Flex Financing Drives New Apartment Construction in Hamilton

  • First National Financial LP

Valery Homes is one of southern Ontario's most well-established builders. Since its founding in the mid 1950s by Clemente Valeri, this family-owned business has proudly built thousands of high-quality homes and condominiums for the residents of Burlington, Milton, Brampton and Hamilton to enjoy.

Traditionally, this builder used conventional financing and in recent years, has been one of First National's key commercial clients. More recently, and in response to strong community need, Valeri has used its proven construction capabilities to enter the purpose-built apartment rental market.

To fuel this expansion strategy, Valery Homes employed a new financing option that is quickly becoming a popular choice with developers across Canada: it chose to secure an insured loan provided through CMHC's Flex Financing program. Introduced in 2017, this program gives for-profit developers lucrative incentives to build apartment units, including 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.

Daniel Bragagnolo, Director, Commercial Mortgages at First National Financial, worked closely with one of Valeri Home's principals, Ted Valeri, to evaluate the merits of this program and its potential application in funding construction of a 183-unit, two tower apartment complex on Hamilton Mountain.

"Valery Homes has a very strong track record and it's matched by tremendous financial strength and knowledge of financing," said Daniel. "In this case, we assessed Ted's options and took note of the fact that he has plans for other developments in and around the Golden Horseshoe and that he has far more equity on this particular project than he needed, if he opted for insured rather than conventional financing to build. This was the catalyst for us to recommend the CMHC Flex Financing program because it allowed Ted to free up equity and deploy it elsewhere to accelerate additional community development."

In round numbers, the strategy First National suggested liberated $1.2 million of land equity plus additional soft costs already incurred. Those funds were used by Valeri Homes to catalyze some of its other construction projects, including a second Flex Financing deal in Milton.

For the Flex initiative, a project must meet both of the 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.

A Boon To Aging In Place Boomers

To meet the terms of the Flex Financing program, Valery Homes will offer the units at just under market to meet the thresholds noted above. This approach addresses a significant need for brand new condo-quality apartment units in the City of Hamilton where the vacancy rate is low and many residents wish to age-in-place after selling their single-family homes. The median list price for homes in the Hamilton Mountain neighbourhood that is contiguous to this development is approximately $550,000. Using this figure, a homeowner could sell, pocket $550,000, and cover the entire annual apartment rent from the interest earned on the proceeds alone (assuming a 3% annual return) – without ever leaving Hamilton Mountain.

"Although this project absolutely qualifies as affordable housing, it's certainly not what consumers would normally associate with the term affordable," said Daniel. "Each apartment will have granite countertops, Moen faucets, Kohler bathroom fixtures and five-inch baseboards. The two and three- bedroom units will each have two bathrooms. And there will be a gym and yoga studio and a common theatre room. When it opens in late 2019, it will serve as a great addition to the Kennedy West neighbourhood on the Mountain."

A Natural Segue to Term Financing

First National began investigating various financing options for this project – conventional, mezzanine and insured – in the spring of 2017 and outlined all of the associated pros and cons for Mr. Valeri to consider. One of the benefits of using the Flex Financing program that Daniel pointed out is that there is a natural segue to term financing.

"For this particular project, we proposed a 24-month construction loan and then a 10-year term loan with a 40-year amortization for total loan value of $50 million," said Daniel. "This approach was designed to provide sufficient funds for construction, for the lease-up period and well beyond, so it was a comprehensive financing strategy."

In fact, one of the perqs of this strategy is that once an occupancy permit is granted, the term loan can be initiated. In a conventional construction deal, a term loan does not fund until the lease-up is complete, which often takes eight to 10 months. In a rising interest rate environment, a lot can happen in eight to 10 months to the costs of loan servicing and so this is part of the calculus that every developer should take into account, according to Daniel.

Mastering The Art of the Deal

Once Mr. Valeri decided to pursue the Flex Financing strategy, Daniel prepared an 81-page proposal for CMHC, submitted it in summer of 2017 and by December, the sought-after funds were advanced once the client had all of their City approvals in place. The footings are already in place and the towers are beginning to rise.

As CMHC financing experts, First National is well versed in creating loan submissions that address all of CMHC's needs. As a result, formal proposals include market, demographic, income and competitive rental rate studies of the surrounding area to provide support for the new development, along with the financial statements of the borrower. Daniel and the other members of the First National team have this down to an exact science and as a result, CMHC typically approves the vast majority of submissions as expected from First National, which has been an approved CMHC lender for decades.

Given the 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. 

“When a builder with Ted Valarie's stature and expertise chooses CMHC Flex Financing, I think it provides a strong validation for the economics of this program,” said Daniel. "While CMHC has adjusted some of the qualifications for the program in recent months, it has not included the onerous conditions that have, in past, kept for-profit developers on the sidelines. This is good news."

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, sufficient funds to cover cost overruns and construction management experience on a similar project (of appropriate firms to complete the construction). 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 and demonstrate their ability to cover cost overruns throughout the project.

It is not often that a program of this nature is introduced. While it has its own complexities, 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.