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Canadian Pacific Perspectives with First National’s Michael Yeung: Volume III

  • 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 multi-unit housing market, which has long been fueled by newcomers to Canada. With COVID-19 border restrictions in place, the source of demand has changed and the pandemic has caused a shift in the lifestyle needs of many residents. Michael tells us more in Volume III of Canadian Pacific Perspectives.

Michael, we’re now seven months into the pandemic lockdown. What’s happening in the market?

From First National’s perspective, our financing volumes were well ahead of last year at this time, so conditions have been remarkably strong. Our third quarter report, which we issued on October 27th, has all the details. We’re financing purpose-built rental buildings all over B.C. and as a result, we are on track to surpass 2019’s originations for the full year. But thinking about the market in more general terms, I would say we’ve started to see several changes take hold. Some of these changes are pandemic-related and others are rooted in events that happened well before the pandemic but are exacerbated because of COVID-19.

Let’s start with market changes that took hold before the pandemic.

You may recall that a couple of years ago, policymakers introduced a foreign buyer’s tax, a speculation tax and an empty home tax. As a result, speculators and foreign buyers retreated from B.C. well before COVID-19. In their absence, the luxury market suffered because it was fueled by their willingness to pay ever higher prices. What’s left in the market now is the domestic consumer – the local resident who wants to purchase a home or rent an apartment. That’s a big change that is largely independent of the pandemic, although in fairness, border restrictions have also played a part.

How have these taxes affected the condo market?

An estimated 30% of condos in Vancouver are purchased by investors and foreign buyers so these pre-COVID taxes put a damper on sales and pre-sales activities. Currently,  there is a surplus inventory of units heading into the winter when buying activity usually slows. This presents a potential cash-flow challenge for condo developers who don’t want to leave the units unoccupied for too long and get penalized with the empty home tax or put the units on the short-term rental market and pay GST. The economics certainly make apartment construction more advantageous.

What about pandemic-driven changes?

These are what I would call behavioural. We’re beginning to see a pattern of residents in downtown Vancouver moving to the suburbs in search of bigger accommodations, bigger home offices or more than one home office, and in the case of detached housing, a yard to play in. As result, sales volumes in the Fraser Valley up were up 53% year over year this summer while at the same time, downtown condo listings between June and August increased by 80% and condo sales stayed flat on lower demand. This pivot is not income driven or due to a change in immigration levels. It’s based on how people want to live going forward. I think COVID-19 caused B.C. residents to challenge their own thinking on downtown versus suburban lifestyles.

What do these changes mean to the development community?

In past, many developments catered to people who would pay the highest price per square foot or speculators who would buy a unit to flip it or turn it over to a short-term vacation rental company. Those consumers are no longer here driving the market and driving ever higher rental rates. So the focus is changing. To be successful now, developers will need to build for the domestic consumer and pay more attention to that renter’s lifestyle expectations. The theme that has emerged is that many people want to be away from the downtown core, they want more space to rent or own, and they want product that is affordable. Smart developers see this and are responding.

Effectively the needs of local residents are becoming paramount.

That’s right. This is a chance for the local market to get what it wants, to see their needs looked after. To take this a bit further, property owners need to seriously consider the changing lifestyle needs and tastes of local professionals who are now working at home and may do so for quite some time. Two young professionals living together are much more interested in renting an apartment with a den than without, for example. Developers who cater to specific, targeted local demographics when building new apartments, who think about the sustainability of local neighbourhood populations and establish realistic proforma rental rates that can be sustained are going to find much greater success in this new environment and are going to stay competitive.

When you finance new construction, are you taking these changes into account?

Yes, sustainability of neighbourhoods is an important topic that our underwriters consider when assessing a project. Sustainable neighbourhoods create sustainability of occupancy and rental rates. When it comes to occupancy, we want to see sustainable population in the neighbourhood surrounding the development and we want to see transit infrastructure that will support and sustain the population.

Doesn’t Vancouver have a subway project underway that will support this kind of sustainability?

That’s right, the Broadway Subway Project is a 5.7 km extension of the Millennium Line connecting Vancouver East to Vancouver West. We see this project as a catalyst for community growth. That said, apartments constructed along transit lines still need to be configured to address the needs and lifestyles of prospective tenants. Will it be necessary for those apartments to have as many parking spaces as a suburban development or are there other ways to serve tenants and maximize revenue? These are questions that need to be asked and considered in the context of local needs, tastes and demographics.

What is happening on the ground in Vancouver currently with apartment vacancies?

We entered the pandemic with an apartment vacancy rate of just over 1%. My personal forecast is vacancies will probably increase slightly in the short run for a couple of reasons. Young people who have lost their jobs or experienced a reduction in working hours due to COVID-19 are moving back home with their parents rather than renting. As well, international students are staying away and the absence of international travellers puts pressure on short-term rental accommodation. All of this is compounded by the fact that in this COVID-19 environment, it’s difficult for owners to show vacant suites. But I believe this will be temporary.

Presumably Amazon’s recent announcement that they are creating 3,000 tech jobs in Vancouver is going to enhance apartment demand.

That’s a reasonable assumption. If we were to finance an apartment construction project next to Amazon, I would expect it to have sustainable occupancy from day one.

What’s happening with rental rates?

In some areas of Vancouver, they have declined by as much as 10% due to the absence of international students and immigration. We’re also aware that tenants are being offered a variety of incentives But remember, rates were high to begin with. Again, I don’t think this phenomenon will last forever.

Recently, the Ontario Government announced a rental-rate freeze for 2021. Has the recently re-elected B.C. Government adopted this same kind of policy?

Prior to the election, the published B.C. Guideline for 2021 was for a 1.4% increase. That number may seem low but remember the August inflation rate here was at an all-time low of 0.1%. That’s still a net gain of 1.3% for landlords. However, during the election campaign, the governing party proposed to freeze rates until 2022. We’ll have to see how this plays out in the legislature in the coming weeks but the government was granted a majority so I would expect this change to occur.

There has been speculation that many Canadians in Hong Kong are making plans to return. Is this likely to drive market activity?

Many local accountants and lawyers tell me it already has. One of our clients started their pre-sale exercise a couple of weeks ago. Not only have 40% of the units sold already, a significant portion of the purchasers were returning citizens from Hong Kong.

Taking into consideration all these changes, is it still a good time to build apartments in B.C.?

Absolutely it is. It takes five to seven years from permitting to lease up to complete a new project. Developers who start today will do very well five to seven years from now. That’s because we have a significant shortage of housing supply and B.C. is and will remain a wealthy province and a magnet for immigration, which will eventually return. Remember also that despite this COVID-19 environment, there is still a significant barrier to home ownership in British Columbia. Rental is the alternative. The caveat is that the greatest success will be enjoyed by those who recognize and adapt to marketplace change, and who are thoughtful about catering to specific demographics and lifestyles as they plan their new rental projects. First National is here to help developers make plans that work now and for the years ahead.

 

Michael Yeung is recognized for his expertise in real estate financing including high-value commercial construction lending. 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.