Q4 2022 Commercial Mortgage Market Update

The yield curve inversion between the 10-year Government of Canada Bond (GOC) yield and the overnight rate has reached an extreme, with a 140bps point difference, a strong precursor to a recession. However, there is also speculation that the market expects an overnight rate cut in the near term, potentially as early as late 2023. While we won’t beholding our breath on that one, the sentiment heading into 2023 is brighter than the past two quarters.

In mid-December, GOC bond yields dropped nearly 40and 30bps for the 5-year and 10-year bonds, respectively, relative to the end of Q3 2022, a bullish sign for the future. However, the Bank of Japan's surprise move to increase its rate cap for the first time in over 20 years sent shockwaves through the global financial system and GOC bond yields were back to where they were at the end of Q3.

Despite positive sentiment heading into 2023, there is uncertainty about what to expect in Q1 2023. There has been an uptick in refinancing and acquisition activity in the commercial real estate market because of the shift in sentiment, with some adjustment of buyer and vendor pricing expectations.

Lender spreads for most asset classes have remained constant with what we saw at the end of Q3, with some upward pressure on spreads for office assets. The insured multi-family loan market remains unchanged, with a few lenders providing unprecedented spreads over the CMB for MLI Select affordable refinancing loans (as low as 32bps over CMB). Land financing remains challenging, with developers looking to take advantage of CMHC MLI Select and RCFI programs. Construction underwriting has tightened, with most institutional lenders requiring higher contingencies and step-ups in the interest rate.

The latter half of Q4 saw a return to more normal acquisition and construction activity, with vendors becoming more realistic on their cap rate expectations and developers being more optimistic about the market stabilizing in the coming year. However, lenders being more conservative are lagging on the sentiment, with a few mezzanine lenders experiencing liquidity issues. It is expected to be a busy Q1 with institutional lenders focusing on their core clients and secondary and mezzanine lenders picking up the slack for the rest of the market in early 2023.

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