KEEPING YOU INFORMED: COVID-19 information for residential customers & commercial borrowers
╲╱

Our residential call centre is experiencing higher than normal wait times.

If you are a residential customer experiencing financial hardship due to COVID-19 and need to request a mortgage payment assistance, please submit a payment assistance request through My Mortgage.

If you are a commercial borrower experiencing financial hardship due to COVID-19, please email our Payments team at commercial.payments@firstnational.ca.

Be assured that we are committed to getting back to all of you who have contacted us.

Your patience is appreciated, and we thank you for your understanding.

Close

Canadian pacific perspectives with First National’s Michael Yeung: volume 2

  • First National Financial LP

Earlier this year, Michael Yeung, First National’s Regional Vice President, Commercial Lending, shared his perspectives on the state of British Columbia’s commercial real estate market, which has long been the most sought after in Canada. Since then, COVID-19 has upended the provincial economy and led to some surprising developments. Michael tells us more in Volume 2 of Canadian Pacific Perspectives.

Michael, before you describe the impact of COVID-19 on B.C., perhaps you could start by reminding us of what drives the commercial real estate market in the Lower Mainland.

It starts with population. The Vancouver/Lower Mainland area represents about 45 to 50% of the entire population of the province. We have a natural birthrate here of about 1%, so very low. But on top of that, we’ve typically had the highest rate of net new migration of any city in North America. Migration is about 14 times higher than the natural birthrate in our community, so for every child born here, 14 new people come to our city and they do so because our community is safe and multicultural and the educational system is sought after on a global basis. 

Who are all of these newcomers?

A statistic I read is that last year, there were 200,000 international students living here, that’s a 13% increase over the prior year. Policymakers likes this because international students contribute $1.8 billion of spending within the B.C. economy annually and pay taxes that help to balance government budgets. Landlords also like international students and workers because they often wish to rent luxury apartments.

In Volume 1 of Canadian Pacific Perspectives, you noted that the local technology industry was also drawing people in.

That’s correct, in recent years, the tech sector and film production have both attracted international workers. In my own neighbourhood, TV production takes place 12 months of the year with a lot of actors and crewmembers coming from the U.S.  We also have a number of U.S. headquartered companies like Microsoft, Apple and Amazon setting up large offices here plus Canada’s own tech giant Shopify.

It sounds like the Lower Mainland is highly dependent on immigration.

Precisely, this is an economy that is substantially influenced by external forces and that brings us to COVID-19 and its impact. When the border closed, many non-residents of British Columbia headed home and those students and workers planning to come here delayed doing so. On top of that, tourism has dropped substantially. Because we are reliant on visitors who cannot venture here right now, Vancouver is ultra sensitive to the pandemic.

How has this affected the apartment market in Vancouver?

International workers and students often rely on short-term rentals. Absent demand from these tenants, some landlords are starting to experience vacancies. Rather than pay the empty home tax, these landlords are returning their properties to the long-term rental market. Since the pandemic was declared, we’ve seen a large supply of short-term rental housing stock rushing into the market. The data show that downtown Vancouver has had the most units available for rent in each of the past two quarters. So there is a short-term shift in demand patterns right now.

You mentioned tourism has declined. What has that meant for the commercial real estate market?

It’s resulted in lower demand for short-term rentals. A statistic I read some time ago suggested there were about 6,600 short-term rental postings on websites in Vancouver alone. We’re seeing some of these units being added back to the long-term market because demand from visitors has dried up.

So this has put pressure on landlords who have traditionally rented units to temporary visitors?

Yes, if a landlord has a vacant unit normally used for short-term purposes, they really have no choice right now but to put it on the long-term market and to compete for tenants. The alternative is to pay the vacant home tax and collect zero rent. That’s not an attractive scenario.

Given more supply and lower demand, how have rental rates held up?

In some pockets of the city, particularly the downtown core, we’ve seen 10 to 15% decreases in the last couple of months. This caught many people by surprise because Vancouver hasn’t seen a rental rate decrease in many, many decades. It’s a new phenomenon for our marketplace to see landlords offering inducements like free rent and free parking. The pandemic has also reduced housing formation as more young people stay with their parents.

