Q3 2024 Commercial Mortgage Market Update

In late September, as an additional stop-gap to maintain bank capital reserves for overnight settlement, the BoC restarted their Securities Lending Program (and discontinued the Securities Repo Operations) which appears to have higher maximums in amounts borrowed (up to $5bn per counterparty) and relaxed oversight. An interesting thing to note is that the BoC is now counting Canada Mortgage Bonds (CMBs) as eligible collateral, which ties into their recent decision to purchase $30bn of CMBs from the market. Without doing a deep-dive into this complex economic issue, it could potentially point to a potential “house of cards” effect if the underlying home values drop substantially which would significantly impact liquidity in Canada. With all that being said, the bond market is optimistic and has priced in a potential 75bps being cut before the end of the year which has sent a signal that the worst of the post Covid-19 inflationary era may be behind us.

Office Financing?

There is cause for optimism in commercial term lending as GOC bond yields have dropped drastically this quarter, hovering around the 2.70% mark for the majority of September. Although office is still a challenging asset class, we have observed some lenders are starting to defrost on the asset class and are starting to provide quotes for well-located office properties with name brand tenancies. Preference of course is still for longer weighted average lease terms and requests below 50% loan-to-value. Aside from office term lending, we have seen almost no change on lending spreads from last quarter for good quality industrial and retail properties.

CMHC Update...and Positive Leverage is Back

On the insured side of the market, the CMHC Correspondent changes came into effect on September 3 amidst the myriad of other changes that we discussed on last quarter’s report. CMHC continues to be backlogged, with typical wait times at about 10 weeks for refinancing deals (with affordability). More complex deals can see wait times of 3 - 4 months before they are picked up by a senior specialist. Our last update noted that moving forward, lenders would need to fund 80% of the CMHC certificates (“COIs”) that they originate, which we were told by inside sources at CMHC. While not yet confirmed (and still under much debate with stakeholders), we have been made aware that an announcement could be made within the coming weeks. This would cause a fundamental change in the market as borrowers will lose pricing power as lenders will be more reluctant to release COIs in favor of other lenders with better pricing. Another change that CMHC recently implemented is that construction “ceiling rates” are no longer able to be set by lenders for ten-year deals. Previously, lenders were able to suggest (within reason) an underwriting ceiling rate that could be lower than the prevailing market rate in order ratchet up leverage. This change now harmonizes 5 and 10-year deals to be decided by CMHC alone. This change combined with the 5/10- year yield curve normalizing has resulted in a shift for insured borrowers towards choosing 5-year deals, almost en masse. There is a significant shortage of 5-year funds remaining for deals funding in 2024, with some lenders significantly dropping spreads for 10-year deals that can fund within the calendar year. Today, 5 or 10-year all in CMHC rates are anywhere between 3.5% to 3.9%, almost 100 bps off the highest rates seen at the same time last year. If the BOC and US Fed both come through with the expected rate cuts, we may see 10-year rates approaching pre- COVID levels of around 3.50 to 3.70%... meaning positive leverage seems to be back! (ie. term lending rates less than prevailing cap rates).

There are rumors (which we have substantiated with insiders at CMHC) of a change that will be announced within a few months for the ACLP program, which has caused some borrowers to rush the submission of their applications. Remaining ACLP budget allocation for deals funding in 2025 is drying up quickly. Finally, CMHC has signaled that there will be an update to the affordable rents for the MLI Select criteria sometime this Fall, which would be welcome as the dataset being used is now over 5 years old.

Optimism on Condo Market Returns

TD Bank’s economist, Rishi Sondhi, recently penned an article expecting a modest revival in the Toronto condo market by the middle to end of 2025 with price growth between 2-4%. Housing experts are beginning to sound the alarm bells that a supply crunch may be in store for 2026 and 2027 as BILD reports a massive drop in housing starts which are consistent in every major Canadian city except for those in the Prairies. Consistent with the above, we have observed that land financing is starting to see a slight uptick as we begin to see acquisitions either from distress sales or refinancing activity for projects gearing towards a 2025 sales launch. While the future may look rosy, the current condo market remains in deadlock, with assignment sales dominating the headlines, often trading with purchasers walking away from six-figure deposits, and trades occurring in the $900 PSF mark in Toronto. In addition, the months of inventory for Toronto condominiums has reached a 20 year high of 7.4 months. As we mentioned in previous updates, select lenders are providing inventory loans on newly completed condo/townhouse product to provide liquidity for developers who either have construction loans to pay off, or equity trapped in unsold condo stock.

As we approach the final stretch of the calendar year, it feels like cautious optimism is in the air. While some asset classes are certainly still challenged, what was previously a “no” from both lenders and borrowers alike has evolved into a “maybe.” As mentioned above, there is a differential between all-in CMHC financing rates and vendor expectations right now, a gap that will almost surely close as rates continue to fall in the next few quarters. Borrowers are taking advantage of the attractive rates and CMHC insured money is in short supply and/or delayed for months. We advise moving quickly with lenders that are offering good deals instead of pushing for “perfect” as lenders are currently in the driver seat with increased demand and short supply.

Finally, there is an incoming regulatory change for the industry as the Proceeds of Crime Money Laundering and Terrorist Financing Act (PCMLTFA) regulations now apply to the mortgage industry as a whole, including mortgage brokerages, mortgage administrators and private lenders. These entities will need to have proper KYC/AML procedures in place by October 11, 2024 according to FINTRAC standards. Borrowers, do not be surprised if your private lenders are now requesting more due diligence and sponsorship related material up front.