would cover creditors’ debts in the proposed auction solution. However, if victims are given first-bid priority and do not bid to their utmost capacity, creditors could potentially incur losses, undermining the overall efficacy of this measure.

Further, the government’s decision to reject the DP’s proposal to acquire all properties involved in fraud and return victims’ jeonse deposits also presents difficulties. The government’s concern about setting a negative precedent — effectively, the state taking responsibility for private sector fraud cases — has led them to favor a different solution. 

The government’s preferred approach involves the state-owned Korea Land and Housing Corporation (LH) purchasing properties that victims wish to continue renting at 30 to 50% of the market price with biannual contract renewals, allowing victims to maintain stable tenancy for up to 20 years. But this plan does not directly address the issue of victims’ lost deposits.

The transport minister’s suggestion that landlords deposit a portion of the jeonse in escrow accounts presents its own complications. The proposal could face strong resistance from gap investors who take advantage of the very margin between jeonse and market prices to build their real estate portfolio.

“This requirement could also negatively impact developers who depend on pre-build sales financed by jeonse, causing them to suffer financially,” Cho of Konkuk University told Korea Pro.

In essence, each of the South Korean government’s proposed solutions appears to create new problems or fails to address the core issues of fraud victims. Consequently, these attempts may prove insufficient to bring an end to jeonse fraud, as victims continue to seek justice.

Edited by John Lee