More cautious criteria for condo project financing could upend some development pro formas and potentially constrain housing starts in the coming months. CBRE Canada’s annual survey of lenders finds them generally less open to loans on high-rise condo projects than they were 12 months ago.

“Headwinds are hitting the condo sector. A tightening in underwriting is on the way,” Carmin Di Fiore, CBRE’s executive vice president, debt and structure finance, warned during the online release of the 2022 survey results earlier this week. “Cost-push inflation and rising interest rates are pencilling out very differently compared to previous years.”

In the period between November 2021 and November 2022, high-rise condos have shifted from being one of the least worrisome underwriting candidates to midway in the pack of 18 categories of commercial real estate assets. More than 30 per cent of respondents — from a total survey base of 29 companies that collectively hold about $200 billion in real estate loans — expressed reservations versus fewer than 10 per cent naysayers last year.

That still gives high-rise condo developments a significant margin of comfort over all types of office properties, hotels and regional malls, while eight other asset classes garner more favour. That includes three other types of housing: single-family development;, seniors housing; and multifamily rental buildings. Notably, the latter shares preferred status with grocery-anchored retail, eliciting no concern from lenders.

Prospective condo developers will now be seeking capital in an environment where 67 per cent of surveyed lenders want more upfront equity and 39 per cent will looking for unit purchasers to make larger deposits with shortened payment schedules as a condition of financing. Upwards of 25 per cent of survey respondents also indicate they will demand greater development contingencies and fewer presale assignments.

“It could be a game-changer for many projects in the pipeline,” Di Fiore said. “The condo market could see a slowdown based on the changing arithmetic.”

He also foresees potential hiccups for mixed-used developments given lenders’ considerably less enthusiastic outlook on new office space. Declaring the office development cycle effectively over in most Canadian cities, Di Fiore hypothesized that only a fully pre-leased office project with a credit tenant financing structure is likely to attain lenders’ approval in the current environment.

“Given recent trends toward more mixed-use high-rise developments, there may be a spillover. Those projects featuring an office component will be much harder to underwrite,” he maintained.

Few surveyed lenders suggest they’ll exert pressure for loan candidates to scale back the size of their projects or to phase completion over a longer period, leading CBRE analysts to conclude “lenders are adjusting to increased risk solely through financing adjustments rather than to the development process itself”. That appears to be aligned with general expectations for sustained housing demand.

For 2023, 19 per cent of survey respondents intend to increase their budget for high-rise condo loans with a smaller 13 per cent portion pulling back from their 2022 levels. However, lenders show more enthusiasm for other housing types, with 54 per cent of survey participants augmenting their 2023 budgets for multifamily rental and 30 per cent increasing budgets for single-family housing. Nor are any lenders cutting their budgets for either of those asset classes.

Also related to new condo development, land experienced the steepest fall from grace over the course of 2022, with 52 per cent of surveyed lenders now expressing hesitancy compared to about 17 per cent with such concerns last year. Land is also the only asset class for which no lender has an expanded budget in 2023. However, a significant majority (72 per cent) is committed to holding steady with 2022 loan levels, in contrast to the 59 per cent that intends to reduce office budgets next year.

Peter Senst, president of capital markets for CBRE Canada, further qualifies that sites zoned for multifamily development are capturing the most attention within the diverse asset class. “When you break down land between ICI and residential, you can see it’s all about residential values and activity. As you go further into this, it’s all about high density,” he said.

In almost all cases, borrowers can expect higher financing costs at least in the near-term future. Year-over-year loan spreads widened in 2022 and a significant majority of lenders (65 per cent) anticipate further stretching in 2023. Most project that will be in the range of 10 to 30 basis points (bps) on a five-year term, while 52 per cent foresee a 20 to 40 bps increase on 10-year terms.

“The implication of rapidly inflating costs of capital since the first quarter has created some new math across every investment sector, including real estate,” Di Fiore reiterated.

Barbara Carss is editor-in-chief of Canadian Property Management.