Construction activity is on the upswing across Canada — particularly in the apartment sector – thanks to increasing risk capital flows in response to strong demand for new buildings. How long will this trend last and what factors are driving it? We asked Jeremy Wedgbury, Senior Vice President, Commercial Mortgages at First National, to share his insights from decades in construction lending.
Where is lending activity strongest?
Definitely in the rental apartment sector, and for two reasons: there is significant demand for new apartments and more capital available than ever to fund construction of this asset class.
What’s fueling consumer demand for apartments?
Population growth; many years of product undersupply, which has resulted in a substantial aging of rental stock; the fact that single-family homes and condos are out of reach for many first-time buyers; and a powerful demographic shift that has led baby boomers to divest their homes in favour of upscale apartments.
I
t sounds like you are surprised by inflation in rental rates.
It is surprising how quickly rents have escalated, but that’s due to the demand and undersupply factors I mentioned. The stars have aligned for the sector and, as Canada’s largest apartment lender, they’ve aligned for First National. We see that right across Canada.
Where is the capital coming from to fuel apartment construction?
CMHC created their Flex Financing program spring 2017, which is aimed at incenting new apartment construction by offering up to 95 per cent loan to cost compared to 75 to 80 per cent for conventional construction financings.
Building affordable units is the goal but the program’s definition of affordable means that only a certain percentage of the units must be affordable, not all units. As well, affordability is judged in the context of competing rents in the local neighbourhood. Therefore, it’s not unusual to see apartment units funded by this program charging rents close to $2,000 a month. The incentive was designed to bring for-profit developers into the apartment market, and it’s working.
Has there been a change in CMHC’s and First National’s appetite for construction loans?
CMHC has always supported construction lending and First National has as well. What’s changed is that developers are recognizing the value of building and owning rental apartments, which has created more demand for financing, and the Flex program has certainly been there to satisfy this demand. By the way, Flex is also a great gateway product for our insured term loan business.
How does the Flex program serve as a gateway to term takeout financing?
One of the compelling features is that once an occupancy permit is granted, term loans are made available. Conversely, in a conventional construction deal, a term loan does not fund until the lease-up is complete, which often takes another eight to ten months as apartment owners search for the right tenants and strive to achieve the highest rental rates. In a rising interest rate environment, a lot can happen in that period to term loan servicing costs, so this feature is a significant advantage for borrowers. For First National, it also means we can package the construction and term loan together, mitigate borrower risk, and provide greater certainty to a project’s economics.
Before we conclude, congratulations on reaching $25 billion in commercial mortgages under administration.
Thanks. We’re very excited to have achieved this milestone during First National’s 30th anniversary. It validates what we’re doing to help clients meet their objectives while building our position as Canada’s largest commercial mortgage lender.
For more information, visit https://www.firstnational.ca/home.
