A lender's perspective on Montreal's commercial real estate market

  • First National Financial LP

As Canada's largest commercial real estate lender, First National Financial makes financing decisions every day that affect the growth and prosperity of communities and borrowers across the country. For this reason, it's of more than passing interest to know where Montreal ranks as an investment and growth destination for the decision-makers at this industry-leading, $106 billion mortgages under administration firm. In this interview, we ask Michael C. Williams, First National's Regional Vice President, Commercial Financing, Quebec to share his perspectives on the Montreal market and comment on his firm's appetite for investment and growth in this market at this stage of the business cycle.

Michael, how popular is Montreal as a destination for investment and growth at First National?

We've financed commercial properties in Quebec alone and in partnership with other institutional investors for years, but I would say our appetite for assets in Montreal has never been greater.  As a resident, that's good because Montreal still has a lot of catching up to do from an investment perspective. While this is a world-class city, the investment flow has not been anywhere near world-class levels for a long time.  As a consequence, despite positive increases over the last few years, Montreal's commercial real estate continues to trade at a discount to other major metropolises in Canada and globally, which is certainly no secret to my colleagues at First National or to our investing partners. So even though I think we're late in the real estate cycle nationally, and the market is changing rapidly, this City has a lot more to offer astute investors.

What did new loan volumes look like for First National in this market in 2018

2018 was another great year for First National’s commercial mortgage team in the Quebec market, having disbursed about $1 billion in new loans.  We grew our commercial team by adding two new analysts as well as a director for commercial mortgage origination.  We also invested in taking on additional office space to anticipate future growth with renovations currently in process and expected to be completed by May 30, 2019.

What's driving your interest?

Macroeconomic factors for starters. Employment is up and continues to be strong with unemployment at historical lows. Net migration has also shown a significant improvement, having hit historical records in 2018 and expected to do so again in 2019. In rough terms, net new migration to Quebec has quadrupled in the past four years. We're seeing more people coming to Montreal, including many more foreign students who are drawn to attend some of the country's best academic institutions and live in a vibrant, multi-cultural, safe city which continues to rank high on the affordability scale. Furthermore, Montreal has become a technology hot spot, particularly for multinational companies, including in the field of artificial intelligence. A lot of investment and job gains are being made in these high-paying fields, which are attracting young professionals who need and want quality accommodation. This is feeding huge demand for apartment rentals, as is the new stress test underwriting rules set by the Department of Finance.  The federal government’s implementation of new residential mortgage qualification rules has made it much more difficult and restrictive for potential home-buyers to now qualify for a residential mortgage.  These restrictive changes caused many previously qualified would be first-time home buyers to remain in the rental market, driving demand further.

In its spring 2019 budget, the federal government announced new measures to help first-time home buyers.

That's true and they include incentives from CMHC and an increase in the allowable RRSP withdrawal limit. Although these measures will likely help some first-time home buyers, I do not see these actions having a material impact on the rental market.

Is that demand being met by the development industry?

Well let's put it this way. About 8,000 new rental units came on line in 2018. But the apartment vacancy rate was still under 2% and declined everywhere except in certain areas of Laval and Vaudreuil-Soulanges. This means the City has done a good job of absorbing new stock. And while the greater Montreal area is by far the largest apartment market in Canada, something like 584,000 units at last count, quite a large percentage of the housing stock remains old. So between new apartment construction and renovations, I would say there is a need for more investment and continued runway for market growth.

Has new supply done much to curb rental rate inflation?

Although new construction rentals are obtaining rents per square foot anywhere from $1.75 to as high as $3, there continues to be a significant amount of older stock, yielding much lower rents.  Last year, average apartment rents increased a modest 2.5% to $796 so there was certainly some inflation. But when that rate is put alongside average rents in Canada's other leading cities, Montreal remains a screaming bargain. In fact, I would say Montreal is unquestionably Canada's most affordable big city rental market when you consider that average rents in Vancouver are $1,385, and Toronto's average is $1,359.

Is First National principally interested in lending on rental apartment assets in the city?

At First National, our core business has always been and continues to be multi-residential rental apartment lending, whether it be in the form of insured, conventional, bridge or construction financing. That being said, we also lend on retirement home assets and have conventional funds for commercial assets such as Industrial and self-storage, which are two other asset classes that we like and are performing very well.

Why industrial?

