Last year was a good one for landlords in the multi-residential market who continued to enjoy some of the lowest interest rates in Canadian history. Many took advantage of these favorable rates by refinancing and unlocking equity from their buildings.
Borrowers used this equity to acquire new properties, complete much needed capital expenditures and green their buildings. The Bank of Canada rate remained unchanged at one per cent for the entire calendar year.
This past year has seen an improvement in Canadian consumer confidence. Cap rate compression in the apartment industry pushed market values to all-time highs in many Canadian cities. The Canada Mortgage and Housing Corporation (CMHC) insured mortgages continued to be the most popular mortgage product of borrowers in 2013.
Interest rates
The sheer size of the U.S. economy and its impact on the rest of the world continued to affect the Canadian markets and interest rates. On May 22, U.S. Federal Reserve Chairman Ben Bernanke announced that the Fed might taper or reduce the size of the bond-buying program, known as quantitative easing. This bond-buying program was designed to stimulate the U.S. economy.
The announcement was a surprise, and led to turmoil in the financial markets in the second quarter. The mere mention of a possible reduction of spending from the current $85-billion-per-month stimulus caused panic. Within seven days of Bernanke’s announcement, Canadian bond rates temporarily spiked 100 basis points, causing concern for Canadian borrowers.
However, the U.S. bond-buying program remained unchanged for the balance of the year. As a result of the continued stimulus program, Canadian bond yields began to decline. Overall, last year saw the five-year Canada Mortgage Bond increase by over 30 basis points, and the 10-year rise by 70 basis points. This highlights the volatility that can occur when our friends to the south make any changes to their monetary policy. In many ways, Canadians are at their mercy.
Five- or ten-year terms?
Throughout 2013, 70 per cent of our clients opted for 10-year term financing. This was a substantial shift from prior years where five-year term was the norm. The decision should be based on the client’s overall business plan for the property. The ability to absorb a large jump in interest rates at the end of five years must be strongly considered when deciding on length of the term.
The Canadian apartment rental market
The low interest rate environment in 2013 kept the real estate market competitive. Cap rate compression forced premium pricing in the multifamily market. In CMHC’s October report, vacancy rates increased slightly to 2.7 per cent, up from 2.6 per cent in 2012.
Demand for properties outstripped supply, and the seller’s market continued throughout the year. Vendors received multiple offers for their properties, resulting in bidding wars driving prices to all-time highs.
What is the outlook for 2014?
We anticipate seeing more of the same in 2014. The outlook for employment and economic growth is expected to gain further momentum this coming year. Rates should slowly climb once again as confidence grows in the economy and the U.S. government gradually reduces its monthly stimulus program. A sustained increase in interest rates may lead to a slight climb in cap rates over the year.
Vacancy rates will remain low as residential mortgage restrictions will continue to force potential home buyers to remain in the rental market longer.
In summary, we predict the multi-family market in 2014 will remain an attractive low-risk investment and demand for apartment buildings will be high throughout the entire year. It will still be an excellent environment to refinance, unlock equity or acquire new property.
Peter Cook and Robert Fleet are from First National Financial.
