Over the past two years, Alberta and Saskatchewan have lived through economic turmoil caused by a collapse in the price of oil. As a commercial mortgage lender, First National’s local team has a front-row seat from which to observe the challenges faced by the real estate and development communities in both provinces. In this interview, Troy Barker, First National’s Assistant Vice President, Commercial Financing and Damir Jesic, Director, Commercial Financing provide their boots-on-the-ground perspectives on these important First National markets and discuss their expectations for 2018.
Troy, what’s happened in your home markets since oil prices began to slide?
It’s been tough. We’ve seen more jobs lost than in any downturn since 1982. As a result, downtown Calgary office vacancy rates have approached 30 percent, condo sales have softened and apartment vacancy rates have climbed to the 7 and 8% range in Edmonton and Calgary. Regina and Saskatoon have also been hit hard. Not surprisingly, lenders have pulled back and the real estate and property development communities have retrenched. That said, as an Albertan, I’ve worked in the commercial real estate industry since 1996, lending over $4 billion on a wide variety of properties throughout the Prairies and in my early career selling commercial real estate when oil was trading below $10 a barrel. So I can say with some experience that market cycles are a way of life. As oil cycles up and down, development activity ebbs and flows. We’re now waiting impatiently for a new flow.
The oil industry dominates discussions about economic activity in your territories. Is it fair to characterize your markets as oil-patch communities?
The energy sector is a major driver in both provinces but that characterization is a bit too broad. Some of the areas we serve, such as Lethbridge, have strong agricultural sectors, others such as Edmonton and Regina are government towns and in Calgary, we have one of the most vibrant hubs for entrepreneurial start-ups in the country.
First National has been active in the Prairies for years but you spearheaded a business expansion in 2005. What makes this market, which is cyclical, attractive?
From a strategic perspective, Alberta and Saskatchewan remain key drivers of Canada’s economy, so despite what’s happened over the past couple of years, these are good markets to be in for the long run which is why First National set up shop here a decade ago and has supported the growth of our local commercial team. More specifically, one of our core specialties is apartment financing backed by CMHC insurance. So being here positions us to participate with high-quality borrowers in the long-term growth of the multi-family commercial sector which is being driven by population expansion and demographic changes. At the same time, having the CMHC component mitigates risk through market cycles.
Damir, do your funding partners think the same way you do about Western Canada?
Many of them do, yes. From a risk perspective, they like to counter-balance their exposure to Toronto and Montreal by diversifying to the West and they’re attracted by the fact that cap rates are superior to what they find on commercial real estate assets in communities such as Vancouver and Toronto.
How have capitalization rates performed during this recession?
They’ve gone up in some asset classes, but not significantly so and the reason is a lack of movement in interest rates in the early part of the downturn. During the recession, interest rates in Canada didn’t rise and at certain points actually fell. In Calgary and Edmonton, cap rates on industrial properties are 6 to 7%, retail properties have ranged from 5 to 6% and for apartments, they’re in the 4.5 to 5% range. With interest rates on the rise, we may now see a change as we head into 2018. Having said that, capitalization rates have thus far been resistant to upward movements in interest rates.
What about office properties? It sounds like that sector has been hardest hit.
They’ve taken it on the chin. Cap rates are in the 7 to 8% plus range. But interestingly, we have not seen fire sales. Office property owners know that the market will come back and they are staying committed.
Obviously, your clients have found the past two years difficult.
No question. It takes creativity, perseverance and sound management to survive market cycles and our borrowers have all three qualities. Many are second and third generation developers and property owners whose organizations know exactly how to survive and prosper even in the worst conditions.
It can’t have been easy for your team either. Troy, how have you made a go of it?
Like our clients, we’ve tried to adapt by being creative in our approach. For example, we’ve put more emphasis on construction lending and on financing retail and industrial properties to complement our leadership in conventional and CMHC lending in the multi-family apartment sector.
Why construction lending?
Given our expertise in term lending on existing apartment buildings, it made infinite sense to extend our programs to help our clients get new development projects underway. This is a niche that some of our competitors shy away from, but because we understand the sector and work with very experienced builders, we know how to mitigate risks. Our borrowers also like our participation because they know that when a construction project is complete, we can provide either conventional or CHMC take-out financing. To them, First National is a one-stop lender.
But is anyone still building?
Of course. Remember, the construction of an apartment complex or really any large-scale development is a two to three-year venture. So when a developer engages now, they are thinking beyond the current environment and planning for a market that will exist in a few years’ time.
Despite the downturn, consumer spending activity in Alberta is still relatively strong and as a result, there is demand among our funding partners for retail assets, particularly in mid to major markets. For a lender, financing a retail property is less risky than lending on an office development where the major tenants are oil and gas companies. The last time I checked, there were no oil and gas tenants in a Calgary shopping mall!
So you lend on a variety of commercial real estate assets?
Yes and that exposure gives us broad market insights that our clients and our funding partners value.
Damir, is there a sweet spot for how much you will lend on a given project?
We put financing packages together that range anywhere from $2 million to $100 million, so our sweet spot would be anything in between.
Despite the downturn, many other lenders are active in your markets including Canada’s big banks and regional competitors. Troy, what makes First National stand out?
Our willingness to think outside the box, to put together competitive financing structures that meet the needs of our clients. Don’t get me wrong, Canada’s big banks have lots of capital, but they look for opportunities that fit into their mold. We make a mold that fits our clients, and then we work hard to outflank our competitors by being faster, more responsive, more flexible and more willing and able to provide insightful advice.
Can you give an example of your approach?
In Regina, we developed a multi-faceted financing program that enabled a very experienced Western Canadian developer to acquire a vacant industrial building with a large parcel of surplus land. The borrower’s vision was to renovate the building, re-lease with new tenants, and sell off the vacant land. Many lenders would have taken a pass on this project because of its inherent risks but we provided funding for the land acquisition, funding for the renovation and allowed the developer to sub-divide the title, which in turn allowed them to sell off parcels of surplus and use the proceeds to pay down their loans as they divested. It was a complex deal that featured interest-only financing. It all started about a year ago, but the renovated building is now being leased up and it’s on track to be a great success for our client, the local community and First National.
In the last few months, oil prices have stabilized at a higher level. How have your markets responded?
I would say market sentiment is improving. It’s too early to declare that a turnaround is underway, but we are cautiously optimistic that better times are ahead. In the meantime, we’ll continue to do what we’ve been doing: making sure our clients know we’re committed to their long-term success and finding quality lending opportunities that First National and our funding partners can get behind.