Trends in the commercial property industry can be hard to track. Nonetheless, keeping tabs on market conditions and headwinds can help asset stakeholders make the most of their investments.
Here with his thoughts on the current industry and outlooks for commercial mortgage financing is Jeremy Wedgbury, Senior Vice President, Commercial Mortgages at First National Financial.
Now that we’re nearing the end of 2019, how would you characterize the year?
Incredibly productive. At First National, we’re experiencing record volumes; in our second quarter, commercial segment originations of $2.6 billion were 50 per cent higher than a year ago, reflecting strong market demand. As well, commercial renewals of $664 million were about 2.2 times higher from a year ago on the same fundamentals.
Is there a demand trend between insured and conventional origination volumes?
Interestingly, we see a 50-50 split between the two. Honestly, I didn’t think we’d ever get to an even balance like this, and it’s been accomplished even as demand for both insured and conventional has continued to rise.
What’s driven that mix change?
We’ve expanded our lending platform and brought even greater focus to the needs of the market. Compared to the past, we’re getting far more inbound calls from institutional investors who want to partner with First National on conventional deals. That’s a testament to the strength of the commercial property market.
What markets are hot in Canada right now?
As an overall asset class, commercial real estate is hot, while apartment properties pretty well anywhere in Canada are also hot. As for specific jurisdictions, Montreal is very strong, and I think it will be for the next three to five years and beyond. In terms of challenging sectors, retail is difficult because of changing industry dynamics, and we see a continuation of economic challenges in some regions in the West.
You mentioned that multi-family apartments are a popular asset class. What’s driving its popularity, and is it sustainable?
There is a tremendous undersupply of new apartment stock in Canada at a time when there is significant demand coming from those who cannot afford to buy a home and those who previously owned a home and wish to cash in their equity to fund their retirement lifestyles. I think this dynamic is going to continue playing out likely for the next ten years, not necessarily in every Canadian city, but certainly in many communities.
What cities are moving toward a balance between apartment demand and supply?
We’ve seen a considerable amount of apartment construction in Victoria, Halifax, and Edmonton. In the case of Victoria, a lot of people are moving there, so I think the demand will continue to take up the supply, but it’s becoming more balanced. In the East, apartments were being built in Halifax 10 years ago when comparatively little was constructed elsewhere in Canada, so it’s reaching a more balanced level. Edmonton has quite a bit of product coming on stream, and there is concern about the level of demand because of the state of the provincial economy and unemployment. What may happen there is a new product attracts renters who are currently in older units. If this happens, it could have a detrimental effect on occupancy rates in older stock, but we’ll need to see how it plays out. All of that said, we are very comfortable with all three of these markets at present.
A couple of years ago, you mentioned seeing some condo developers move into apartment construction. Has that move continued?
It has depended on the region. In Alberta, we’ve seen a move to rental construction because demand in the condominium market is depressed. In Toronto, the demand drivers are different. Here we see developers choosing to build rental rather than condos because, in many cases, they want to hold on to the property for the long term rather than selling it off. Many second and third generation developers in Toronto tell me they’ve built lots of great condos but lament the fact that they no longer own them. It’s a pretty attractive proposition to build an apartment, collect the cash flow for the long run, and in the end, still own a property that will appreciate in value if it’s well located in the city.
Speaking of inflation, one of the attractive features of owning an apartment is the increase we’ve seen in rental rates. Is that trend continuing?
Yes, although I think in some markets we are pushing the upper limits of how much renters can afford to pay. One of the interesting things we see in large cities is new rental units shrinking in size, which allows the monthly rental rate to be more affordable. At the same time, developers are investing more in common spaces like party rooms, games rooms, exercise areas, and so forth, which add more value to tenants with smaller units. It’s a creative solution.
Thinking about the commercial financing market generally, have you seen any changes?
Not really. There’s lots of capital available, lots of liquidity and a good level of competition for high-quality assets.
Interest rates have changed pretty dramatically over the past year. How is that playing out with borrowers?
Correct, we’ve seen more than a 100-basis point drop off in Canada Mortgage Bonds and Government of Canada bonds since September 2018, and it’s really changed the conversation we have with borrowers. It’s given rise to healthy discussions about the merits of taking much longer-term loans, and it’s created exceptional demand for 10-year CMHC money in such quantities that we believe demand is outpacing supply industry-wide. As a reaction to that demand and to balance availability, on a limited basis, First National has started to offer 15 year and 20-year insured financing. With these additional options, we’re able to offer terms from 1 to 20 years, plus insured construction financing. I would say that this is the point in the cycle where it really pays to be proactive about rates and to strategize with one of our First National advisors who are empowered to structure the best deals for our clients.
Finally, is now a good time to be a commercial property owner and a lender?
There’s never been a better time generally. Still, I will also qualify that by saying it’s important to look carefully at the asset class, the location, and the deal fundamentals before jumping in. We make it our business to do that, and we’re always happy to help borrowers size up opportunities in advance to ensure they secure the very best financing structure available and avoid unnecessary risk.
Jeremy Wedgbury is Senior Vice President, Commercial Mortgages, with First National. For more information, visit https://www.firstnational.ca/home.