Q3 2022 Commercial Mortgage Market Update

11 Oct
Aaron X. Sun
In early September, Jerome Powell came out with a contradictory phase, "Growth Recession." This term implies that the US is facing lower GDP growth but not an actual recession, a notion that many experts are now disputing with 98% odds of a recession in the coming months. Due to a drastically falling Pound Silver, The Bank of England has also recently reversed course by re-implementing a bond buying program to restore order to the market.

But what about our side of the pond? Prior to the September announcement of another 75bps increase to the Canadian Prime Rate, we noted that there was absolutely no consensus amongst the major banks as to what the size of the increase was going to be and if there are more coming. This remains the same heading into October and it’s anyone’s guess as inflation continues to run hot. Most economists in Canada are also now forecasting a recession within the next year, with some calling for soft landing and some warning of a moderate recession…meaning we have opinions across the board.

The real estate industry is feeling the impact of this uncertain economic climate, with housing prices down significantly year over year. With this, there seems to be lots of debate between industry peers as to how bad the contraction will be for commercial real estate activity in Canada. Is the house on fire? We are certainly seeing the sparks and smoke.

The commercial term lending market is facing challenges as well, with the DSCR on amortizing deals remaining the major limiting factor in pushing leverage. Due to this, we’re seeing the lowest Loan-to-Value ratios in decades and lender spreads are increasing as the risk of a recession is priced in. Office deals appear to be facing difficulty in obtaining capital, with lenders unwilling to take on the risk of equity take-outs. The only exception remains the insured multi-family loan market, where spreads over the CMB and lender appetite remain consistent.

Land financing is also facing headwinds with conventional lenders either fully deployed for their 2022 allocation or only servicing existing borrowers. Equity take-outs are largely being declined, and spreads for land financing have widened, with borrowers needing to reset their expectations from what we seen 12 months ago. While select deals are being done in the Prime +1.00% to 1.25% range, they are few and far between. In general, we are seeing a 0.50% premium to historic pricing with Prime +1.75% to Prime +2.50% being the new normal for “A” tier land financing. Unzoned land is even more challenging with mezzanine/alternative lenders being inundated with requests. From surveying these lenders, they are rarely stretching the 50-55%LTV range with rate expectations often north of 10%.

The implementation of Basel III regulations in March 2023 will also raise interest rates, affecting pricing for both land and construction financing. Capital requirements for most land and construction loans will necessitate OSFI regulated lenders to risk weight at 150%, which will inevitably raise interest rates in lockstep with the increased cost of capital. There are some exceptions to residential land and construction financing that will maintain current risk weighting at 100%, including lower LTV multi-family construction and zoned multi-family land.

Oakbank has seen a dramatic shift in the lending market, with acquisitions and new construction starts slowing down. With rising costs of borrowing and the potential for over-leveraging, this could be the make or break for borrowers in early 2023.

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