In your view, are these changes permanent?

I would say no, they are temporary. Not only is the economy starting to open up again, which is positive for demand, supply of new units is constrained because new construction has slowed. Something like 50% of new condo construction is on hold and that’s partly because many condo developers are having difficulty selling units. It also now takes longer to erect each floor in a new building because of worksite requirements for physical distancing.  As the situation normalizes, and foreign workers and students return, which they will, rental rates will rise again and perhaps rise to even higher levels than in the past. Remember also that land use policies favour rental apartments over condos and that is a recent change and one that I think will be here to stay.

Isn’t it possible that international students will just study online and not return?

I don’t think so. Students want to experience life, experience our local culture, our local cuisine and our natural attractions and that’s just not possible with online learning. Don’t forget as well that because of the dramatic situation happening in Hong Kong, there will be many people who want to leave those hostilities behind. B.C. is a natural and welcoming place to land. There are 300,000 Canadian passport holders living in Hong Kong right now, so this is a big factor.

Just a few months ago, the Lower Mainland was experiencing very strong forces driving rental rates higher and increasing demand for new apartment construction. Have you noticed a change in attitude among developers or CMHC in terms of their appetite for growth?

Generally no, I think developers see this for what it is, a temporary situation but that’s not to say there hasn’t been an impact. CMHC has a construction financing program that requires us to submit the proforma of the rent that may be achievable in a given neighbourhood. This program is valuable because it allows developers to proceed with construction and once an occupancy permit is issued, pre-qualify for term takeout financing without having to wait for lease up. Of course, the rent proforma needs to be reasonable and it guides the value of the loan CMHC is willing to insure. Since the pandemic, the housing agency has tended to be biased toward the lower end of the average range of proforma rents that may be attainable. That’s certainly triggered us to have conversations with CMHC since we believe what’s happening with rental rates is a blip.

If CMHC will only underwrite a construction loan at a lower than optimal proforma rent, how do you respond?

The best response is to move forward with a 75% construction financing and then lease up the property at the higher rents originally projected. Once lease-up takes place, we will return to CMHC, present the facts, and help our clients qualify for a higher takeout value mortgage. We have a pari passu program in place to make this happen for our clients. Relative to conventional financing, this approach is economically advantageous due to loan costs and longer amortization periods.

You mentioned that construction of new units is taking longer due to the pandemic.

That’s right but the good news is that construction was declared an essential service in B.C. so sites stayed open and the last I heard, 85 to 90% of construction workers were back on the job. Understanding how important construction is to the economy, the local government has been very accommodating as well by allowing building to take place up until 9 pm.

What’s happening with the cost of construction; has it increased?

It’s too early to say definitively. Contractors have not yet priced inefficiency or the cost of safety precautions into the quotes we’ve seen. What we do know is that construction is likely to take longer and that suggests higher costs. One thing we are not doing is banking on a reduction in construction costs.

What about the pandemic’s impact on supply chains for construction materials?

This an issue we are actively discussing with our clients. It’s fairly common practice for developers to source construction materials offshore to manage their costs. With the coronavirus, global supply chains have been broken as workers and plants are shuttered in China and other parts of Asia. This presents two immediate problems. One, it can lead to construction delays and depending on the severity and duration of this pandemic, supplies might be held up indefinitely. Two, if new alternative supply sources need to be found, this will take time and could result in higher project costs. As a lender, we want to make sure our clients have sufficient contingency plans in place to offset these challenges and we think it’s our role to bring this issue forward. However, as the economy starts to open up again, we are hoping that this dilemma will be resolved.

It sounds like it will take time for all of these temporary conditions to work themselves out.

That’s true and because of that uncertainty, we’re deeply engaged with our customers in plotting strategies, running different models and revising forecasts. In particular, because market absorption of condos is low and local rules require condo pre-sales to occur within a 9-month window, many developers are actively discussing a switch to apartment construction, tapping into our knowledge and experience and asking us for market comps and advice on things like amenity levels and what sort of rents are possible. First National thrives on this kind of consultative work.

