Lender confidence varies across market segments, but there is a general affirmation of commercial real estate heading into an expected recession. Logistics warehouses, multifamily rental buildings, data centres and life sciences labs are tapped as favoured assets in CBRE Canada’s newly released survey of 29 companies that collectively hold $200 billion in real estate loans.

“The rapid escalation of costs of capital, valuation uncertainty and general chill over the real estate market stood out this year,” Carmin Di Fiore, CBRE’s executive vice president, debt and structured finance, observed during last week’s online presentation of the survey results. “Given all the news influencing real estate, the best news we have is that 93 per cent of lenders still expect to grow their portfolio next year.”

Even so, their enthusiasm has ebbed from 12 months earlier. This year, 48 per cent of survey respondents state they’ll be actively or very actively bidding on real estate deals in the coming year, with the slightly larger majority typifying themselves as cautious or conservative bidders. That contrasts with the fall of 2021, when 90 per cent of respondents foresaw they’d be active or very active bidders.

Last year, 53 per cent of participating lenders envisioned a 20 to 30 per cent year-over-year expansion in capital debt for real estate while 40 per cent anticipated a 10 per cent increase in their budgets. Across all asset classes, lenders collectively fell about 30 per cent short of their 2022 targets — an outcome CBRE analysts attribute largely to “rapid escalation in the cost of capital” in the second half of the year, but also somewhat to a simple shortage of some highly sought asset types like data centres and life sciences facilities. Notably though, 78 per cent of survey respondents met or exceeded their budgets for loans on industrial assets.

For 2023, two thirds of respondents are targeting a 10 per cent year-over-year increase in real estate loans. “Relative to last year, the pressure to put out more money has been dialled back,” Di Fiore said.

Nor are lenders as eager to shift a larger share of their overall capital debt portfolio to real estate. In the fall of 2021, more than two thirds of survey respondents voiced that objective, while this year, more than three quarters expect to keep their real estate allocations at current proportions. Only three per cent intend to shrink their real estate allocation relative to other investment classes, which is consistent with the sentiment garnered in 2020 and 2019.

“No typical lender in Canadian real estate is isolated from the comparable liquidity issues of competing investments nor the overall increase in costs of funds witnessed in higher credit spreads,” Di Fiore submitted.

Canada considered well positioned for 2023

Although survey respondents unanimously concur that a recession is coming, 83 per cent do not expect it to have more than a minor or moderate impact on real estate underwriting. Picking up on that theme, Peter Senst, president, capital markets, with CBRE Canada underscored the relatively stronger outlook compared to elsewhere. While a 16 to 17 per cent decline in global real estate transactions is projected for 2023, a more modest 4 to 5 per cent drop is foreseen for Canada, with sales volume falling from about $59 billion to $56 billion.

“In Canada, we’re just not feeling it the same way. We’re still trading with reasonable velocity,” Senst maintained. “The size and significance of the deals we’re doing in Canada, especially in the second half of the year, will be the biggest in the world.”

Among trends backing his optimism, he hypothesized that interest rates are nearing a peak, and a projected 70- to 80 basis point drop in the 10-year Canada bond rate by the end of 2024 will bring predictability and lower financing costs. For now, he suggests many investors with capital to deploy will seek out value-add and opportunistic assets.

“Really, more than half the money that’s available will be looking for ‘alpha’; they’re going to be looking for outsized returns going into the year. When we’re pricing core, it’s tough to make core work today with today’s cost of capital,” Senst advised.

Office stumbles, multifamily and industrial retain favoured status

From lenders’ perspective, Class B suburban and downtown office properties are the least preferred loan candidates, causing concern for more than 90 per cent of survey respondents. Class A downtown and suburban office have more positive profiles, but both slipped in lenders’ estimation over the course of 2022 and lag 11 other types of assets on the confidence scale. A fairly substantive majority of lenders — 59 per cent — plan to decrease their budgets for office loans in 2023, representing the largest shift away from any asset class.

Continued low levels of office attendance is a key factor. Thirty six per cent of survey respondents do not foresee near-full conditions for at least 18 to 36 months, and another 36 per cent push the timeline beyond 2025. “Softer office attendance is materially or moderately impacting the opinion of over 80 per cent of lenders,” Di Fiore affirmed.

Upwards of a third of survey respondents are uncertain of the long-term impacts of a hybrid workplace model in which some to many staff spend only a portion of the work week in a formal office setting. However, more see it as a long-term risk in suburban offices (48 per cent) versus downtown (34 per cent). As well, 21 per cent of respondents view hybrid work as a potential long-term opportunity for downtown office compared to just 10 per cent holding that view about the suburbs.

Lenders’ favoured asset classes for 2023 include: multifamily rental buildings, for which 54 per cent of survey respondents are planning to increase their budgets; industrial properties; and a trio from the alternative asset class — data centres, life science/biotech labs, and self-storage facilities. Toronto, Vancouver, Montreal and Ottawa emerge as the top markets, with 76 per cent of respondents expressing a “strong” appetite for deals in Toronto and 72 per cent for Vancouver.

Looking at potential or likely adjustments to the underwriting process, 71 per cent of survey respondents indicate they’ll be more questioning of appraisal values and stringent about sponsorship evaluations. A majority will also be modelling for increased vacancy in properties (57 per cent) and adjusting growth projections of net operating income (52 per cent). As well, 48 per cent intend to increase debt service coverage ratios and lower maximum allowable loan to value.

“Given these expected changes, debt underwriting will likely be fluid and protracted,” Di Fiore said. “It may also influence the terms of initial buys and what shape a formal commitment will ultimately look like.”