Many of Canada’s top commercial real estate industry owners, developers and decision makers gathered in Toronto from December 3 to 5, 2019 for the 28th annual national Real Estate Forum to explore key issues, trends, challenges, risks and opportunities in the acquisition, investment, management, financing, development and leasing of all property classes. During the Capital & Debt Markets’ panel, First National's Jeremy Wedgbury, Senior Vice President, Commercial Mortgages, made the following key observations.
Multi-family and industrial are the two strongest asset classes in Canada and there is significant liquidity in the market to finance property purchases. Demand for these assets is coming from all directions: REITs, pension funds and private owners. First National is the lending leader in these asset classes and will likely surpass $7 billion in commercial financings in 2019.
Due to strong demand and a change in the yield curve, spreads on 10-year insured mortgages have risen 10 to 20 basis points in the past six months. In order to help borrowers, First National recently introduced 15 and 20-year CMHC-insured mortgages.
Interest rates may remain “low for long” but interest rate hedging strategies are still important. While it appears low interest rates may be in place for a while, rates remain volatile day-to-day due to market forces, some of which are beyond Canada’s borders. To take advantage of dips in the market, it pays to work with a lender like First National that can present flexible rate-lock options.
Land prices for condo and rental apartment developments are now dramatically different in many markets. Demand for condo pre-sales in Vancouver has stalled and Alberta’s condo market is inactive. This trend has affected the ability to finance land, depending on the location and the end purpose.
Purchasing activity is aggressive and valuations are often based on future cash-flow projections. It’s now common to see a 2.5% cap rate on multi-family apartment purchases in Toronto, meaning there often is not enough cash flow to achieve a 75% loan proceed deal. This represents a significant change in economics over the past year with borrowers now putting considerably more cash equity into their deals on the understanding that they will achieve a higher rate of return over time.
Purchasers of apartment assets who buy at a 2.5% cap rate in a major market are hoping to achieve an attractive return on a levered basis with the right plan. To achieve a high single-digit return on a property purchased at a 2.5% cap implies raising rental rates within two to three years of acquisition to achieve a stabilized (unlevered) cap rate of 4.5% to 5%. In rough terms, a 4.5% cap rate would currently represent a 300-basis point spread over current bond yields.
The potential for global economic or trade-war shocks to affect capital inflows, lack of skilled contractors and government regulation remain the key macro risks for the Canadian property industry. Vancouver has already seen the impact of lower capital inflows from China. In major cities, construction projects have been delayed and building costs inflated by contractor shortages and price premiums. And in cities like Toronto and Vancouver, lack of rental housing affordability could trigger new forms of rent control. These risks must be considered but experienced developers and property owners will continue to thrive.
Interested in learning more about First National’s perspectives and the advantage of working with Canada’s most empowered lender? Please contact your First national Advisor today.