If a developer or owner came to you today with a plan for a purpose-built apartment, what advice would you offer beyond considering short-term factors like current rental rates?

Number one, have a good exit strategy and align yourself with a lender who will be there to support you through the full lifecycle of the project from planning through construction and take-out financing. At First National, we take a deep dive into every project and commit to being there from beginning to end. We want to cross the finish line together with our clients and we offer what we refer to as smart-risk solutions to ensure borrowers realize their goals.

What are smart-risk solutions?

There are risks in every deal and we work with borrowers to mitigate those risks through a number of services. For example, we provide interest rate hedging strategies. We have deep knowledge of construction financing. We are good at finding energy rebates to offset CMHC premiums. And of course we are experts in matching borrowers with CMHC products as the largest CMHC commercial lender in Canada. 

Is First National still lending in this environment?

Absolutely, we have a strong balance sheet, a great supply of capital available to finance purpose-built rentals and a strong appetite to support our clients. As evidence of that statement, we’ve recorded record origination volumes so far in 2020.

Multi-unit residential has always been considered a very stable asset class because tenants are consistent in paying rent. Has this held true so far in this environment?

Yes, definitely. The B.C. apartment industry reported that landlords received about 92% of all rents in April and a similar percentage in May and our clients have had an even better experience. I think that’s an indication of the stability of this asset class generally and very effective management by our clients specifically. Another way to look at this is payment deferrals. I administer the mortgage payment deferral program for B.C. We’ve had about 50 general inquiries from property owners wishing to understand the program since the pandemic was declared and only five of these inquiries translated into an actual request for relief. That’s an extremely small percentage of our overall client base.

Michael, a personal question. You joined First National in 2019; did you accomplish what you set out to do?

It was an amazing year for the team here. We achieved record results. We addressed client needs head on by offering a number of services across bridge, construction and term loans, with a real focus on CMHC financings. I really can’t say enough about the people of First National B.C. Russ Syme and Paul Steckler are First National veterans who are known throughout the Lower Mainland for their expertise in construction financing. Earlier this year, we created a second team led by Jesse Selles and Kyle Pawliuk who both excelled in their current roles after finding success in servicing, renewals, training, analysis. And in June, we promoted Zach Vanier to the role of Director. Zach has been with First National for just over four years, serving as an advisor and analyst on a range of insured and conventional transactions. Having founded and operated his own Vancouver-based construction company while in university, Zach also has a special appreciation for the building industry. Together, we’re working on a very significant pipeline of deals and executing rapidly which is critically important for our clients.

Your First National signs have popped up on construction projects all over Vancouver.

Yes, we’re very proud to be part of our clients’ activities.

What do you hope to accomplish in the future?

In a word, grow. We’re determined to share our business value and advisory services more widely within the B.C. real estate development industry and grow by making sure borrowers know we are here to serve them as knowledgeable, empowered experts.

Final thoughts?

The long-term fundamentals that drive commercial property demand, particularly demand for new apartments, have not changed. Amazon is still going ahead with its new office in Vancouver. Microsoft is in the process of opening its new building. High tech employment is not going away. The natural beauty of our community, the multiculturalism and low density relative to Hong Kong where I came from are permanent and attractive features of living here. We have one of the world’s top medical systems and an abundance of natural resources. If I pull out my crystal ball, I will predict that today’s perfect storm will end soon. As the economy opens, we will see a return of net new migration and the new short-term rental units that have flooded the long-term rental market will likely be absorbed pretty quickly. When the Lower Mainland recovers, which it will, look for rental rate increases to resume because we simply do not have enough new housing supply for the demand that will come.

Michael Yeung is recognized for his expertise in real estate financing including high-value commercial construction lending. With an undergraduate degree in Finance & Economics from SFU, an MBA from Dalhousie, and professional designations (Personal Financial Planner and Specialist, Trust Institute), Michael is passionate about sharing his expertise. If you would like to speak to Michael or any member of our B.C. commercial team, you can do so by calling 778.887.8433 or emailing Michael at Michael.Yeung@firstnational.ca.