Cranes are in the air as apartment construction activity increases in markets across Canada. No doubt, these are opportune times for apartment builders, and ones that require a nuanced understanding of the markets and respective lending options.
With a bird’s eye view of what’s taking shape, we reached out to Jeremy Wedgbury and Aaron Cameron from First National Financial LP.
Why is it important to stay on top of apartment market trends?
Jeremy: The market for the construction of apartment buildings is very active, and it’s currently being driven by a strong commercial real estate market and sustained low interest rates. That said, developers need to remember that each sub-market varies greatly in supply and demand drivers, market rents, legislation, and loan structuring terms offered by local and national lenders.
Aaron: And that’s just it; First National has many clients who are developing properties right across the board – from Halifax to Victoria and all spots in between – so being able to speak to those markets and understand the intricacies between them is critical to our borrowers.
How are those markets different?
J: We see regional differences based on the preference of tenants and the economics associated with the rental rates they are prepared to pay. Tenants in Toronto and Vancouver have been accustomed to paying higher rents per square foot on small suites for many years to landlords in the shadow condominium rental market. Other markets that have not had robust condominium markets are starting to follow that trend with higher quality downtown rental buildings that are commanding rental rates well above existing product. The big question will be, how deep is this market for high end rentals in smaller markets? Monitoring this absorption is critical to borrowers and lenders alike.
A: Given our exposure to developers nationally, we have access to firsthand knowledge of absorption rates, rental rates, and concessions that are being provided to lease up new buildings. For example, in many cases we see pre-leasing rates in new developments in Halifax of 30% to 40% or more prior to completion, while the current situation in Calgary would see up to 12 months to lease up with generous incentives.
What are developers’ financing options when it comes to taking advantage of this activity?
J: There’s no shortage of conventional and CMHC insured apartment construction financing options out there for developers. The critical component continues to be the depth of the borrower’s development experience and the best mortgage terms are offered to groups with strong experience and covenants. There is also a steady supply of mezzanine lenders that act as a shadow covenant for primary lenders to support developers with shorter track records.
A: Although interest rates remain low, a significant risk is on the horizon for developers are the steadily increasing interest rates we have been seeing since May. Builders that are forecasting completion in 12 to 24 months must recognize the risk of higher long-term interest rates by the time they complete their projects. First National has developed certain products which allow our clients to lock interest rates up to six months earlier in the process, thereby mitigating some of this risk.
J: Where First National makes things easier, however, is we offer a greater range of financing solutions than you might get with a bank. We’re like a “one stop shop” in that our clients have access to a broad range of products, including conventional products, CMHC insured products, and even higher leverage products that help developers spread their equity more effectively.
CMHC has also come out with new programs as well?
A: Yes. On May 15, 2017, CMHC launched a new direct lending program to developers which should be a big boom to construction financing. It’s a very appealing and supportive program where funds are directed through CMHC and not the lender, so it has some very advantageous terms to it.
First National can also provide access to CMHC’s new affordable program where borrowers can get up to 95% loan to cost. That’s dramatically higher than what you’d find in the conventional market, which is typically 75-80% loan to cost.
That seems beneficial for small developers…
J: It really is. It’s fair to say the conventional market has been well supplied for large developers and, perhaps to a lesser extent, medium-sized builders. Small developers, though, are always challenged to get financing because the banks don’t have the same relationship with them. Products like the affordable program out of CMHC will really benefit smaller developers who may have the expertise to tackle a bigger project but might not be getting support from their bank.
Jeremy Wedgbury (Senior Vice President, Commercial Mortgages) and Aaron Cameron (Senior Manager, Commercial Operations) are with First National. For more, visit www.firstnational.ca.