It’s Time To Reset Expectations For Multifamily Housing

This article was written and submitted by Evan Pawliuk, AVP Commercial Mortgages, First National Financial LP.

The real estate market is dramatically different now than what we have seen over the last 15 years. The condo markets in Toronto and Vancouver that performed incredibly well have slowed dramatically with thousands of unsold units now flooding the market. Purchasers are struggling with financing units purchased at the market peak and project launches are grinding to a halt.

As a result, many condo developers are attempting to pivot towards purpose-built rental. But they are also faced with immediate challenges either due to upfront costs, economic uncertainty with the ongoing trade war, softening of rents in many markets (including Toronto and Vancouver), increased volatility in bond markets, and tightening CMHC lending policies.

While it may feel as if the whole system is changing, we see this as a return to “real estate 101”.

While none of us have a crystal ball, the market seems to be returning to a more typical and normal cycle, where it is common for building lease ups or selling pre-construction condos to take longer. Navigating this new landscape requires patience, careful planning, a strong balance sheet and, in particular, a change in mindset. Regardless of market conditions, the one thing clients consistently say they want and need to make their business decisions is certainty. On the financing side, interest rates on your debt financing can help provide some pieces of certainty. With that in mind, here are some key strategies to consider.

Consider Long Over Short-Term Loans

Most CMHC insured lenders rely on the Canadian Mortgage Bond (CMB) program as the funding backbone for CMHC-insured mortgages, but the CMB program also has limits, especially for 5-year money as the demand for 5-year money has increased significantly over the 12-18 months while the yield curve has steepened. We expect this situation to continue and for 5-year spreads to continue to increase with the demand for 5-year money outstripping the supply.

So, in short, while interest rates with CMHC are currently lower for five-year terms compared to 10-year terms, there is no certainty what CMHC programs and availability will look like in five years so locking in a longer rate creates more certainty on your debt. Moreover, if you look at this option through a historical lens, a mortgage rate in the low 4% range locked in for a 10-year term is quite an attractive deal.

Early Rate Lock

Early rate lock is another tool that can be used to help create certainty. With the recent volatility in government bond yields expected to continue, locking in rates 30, 60, or even 90 days early can insulate projects from market swings that occur at the wrong time and help preserve development pro formas.

Think Like An Operator

When it comes to the multi-unit housing product you will be building, renovating, or refinancing, this is the time to think of design and capital improvement programs more than you ever had to before. Developers and asset owners need to really look at the liveability of their units. What do renters want to live in, and what will they realistically pay for it? Investors and developers that take more of an operator mindset will likely do better on this front.

Evan Pawliuk, AVP Commercial Mortgages, First National Financial LP.

It is also extremely important to know your location and the community you are building for. Be realistic about your target market, your tenant mix, and what they are looking for. Not everyone can afford the $5-6 per square foot in downtown Toronto.

Engage Your Lender Early To Maximize CMHC Programs

For developers looking for construction financing, it is important to understand how CMHC is adjusting their programs and risk appetite. Overall, CMHC’s programs and underwriting have become more aligned with a risk-off approach. CMHC may limit construction loan advances with a rental achievement holdback. They may also require bonding. Working with a lender that understands CMHC along with your track record and business will be important to putting forward a strong loan presentation.

As for new opportunities, construction loans insured under CMHC’s MLI Select program offer preferential terms for projects that meet specific social outcomes around affordability, energy efficiency, and accessibility. This is great news as many builders are already delivering on these fronts, especially those aligned with ESG principles. However, engaging your lender early will allow you to maximize those opportunities or adapt your plans to align better with those incentives.

Be Aware Of New Federal Policies That May Shift The Landscape Further

With the federal election now behind us, we should get more clarity over the next couple of months as to what actions they’ll take, and we are going to monitor that so that we can help shape projects to align. Many in the industry are keen to see if the speculation about the potential return of the MURB program, accelerated depreciation, and deferral of capital gains on the sale of assets to non-profits materializes. Real estate developers and investors should get acquainted with the various incentive programs that are being made available from all levels of government, and work with their lenders to align their business plans accordingly.