One of First National’s strengths is construction lending, a segment that includes many different asset classes and involves financial support for land development all the way through new build lease-up. In this interview, Jeremy Wedgbury, our Senior Vice President, Commercial Mortgages, talks about national trends in the construction market, First National’s specialized approach to construction lending and our business aspirations.
Jeremy in many communities, cranes dot the landscape. How important is the construction market to your commercial business?
We’re long-term participants, active with some very experienced builders and developers in communities from coast to coast. We write dozens of loans for condominium, multi-family rental and commercial construction projects every year and we’re expecting to set a record for construction volume in 2017. So to answer the question, the construction market is important to us and to our plans for the future. Strategically, we’ve always provided take-out term loans on new builds particularly in the multi-family sector so extending our focus to construction loans made perfect sense.
What’s driving growth?
Generally, I would say strong commercial real estate market conditions and low interest rates which provide an ideal backdrop for our clients to borrow and build. Looking at specific asset classes, growth is most pronounced in the apartment sector. Investors are particularly interested in owning this type of product and there just isn’t much inventory available for them to acquire because apartment construction has substantially lagged for the past 20 or 30 years. That’s created a supply-demand imbalance that will take a long time to correct.
Considering the age of many apartments, the supply side is easy to understand, but what’s behind demand when so many Canadians are buying houses?
In migration and population growth are two large forces at work. But within the population, we see strong interest in apartment rentals from two demographic sources. One is seniors or near-senior empty nesters who are selling their homes, cashing in and wanting condo-quality living without the cost and hassle of ownership. With an apartment, they can lock up and travel for six months worry-free. Millennials are also fueling demand for rental units particularly in downtown locations. For both age groups, quality is a must and they are willing to pay up for it under the right circumstances.
So it’s a good time to be an apartment builder?
It’s a great time to be active in this space. Investors want new apartments, tenants want new apartments, and the economics are strong. Cap rates are low, reflecting high property valuations and there appears to be a market for higher rents. For apartment developers who are experienced and have a good location, First National has the capital, a diverse set of dedicated lending products and the know-how to make things happen.
What type of construction loan products does First National offer?
Conventional loans, mezzanine financing and CMHC loans. In fact, First National is Canada’s largest CMHC-approved lender and while the conventional market for construction loans is very deep right now, we absolutely source and present CMHC options to borrowers, which is a key differentiator.
Doesn’t CMHC also have a new program supporting apartment construction? What do you make of it?
It's a very appealing program that supports the construction of new affordable housing units. Under the program, borrowers can get up to 95% loan to cost. That's dramatically higher than the 75 to 80% range available in the conventional market. We’ve made a point of getting to know the program so we can help our borrowers qualify.
Commercial borrowers have quite a few choices of where to seek capital. On big projects, needing significant capital, is there a difference between First National and pure balance-sheet lenders?
There is. In many cases, balance sheet lenders like the big banks choose to syndicate loans over $50 million in size. They’ll bring in two or three other banks, each with its own lending standards and requirements. For a developer, those scenarios can create pretty onerous conditions. In contrast, First National is able to use our diverse funding sources to be a one-stop shop for large construction deals.
Is First National only in the business of helping big developers do big construction projects?
Absolutely not. In fact, the big banks tend to go out of their way to supply the largest developers and so we make it our business to work extensively with small and mid-sized developers whose construction projects are very bankable but fly under the radar of the biggest financial institutions. I would say this part of the market is our sweet spot.
Some lenders seem to favour downtown markets like Toronto. Is First National really national when it comes to construction lending?
Absolutely. We’re an apartment lender of choice in many markets and not just in the biggest cities. In Ontario as one example, we’re not just lending in Toronto and Ottawa and Hamilton, we’re active in St. Catharines, Niagara Falls, Cambridge, Guelph and Leamington to name a few communities. In B.C., we don’t just serve Vancouver and Victoria, we’re in Kelowna. We specialize in knowing each market.
That must make you a source of market insight for developers.
We don’t just lend money, we seek to provide advice and counsel to our clients as they do their financial modelling and contemplate what borrowing products and structures will work best for them. One aspect of that counsel is to know the local market, know what rental rates the market will bear, and help clients test and validate the projected economics of their projects. It’s just part of providing well-rounded service and of course, it helps us with our due diligence, as does knowing the regulatory environment, zoning restrictions and so forth.
Why do borrowers in the construction industry seek out First National?
They like the level of responsiveness we provide which manifests itself in quick turnaround on underwriting decisions. They like the fact that we can offer different lending products, conventional and CMHC, that will support them across all stages of development from construction to opening and lease up and beyond that to term loans. And they like the fact that we don’t just lend money at competitive rates. We offer constructive advice that adds value to their projects.
What do you look for in a borrower?
Experience is very important to us. And by that I mean we sometimes work with second and third generations of the same development families, people who know exactly what they’re doing. We also value relevant experience. So if a developer has built three apartments in the past, and wants to build a fourth, that gives us the confidence to know our money will be in good hands.
Construction lending is often considered the riskiest form of commercial lending.
It is risky but that’s why we align ourselves with experienced developers first and foremost and look carefully at the covenant on each deal. Given our exposure to markets and developments across Canada, we’re also able to critically assess local prospects for each project like the appetite or absorption rate for high-end rentals, the costs of concessions or inducements, if any, to spur lease up activity and zoning changes. That said, because we have diverse investing partners, we can find creative ways to mitigate risk and still help a developer get a project off the ground using strategies our competitors won’t, like providing mezzanine financing.
One of the risks in any deal is rising interest rates, particularly since many apartment construction projects may not be occupied for 24 months into the future. Is there a way a developer can mitigate that risk?
We offer an advance rate-lock program that under certain circumstances allows our clients to lock in an interest rate during the lease-up period. Borrowers find that feature very appealing in a rising rate environment because it does mitigate some of their risk. But fundamentally, it’s about making sure the borrower has a comfortable amount of leverage. One of the best services we can provide to a borrower is to make sure they don’t take on too much debt or make projections about rental rates that are unrealistic.
Final question. What resources do you bring to bear to help your clients?
We have both financial and human capital available to deliver our mandate for borrowers and we keep adding to both to fuel our growth aspirations. Most recently, we recruited a construction lending expert who spent many years working in the development industry. The first thing he did was to create a proprietary First National data analysis model that allows our borrowers to critically assess the economics of their projects, test their baseline assumptions and determine the likely investment returns they will generate. This is just one example of how we try to add value well beyond a competitive interest rate. When a developer comes to First National, they will find a firm that speaks their language and is committed, like they are, to building bigger, better communities one apartment and one condominium at a time.