Credit Constraint and Excess Return: The Case of Chonsei Leases in Korea

Chonsei lease arrangements, in which an up-front deposit is paid at the start and returned at the end of a lease without any periodic payments, are a unique and dominant form of lease in Korea. This paper offers a simple model to explain the existence of the chonsei lease arrangement. The chonsei deposit can be thought of as a loan from the tenant to the landlord, and interest is paid in the form of housing consumption. From this perspective, a chonsei deposit is cheap because the calculated interest rate is higher than the market rate. The landlord should have a good investment opportunity to justify the use of chonsei. However, it is widely understood that chonsei deposits are used mostly as leverage to purchase a house. With credit constraints, this paper suggests excess return can exist in the housing market and that the chonsei lease arrangement is utilized to capture this return. The current demand for housing can be restricted by credit constraints and house prices can be undervalued. A credit-constrained agent may resort to chonsei to fund the purchase of a house. In contrast, the tenant will ask for high-interest payments.