Greater economic activity and population growth have had a very positive spill-over impact on demand for everything from warehouses and logistics operations to data centres. Growth in demand for self-storage properties parallels the growth of apartment occupancy and the demographic shift of young seniors downsizing from detached homes to condo-quality rental units. If you move out of a three-bedroom home to an apartment or condo, it's pretty common to have surplus furniture and other items that need secure self-storage.  Demand for additional storage for tenants is also being sparked by the fact that newer apartments are getting smaller and smaller in size.

When you think about the type of financing you are being asked to do in Montreal at this point in the cycle, is it mostly conventional or insured?

It's a mix of both, which makes First National unique in the market. Unlike banks, we make it our business to provide access to all different types of financing. In effect, whatever makes most economic sense to the borrower.  For example, there is currently a strong demand for 10-year CMHC insured financing for newly built, stabilized multi-unit residential apartment assets, where asset value has been optimized. At the same time, owners of older assets with upside opt for shorter 5-year term CMHC insured financing or even shorter conventional bridge financing in order to reposition the asset and maximize the asset value before going for CMHC financing.  We can also unlock equity and provide borrowers access to capital on their rental apartments via conventional second rank mortgages where the asset has a lower leverage 1st rank which matures within 1 to 3 years. 

CMHC looks like it's active right now, but is it difficult for Montreal developers and property owners to qualify for insured mortgages?

I wouldn't use the word difficult. I would say it's important for borrowers to be precise in making proposals to CMHC. As a CMHC-approved lender ourselves, one of First National's pre-occupations is to help clients identify the right CMHC programs and complete the requisite applications for those programs/financing submissions. Quite often, developers miss out on really advantageous funding opportunities through the CMHC Flex Financing program for new apartment construction, and insurance premium credits provided by the CMHC Energy Efficiency program because they just don't know they are available. We also pride ourselves in our ability to work with clients to complete quality submissions to CMHC which typically results in a smoother, quicker turnaround process with a better end result. First National does so many CMHC transactions that we know how to get deals done and we also stay on top of CMHC's evolving requirements. Knowledge is power, as they say, and we like empowering our borrowers to make more informed decisions.

We saw three separate increases in the Bank of Canada borrowing rate in 2018. How did this affect local borrower behaviour?

Well the Bank of Canada seems to have done a 180 in their thinking on this subject, based on new economic data, but late last year It certainly reignited the long dormant concern over rising rates. As a consequence, we saw an increase in demand for our Early Rate Lock program, which provides a forward hedge against future rate increases. In fact, in the fall, we financed a $120 million, 7 property deal for a developer, where we were able to rate lock $90 million before even obtaining the CMHC approval. This was greatly appreciated by our borrower as we were able to ease the fear and unknown of fluctuating interest rates.

What size of loans are you entertaining in Montréal these days?

For CMHC financing, I would say our minimum would be $1 million, however we prefer to focus on deals of $3 million and over.  For CMHC insured financing, we really would not have a maximum. The bigger the better. For conventional financings, our minimum would be $3 million. For second rank mortgages, our minimum would be $2 million.

Are you seeing much call for funds to renovate apartment rental properties in the City?

Absolutely, and that's because so much rental stock is aging and because apartment rental properties are, comparatively speaking, much more expensive. In the past, no one paid attention to the old stuff because it didn't pay to do so. Today, even assets that seem unattractive still command strong prices. To squeeze extra value out of a property, one featuring a low cap rate to purchase, smart buyers are actively seeking ways to increase rents through what we would call an asset repositioning. They borrow to invest in kitchen and bathroom remodelling, or remove walls to create more open concept apartments…features that will command a higher-quality tenant paying higher rents.  Doing so properly and successfully can turn a very low purchase cap rate to one that makes much more sense once all is said and done. But I will say that while repositioning an asset is a viable option in certain scenarios, there are still opportunities with many properties in Montreal to simply purchase the cash flows and clip coupons.

Do you think the commercial property boom in Montreal will continue?

It's never possible to predict the future, but I would say the influential economic factors are generally positive, especially for apartment rental assets, our lending pipeline looks great and I believe our City has great momentum and still has some run way ahead of us. Although land values and construction costs are rising, and this certainly creates challenges, the fact is higher rents are being realized to justify investment decisions.

Final question: are you available to share more insights with borrowers?

Absolutely. Not only I am available but so are my colleagues.


For more information, please contact myself by email Michael.williams@firstnational.ca  or a member of First National’s Montreal Commercial team.