“It is what it is” – comparing and understanding market practices in Melbourne and Seoul

Updated: May 5

A couple of weeks ago, I recorded some of the similarities and differences between the Melbourne and Seoul office markets (see link below), partly as a way to help me document and relearn my home market. In this article, I focus on some aspects of market practice. Not surprisingly, there are some significant differences between the market practices of Melbourne and Seoul that I have had to (and more of which I will still need to) overcome. The headline observation so far is that there is a lot more grey (or flexibility) in Melbourne relative to Seoul; upon reflection, market practices or standards in Korea are far more entrenched and, as a result, probably take longer to overcome as a negotiator. That being said, Melbourne also has its fair share of established norms that can dictate negotiation outcomes.

One of the biggest shocks for tenants new to the Korea market is the high security deposits most landlords still expect. This is essentially a relic of the past, whenjeonseleases were made up of large, refundable security deposits as opposed to monthly rental (thejeonsedeposit was around 50% of the property value, upon which landlords earned healthy interest during the pre-Asian Economic Crisis era, when interest rates in Korea were much higher). Most office buildings in Seoul now charge a monthly rental, however the security deposit is a still-high 10 months’ rental and usually payable in cash only (not via a bank guarantee). When I arrived in Seoul in 2007, this was standard and non-negotiable. Over the last decade, there has been some lowering of the cash required in certain cases (to around six months’ rental for blue-chip tenants in some prime buildings) and, in some very rare cases, the acceptance of a bank guarantee for all or part of the deposit. Alternatively, in Melbourne the security deposit required is lower (six months’ rental or less) and bank guarantees are common. In addition, in cases where the security deposit is in the form of cash, tenants in Melbourne are entitled to receive their deposit backplus the interestfrom a specific, interest-bearing account. In Korea, the landlord is only required to refund the principal and they are free to do with the cash whatever they like throughout the lease term (although the tenant can register this amount to secure their capital). Given the size of some buildings in Seoul, the interest earned on these larger security deposits can be sizeable, materially adding to the valuation potential of commercial buildings.

Another landlord-favorable market condition that exists in Seoul is the common area management (CAM) fee, referred to as outgoings in Melbourne. In Seoul, tenants have no audit rights and it is generally accepted that landlords earn a profit on the CAM fee; so much so, that this profit (probably around 20% of the charge) is included in cash-flow analysis. Alternatively, in Melbourne, outgoings are fully auditable and landlords therefore cannot over-charge. It should, however, be noted that landlords in Melbourne do pass on some statutory charges like land tax via outgoings, so it is not a completely raw deal for property owners. Still, the lack of transparency in this area contributes to Korea being ranked at the lower end of the ‘transparent’ band in the 2018 JLL Global Real Estate Transparency Index (in fact, in the 2016 survey, Korea was still ranked as ‘semi-transparent’). Conversely, Australia is consistently ranked as ‘highly transparent’; higher transparency is generally considered a good thing for tenants in their dealings with landlords, as well as for buyers during the transaction process.

In Melbourne, landlords with pockets of vacancy have speculatively built fit-outs for prospective tenants (known as spec suites). The generic fit outs include reception areas, office furniture, kitchens, break-out areas, meeting rooms and IT racks.

One area where Melbourne and Seoul are similar is with regard to handover condition of office space. Both markets provide what it globally referred to as warm shell – floor coverings, ceiling tiles, light fittings, HVAC systems and wall finishes at the perimeter of the demised premises are standard. However, one stark differentiator is the availability of spec suites(speculatively fitted out office spaces) in Melbourne. To be competitive in the market, some landlords with pockets of vacancy in Melbourne speculatively construct fit-outs for tenants of various sizes – most of the ones I have seen are around the 300 square metre mark, based on property owners’ predictions of where demand in the market for fitted out space is likely to come from. The strategy is to provide an appealing office space solution that is ready toplug-and-play(or, more correctly, toplug-and-work!) – much like a flexible space solution (i.e. co-working or serviced office) in terms of speed-to-market, but within a permanent, exclusive tenancy that is directly leased to the tenant by the landlord. The spec suites include meeting rooms, a kitchen, breakout area(s), furniture including desks, chairs and shelves, and usually a reception area and some provision for IT racks. Although generic in nature to appeal to a cross-section of the market, the spaces are tastefully designed and often include top-quality finishes.

In spec suites, the generic fit-out becomes a form of incentive (instead of rent-free, rent-abatement, or contribution to a bespoke fit-out), and since the landlord can retain ownership of the fit-out, they also have the opportunity to depreciate it as an asset. A space that has been speculatively fitted out by the landlord is virtually never offered in Korea in a direct-lease scenario (I can think of only one example from my 11 years of living and working in Seoul). I think this may change as landlords there seek to compete with the increasing presence of flexible space providers – and as new construction continues to keep vacancy at relatively high levels. Co-working and serviced offices have the advantage of offering tenants ready-to-go solutions, and since requirements for space in Korea can be developed quickly (especially for enterprise Task Force Team requirements which seemingly need space overnight) this would allow landlords to satisfy demand in a timely fashion. Given the demand profile of tenants needing speed-to-market in Seoul being larger than in Melbourne, one could expect aggressive landlords there to provide these generic solutions on a larger scale than has been seen here in Melbourne.

This brings me to another market practice – reinstatement or make-good. The market in Seoul is quite rigid in that it has always been a requirement for tenants to physically make-good the space and restore it to handover (i.e. warm shell) condition. In the past couple of years, some landlords in Seoul waived reinstatement obligations in exceptional cases, however reinstatement is generally required and landlords typically do not want to enter negotiations for a financial settlement in lieu of physical reinstatement – they almost always want the reinstatement physically completed by the departing tenant. Melbourne is quite different. There are cases where reinstatement is not required, perhaps because it is more common for tenants to take over a previous tenant’s existing fit-out (hence, there may be no disadvantage for a landlord to waive this obligation during a negotiation). In addition, landlords in Melbourne are generally more open to discussing a financial settlement in lieu of the tenant completing the reinstatement – this can be win-win result by saving the tenant time and also providing the landlord with funds to refurbish the existing fit-out and present it as a fitted out solution (i.e. a spec suite) to the market. Alternatively, the landlord can use the funds to reinstate the premises if market conditions favour that approach (perhaps with some profit on the actual cost given the benefit the tenant has received by not having to manage the process themselves).

Market practices are sometimes explained as “it is what it is”; I have been guilty of providing this basic explanation in Seoul when seeking to explain local market standards to foreign visitors. This is not very helpful, and is often not a matter of fact. I can now see how it is useful to observe differences and to seek to understand why certain processes exist, and I believe this understanding will be helpful in future negotiation. I hope that this is also of interest to those who have lived and/or had work dealings in Melbourne or Seoul, or work in the commercial real estate sector. 

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