In the spring of 2017, First National took note of a new CMHC financing program that we thought would stimulate a significant increase in apartment construction. Now, we are seeing tangible evidence that this program is catching on with builders across the country.

In early 2018, our Commercial team funded the first CMHC Flex Financing deal in Atlantic Canada, following closely on the heels of a similar First National-led financing in Ontario. In aggregate, these deals provided insurance on over $80 million of new apartment construction loans to our borrowers.

Given the enormously attractive features of this program, and the groundswell of interest exhibited in the development community, we predict that 2018 could well turn into the year of apartment construction across Canada.  

Introduced as part of the federal government’s National Housing Strategy, the Flex program is aimed at giving for-profit developers lucrative incentives to build apartment units. These incentives include loan amounts of up to 95% of the cost of construction – compared to 75-80% for conventional construction loans – lower interest rates, significantly discounted premiums, up to 40-year amortization periods and the ability to seamlessly roll the financing into term loans during the lease-up period.

Another notable feature is how the program defines affordability (see below). This definition enables construction of much-needed high-quality units marketed to tenants across the economic spectrum, including to middle-class Canadians who struggle, like everyone else, to find quality accommodation.

One of our first clients to finance an apartment project using this program is J2K Properties, a family-owned and operated multi-residential property company headquartered in Halifax. Normally, the Kanellakos family used conventional financing for their apartment projects, but with urging from Jody Comeau, First National’s Atlantic Canada team lead, this highly experienced group decided to explore the CMHC Flex Financing option.

“I knew J2K was embarking on a new apartment project and like other experienced builders, traditionally used conventional financing for construction followed by CMHC term loans during lease up and operating phases,” said Jody. “However, as an alternative, I suggested they think about an insured CMHC Flex loan for construction and I think I used the words, ‘it’s too good to pass up.’ Long story short, they provided their budget, rent roll and invested in a required appraisal. With that, we worked together on the application to CMHC and successfully closed an insured financing on February 8th, 2018, achieving all of their objectives.”

This latest J2K project will provide 150 rental apartment units in a high quality, amenity-rich and expertly managed 12-storey building in a central Halifax location. Like other Canadian cities, Halifax is experiencing low apartment vacancies as young people compete alongside downsizing baby boomers for rental housing. This new project will make a meaningful difference to the local community. 

In this case and on other Kanellakos family properties, J2K is involved in all aspects of development, design, building construction and day-to-day leasing and operating. J2K constructed and managed buildings are highly sought after by Haligonians.
“When a builder with this level of expertise and knowledge chooses CMHC financing, I think it provides a strong validation for the economics of this program,” said Jody.
Higher ROE from Lower Equity Requirements

Higher ROE from Lower Equity Requirements

By keeping equity requirements low, Flex Financing provides the potential for high and rapid investment returns even in an environment where construction costs have escalated. These simple mathematical calculations, based on a construction budget of approximately $25 million, show why:

• Conventional financing based on 75% loan to cost borrowed @ Prime +1.25% = 11% rate of return over 10 years 
• CMHC Flex Financing based on 95% loan to cost borrowed @ cost of funds plus 2.05% = 15% rate of return over 10 years 
  Low equity -in also liberates capital that can be redeployed to other construction projects. 

As noted in our article of July 26, 2017, we are seeing a growing trend toward development/construction as a capital deployment strategy, particularly in the face of today’s low cap rates and intense competition for property acquisitions. 

“In our view, this program will cause many owners to alter their plans away from pure acquisition strategies to consider development as a way to deploy capital and sustain growth in the coming years,” said Jeremy Wedgbury, Senior Vice President, Commercial Mortgages at First National. “Based on our experience on these first transactions, we are convinced that the flexibility inherent in the program’s design will win over the for-profit community, which is great news for Canadians with rental housing needs.”

A New Meaning for the Term Affordability

For certain, the CMHC Flex program makes it more affordable to build new apartments. It also makes those apartments that are built more affordable from a gross rental rate perspective, but does not do so by including onerous conditions that have, in past, kept for-profit developers on the sidelines. For the Flex initiative, there are two affordability criteria: i) at the time of first occupancy, the program requires that the owner take a reduction of 10% of potential residential rental income as measured using an appraisal report and ii) during the affordability period (generally defined as the 10-year term beginning on the date that an occupancy permit is issued), a minimum of 20% of the project’s total units must have rental rates at or below 30% of the median household income in the local neighbourhood.

These criteria are not overly onerous. In fact, it would not be uncommon for projects financed in this way to include some units with gross rental rates of say $2,000 per month or more as long as the second condition noted above is met. For a property manager, the discount can be offset through efficiency measures. There is also a clause restricting future rent increases; however, it is applicable only to those units designated as affordable within the project. Herein lies another advantage: the owner retains the flexibility to identify how they want to distribute reduced rents within the building. Those units might be on lower levels of a building or on apartments with obstructed vistas.

Recent Program Enhancements

As with all new programs, this one has been tweaked in recent weeks largely to improve clarity. However, CMHC has improved the program by providing additional flexibility when determining the need for personal guarantees, be they corporate, equity retention, replacement reserves or collateral security. In past, CMHC policy required personal guarantees for any financing with a loan to value above 75%.

What hasn’t changed is general borrower eligibility guidelines. To qualify, borrowers must have at least five years’ experience operating a housing property of similar type and size, a demonstrated five-year credit and repayment history and construction management experience on a similar project. Even here, however, there is flexibility, particularly for newly formed groups where CMHC will entertain substitutions for experience. A borrower must also meet minimum net worth requirements as a percentage of the loan amount.

It is not often that a program of this nature is introduced. While it has its own complexities – what financing program of value doesn’t – we believe it is well worth investigating fully before you embark on your next apartment development.

As first movers in applying the CMHC Flex Financing program, and as Canada’s largest apartment lenders, First National stands ready to assist you with best-practice advice at all deal stages. Please contact your First National advisor for more information.

For more information from CMHC about the program, visit their website.