Q4 2024 Commercial Mortgage Market Update

In December, the Bank of Canada (BOC) implemented another 50 basis point reduction to the overnight rate, with economists now predicting additional cuts may be necessary given the ongoing weakness in the Canadian economy. GDP per capita has fallen to levels that have erased much of the past decade’s growth, while overall GDP figures are showing a decline, compounded by a reduction in immigration. Meanwhile, the U.S. Federal Reserve made a more modest 25 basis point cut in December, signaling a potential slowdown in the pace of rate cuts, citing persistent inflation and strong economic indicators. This divergence in monetary policies has pushed Canadian bond yields higher, holding at levels not seen since mid-year, and has contributed to a significant depreciation of the Canadian dollar against the U.S. dollar. Further complicating the outlook, the incoming Trump administration’s threat of tariffs, combined with a lack of decisive action from the Canadian government, is adding additional layers of uncertainty to an already fragile economy.

Demand For Income Producing Properties Increasing

Focusing in on the commercial mortgage sector, demand for income-producing properties has increased in the past quarter, with numerous lenders actively seeking greater exposure to high-quality retail assets and offering attractive spreads in return. We anticipate a significant wave of refinancing activity in the retail sector in 2025, as this asset class faced challenges during the early stages of the COVID-19 pandemic five years ago. During that period, many borrowers had little choice but to accept the available terms for renewals and refinancing, which can now be reassessed. In contrast, the office sector continues to face difficulties, with many lenders reducing their office exposure or requiring substantial paydowns upon renewal. On the other hand, the industrial sector continues to show strong demand, despite a slowdown in both construction and acquisition activity. Renewals in this sector are increasingly focused on securing high-quality assets.

CMHC Construction? The Future is Conventional

In the world of CMHC, a number of changes were formally announced on November 15th, which we covered here. Of particular note was the changes to MLI Select Program and the re-introduction of “Rental Achievement Holdbacks”, which is likely the death knell to the construction financing program. Developers have made ample use of the program as apartment starts are the highest in nearly 20 years, that said, without access to the higher leverage and less restrictive lease-up measures that MLI Select previously offered, we expect a decrease in apartment construction starts as the equity requirements have increased considerably. Some non-insured construction lenders are still underwriting conventional construction to CMHC takeout parameters (including a MLI Select takeout), albeit most are capping leverage in the 75-85% LTC range. This provides a very competitive alternative to developers, as avoiding the headache for CMHC approval at the onset allows for quicker access to funding, and effectively the same net leverage. We have observed more developers opt to pursue this route as of late, despite the higher borrowing costs.

Recent changes to Canada Mortgage Bond (CMB) allocations for both single residential and multiresidential loans have significantly impacted the availability of 5-year CMB funding for insured multifamily properties. Many CMHC-approved lenders are currently out of allocation for their March 2025 pools and are quickly nearing capacity for the June pools. As a result, the spread for 5-year CMHC term money has increased sharply, as these lenders are now required to warehouse committed loans on their own balance sheets until the next available allocation in June.

ACLP Funding Uncertain

Lastly, the Apartment Construction Loan Program (“ACLP”) was also revamped in mid-November, with a revised scoring/qualification chart, and options to finance 100% loan-to-cost, inclusive of appraisal surplus for the top tier of qualifying applications. Heavier weighting now goes to municipalities where CMHC has identified a need for affordable rental units. At this time, the ACLP budget is nearly exhausted for projects that require funding in 2025, with 2026 budget filling up quickly with the influx of applications submitted to beat the scoring changes. It is important to note that, although no updates have been received to the contrary, future budgets for the ACLP and other CMHC programs are contingent on federal government support. This support may be in flux, as leadership within both federal cabinets that oversee CMHC—Housing and Finance—has recently changed. With a potential federal election scheduled for Spring 2025, the outcome could introduce additional uncertainty regarding the direction and funding of CMHC programs moving forward.

Pre-Sale Market Still Quiet

At the risk of sounding repetitive, land financing and condominium construction financing have remained largely unchanged from the previous quarter, despite recent interest rate reductions. As noted in our commentary from the last quarter, condo sales continue to face challenges, with enduser investors largely remaining on the sidelines and potentially not returning in the near future. However, we do anticipate a modest recovery in the condo market, particularly for smaller boutique buildings and well-priced low- and mid-rise developments aimed at end-user buyers, as supply for new units becomes increasingly constrained. We are also seeing an influx of requests for Inventory Financing, as developers look to capture trapped equity in unsold condo stock from past projects.

As 2024 comes to a close, we look back on a year marked by its significant shift to the financing, 2025 looks to be no different as a response to economic headwinds will require patience, a disciplined approach and expert guidance from trusted advisors. We see a continued return to the fundamentals in 2025 — focus on well-located real estate, condominium products that appeal to owner-users, and high-quality income-producing asset — these are the opportunities lenders will be focusing on and competing for.