The Canadian mortgage market has been experiencing changes and challenges in 2022, largely due to the Bank of Canada's interest rate hike and worries of an incoming recession. In June, the Bank of Canada raised its rate by 50bps, and another 75bps increase is expected in July. As a result, economists at leading banks are predicting a larger rate hike at the next announcement, as well as continuing quantitative tightening.
This year, the Government of Canada Bond Yield has also been steadily increasing. The 5-year and 10-year yields reached over 3.50%in the third week of June and regressed to end the month at 3.12% and 3.25%respectively. The combination of the rising yields and market volatility have led to a slowdown in the commercial mortgage market. Lenders have raised their credit and underwriting requirements, and some have even tested term loans near7% interest rates to stress test debt service requirements, which has resulted in a reduction in loan amounts.
The insured multi-family debt market has also experienced similar changes. All-in 5-year and 10-year mortgages have increased, reaching 4.15% and 4.45% respectively, a nearly 40bps increase from the previous month and almost 150bps increase YTD. The average spread of the lenders surveyed ranges from 38bps to 55bps
In March, the Canada Mortgage and Housing Corporation (CMHC) introduced the "MLI Select" program, which has resulted in challenges for construction loans that were underwritten in early2020 through 2021. At that time, the interest rates were much lower, and most projects were underwritten with interest rate ceilings in the low 2% range. As these projects move into permanent financing, the recent increase in rates has made the previously negotiated loans no longer feasible, requiring loan buydowns or cutbacks to meet DSCR requirements. Another option for borrowers would be to layer in subordinate debt to retire the construction financing that cannot be supported by CMHC alone.
Due to the changes in the market, liquidity in the general lending market has been declining. Lenders have reported pausing lending due to various reasons, including above pace Q1 volumes, concerns over volatility in interest rates, housing prices, and construction costs. Major pension funds have also been reducing their commercial lending activities and allocating more to lower-risk products like corporate bonds, causing them to put a pause on commercial mortgage lending. One major alternative bank lender has also ceased considering new commercial mortgage deals for 90 days as it completes its acquisition of a credit union aggregator estimated to close in September 2022.
For those still in the market for land and construction lending, tighter credit and underwriting requirements are being sought, as well as more certainty from borrowers in the form of up-to-date cost consultant verified budgets, proof of guarantor liquidity, and significant firm presales/preleasing. Lenders are also showing a preference for low- and mid-rise multi-family product over high-rise, due to their lower perceived risk and faster timelines. Alternative and mezzanine lenders with more flexible underwriting criteria and shorter credit timelines are picking up some of the slack in the market as borrower expectations begin to re-align with the changing reality. Relief in the form of lower construction costs (or at least material inputs) may also be around the corner, as futures contracts for lumber and steel have fallen to prices far below their 2021 historic highs.
As the mortgage market experiences headwinds, the anticipated response of cap rate expansion and falling prices is starting to show in major markets. A marked slowdown in trades of both development land and income-producing commercial real estate provides potential buyers with leverage to renegotiate deals that are already under contract. Those sitting on the sidelines with dry powder will be in a prime position to take advantage of opportunities as cracks begin to form in vendor expectations.
Oakbank is a real estate capital advisory firm based in Toronto. We originate and structure financing solutions for developers and real estate investors in the form of construction, bridge, mezzanine, and term loans.
Oakbank Capital Group is licensed and regulated as a Mortgage Broker by the Financial Services Regulator of Ontario (FSRA Broker #13455).