Fallout from higher interest rates may continue to subdue multifamily developers, but lenders express more confidence in prospects for new purpose-built rental and high-rise condominium projects next year. Results from CBRE Canada’s recent annual survey finds the 34 respondents — which collectively hold more than $200 billion in real estate loans — ranking purpose-built rental as their preferred asset type and registering an improved outlook on high-rise condos since 2022.
For 2024, 74 per cent of survey respondents aim to increase budgets for conventional loans on purpose-built rental; 64 per cent plan to increase budgets for CMHC-insured loans; and no lenders will be cutting back from what they budgeted in 2023. Intentions for high-rise condos are more muted with 47 per cent of lenders looking to increase their loan books over 2023 levels and 7 per cent opting to reduce them. However, fewer than 15 per cent of survey respondents now view high-rise condos as an asset class exhibiting cause for concern compared to upwards of 30 per cent when surveyed in the fall of 2022.
Even so, lenders’ willingness is just one of the factors involved in getting more housing built. Speaking in conjunction with the online release of the lenders’ survey results, Carmin Di Fiore, CBRE Canada’s executive vice president, debt and structured finance, commended recent government moves to remove the harmonized sales tax (HST) on purpose-built rental construction and provide more financing, but maintained the business case is still far from alluring in an environment where expected returns on new development are only modestly higher than the 5-year and 10-year Canada bond rates.
“With bond yields where they are, the question now becomes whether lenders’ growth desires will translate into deals that make it from the spreadsheets to construction,” Di Fiore mused. “There is a potential for a super-cycle in purpose-built rental construction if politicians enact the game-changing incentives that the private sector needs. Politicians have to accept that investors who take on the risk of development, ownership and repayment of all capital over a 30-year period will need to earn an appropriate return given the risk of such investment.”
Di Fiore’s colleague, Krissy Fry, vice president, debt and structured finance, noted that September’s HST announcement has helped reactivate some proposed projects that were mothballed after interest rates started trending upwards in 2022. Lenders predict the most notable pickup in development activity in Toronto, Vancouver, Montreal, Halifax and Ottawa, with 85 per cent of survey respondents foreseeing either a “significant” or “moderate” increase in Toronto. Meanwhile, acquisitions from the earlier low cap rate era could exert pressure on multifamily landlords, and many of the qualifications that lenders imposed on condo developments last year remain in place.
“Looking forward over the next 12 months, renewals or refinancing for purpose-built rentals could be limited as loans mature at substantially higher interest rates and potentially higher cap rates,” Fry said. “Expect to see further tightening of lending conditions for the residential condo sector with a focus on higher upfront equity, greater deposits and the potential of the size of projects to be scaled back.”
Land deal slowdown expected to ripple through to housing starts
A slowdown in land deals is also identified as an upstream obstacle to new housing supply. Peter Senst, president, Canadian capital markets, with CBRE’s national investment team, reported a five-year low in transaction volume in 2023 for lands zoned for high-density development. Speaking earlier this fall during Altus Group’s online overview of 2023 real estate trends and projections for 2024, Raymond Wong, the firm’s head of research and data, fingered lenders in that trend, while his colleague, Peter Norman, head of economic consulting, projected a ripple effect on housing starts in 24 to 36 months.
“For land transactions, both residential and commercial, the biggest challenge there is capital sources for financing,” Wong said.
“Through this higher interest rate period, we have seen residential land transactions decline quite dramatically on average. This represents projects that would have typically been launched in 2024-25 with starts for 2026-27,” Norman advised. “So this fairly dramatic decline in land sales probably will be a kind of harbinger for weaker construction activity as we go through and beyond the current horizon.”
For next year, CBRE’s lenders’ survey shows that 19 per cent of respondents plan to increase development land budgets above 2023 levels, while 15 per cent intend to trim back. Two-thirds see “significantly elevated” or “elevated” credit risk attached to loan renewals or refinancing.
“Interest rates right now are having the biggest impact on the land market. When you don’t have income (from a building), the idea of land and carrying it with a higher and higher cost basis as interest rates roll, it’s becoming tougher,” Senst concurred. “Some deals are getting done. There is capital coming in, and some of it is new capital coming into the country, but land becomes a tougher and tougher sector to move through.”
In other trends affecting the multifamily sector, Norman linked the 30 to 40 per cent year-over-year decline in condo unit sales across major Canadian markets in large part to investor-owners pulling back. “We’re also starting to see more investor product coming into supply on the resale market,” he added.
Senst highlighted Canada’s low residential vacancy rates, climbing rents and population growth projections. “There are not many numbers like that around the world. This is the type of data that helps draw global capital to Canada when they see these kind of levels,” he said.
A slim majority of surveyed lenders (51 per cent) predict that inflation will ease back down to the targeted 2 per cent rate by the first half of 2025 — in advance of the Bank of Canada’s presumed schedule of year-end 2025 — with 30 per cent suggesting that could occur next year. Nearly half (48 per cent) predict the Bank of Canada’s overnight rate will fall by year-end 2024, but 18 per cent foresee it will stick at 5 per cent, and 15 per cent of respondents expect the rate to rise higher. (The remainder of participants did not express an opinion.)
“If rates are going back down, if bond yields are back to 2.95 by the end of 2025, it starts to bring a little more balance to the market,” Senst observed. “It sets up things that are better.”
