COVID Lender Market Update – May 2020
Capital Supply Side | Lenders:
The lending environment in Canada is largely unchanged since last month’s “COVID Lender Market Update” release, however the general sentiment amongst lenders is starting to become more positive. As the discussion has shifted from shutting down to reopening the economy, many of the capital providers who closed their books due to COVID are gearing up to reinstate their lending programs. The majority of industry leaders are predicting a strong recovery in the real estate as a whole, in large part due to the extensive government aid programs and the robust market fundamentals heading into the crisis. However, it is necessary to segment this prediction by asset class, as some sectors will doubtlessly experience lingering effects following this crisis. The general consensus is that Multi-Family and Industrial assets should be the most resilient, followed by Office, particularly office space catering to tech tenants. Retail and Hospitality will take longer to recover due to lasting vacancy expectations and falling rental rates/ADRs accordingly. The degree of volatility we have seen in the financial markets over the last month has translated into rapidly changing levels of consumer confidence. As such, we have found it essential to be in constant communications with our lending partners so we can serve as a source of reliable information for our clients and industry partners. Please see a summary of the trends we have seen in the Canadian Debt Capital Markets space over the last month below: Aggressive Monetary Policy and QE did not have the desired outcomes of more accessible capital and investor confidence. We are still seeing widened spreads and scaled back leverage points across the board. Lenders are still being consumed with relief requests from their existing clients. Oftentimes qualified borrowers are being granted principal relief, and in some cases both principal and interest deferrals. Funding timelines for most commercial mortgage lenders have been extended for this reason. Lenders are still actively pursuing CMHC-insured deals, as many of the risks associated with COVID are mitigated by the insurance coverage. CMHC is working with borrowers and lenders to allow for interest deferrals and they are even waiving certain required documentation that would be difficult to obtain during the crisis. A select few bridge/mezzanine lenders and MICs are opportunistically taking advantage of the scarcity of capital due to COVID. Some of these groups have return thresholds and therefore are pressured to deploy capital; these groups are able to meet their yield requirements while taking on less exposure than what was required pre-COVID. Prospective borrowers are increasingly turning to mortgage brokers to obtain capital and keep their cost of capital down through creative capital structuring and well-established lender relationships. We have seen an uptick in deal volume since the onset of COVID and are pleased to continue to provide solutions to our clients throughout this crisis. Capital Demand Side | Borrowers:
During the month of April, we spoke with hundreds of developers, brokers, owners, and investors in the Canadian Real Estate Market. There seems to be a mixed sentiment among different asset classes, but generally, it seems that many who are in the early stages of development are capitalizing on the long-run nature of their projects, and making as much progress as possible while the market is in lockdown. Here’s a couple summaries from the outlook we received from the market: Hotels: Some national hotel groups are cautiously optimistic, and still active in the acquisition space for urban and suburban assets. While there is no way to understand or forecast exactly how long the recovery for these assets will take, they are still making an effort to keep the pipeline full. Construction of hotels has halted, causing some stress on existing projects. Making progress on development new projects seems to be considered a reasonable business activity to keep the machines running. It seems that many hotel groups are using this as an opportunity to catch up or cover lost ground by getting new projects into the pipeline while they can’t focus on existing ones. Office: Generally, we’re seeing some optimism from developers of office space, despite the challenges and uncertainty that covid-19 has created. While we’ve seen some commentary from economists that the nature of the central business district will change drastically in the near-term, the demand side does not seem to reflect this sentiment. Developers are having a hard time getting commitment from tenants given the uncertainty, however, most are comfortable and confident enough in the recovery that they’re aiming to proceed with projects of this type, anticipating future demand by the time the project is complete Retail: We have definitely seen a tightening of demand for acquisitions with a retail component, given that this type of unit is so drastically impacted by lockdowns. The recovery scenario becomes more challenging, but rent subsidy policy introduced in April to support retail appears to have softened the blow and mitigated the failure risk of existing businesses, at least for now. Industrial: There seems to be a relatively unchanged sentiment in these spaces, with developers and owners still proceeding as much as possible, outside of construction. There actually seems to be more positive than negative feedback, especially with political discussions alluding to the repatriation of supply chains onto Canadian soil as a result of the challenges we’ve seen with the global supply chain as a result of covid-19. The overall outlook seems to be that Canadian industrial, warehousing, and manufacturing could come back stronger than pre-covid levels. This seems to be the only asset class that is anticipating a growth scenario beyond recovery Mutlifamily assets & residential development: We are seeing increased demand for multifamily development, with a lot of groups building in a purpose-built rental development scenario as a hedge against the unpredictability of sales absorption. Like retail, policy has done a reasonable job at supporting existing multifamily assets through CERB, but the long-term outlook seems a bit more ominous to the groups we spoke with, with fears of unemployment and recession causing stress on rents. Given that vacancy is increasing in many core markets and rental rates are showing signs of decline, there are definitely some short-term headwinds that will continue to cause challenges here, but overall, the long-term outlook seems reasonably positive. Many groups analyze high-rise development in a similar fashion, knowing that the units they’re selling often land in the hands of speculative investors and owners who add them to the rental housing stock. In that respect, declines in construction productivity are creating a bit of stress on capital costs, but the sentiment seems to be that time is on our side if projects are delayed, due to the unpredictable nature of future demand, and the impact covid has had on it. It seems that land cost would be expected to maintain its correlation to unit values, even in a sideways or downward market, so the cost structure is expecting malleability there, given that it’s difficult to model any changes in construction costs we may see. Residential credit creation has not declined as much as commercial lending, so there is little fear that units closing this year will have challenges with buyers closing in the macro sense, because the units have equity built in from price growth since they sold. Obviously, employment statistics allude to some micro challenges ahead, but we haven’t seen anything systemic appearing as a result of this yet. Residential resale volume has declined substantially as a result of lockdown, but supply has not matched it, which could allude to a fear of price drop in consumer sentiment. Some are speculating that the short-term pain from an excess supply scenario could mitigate the risk of a supply flood in the future. Generally, there is a little bit more fear about projects transacted in the past few months, given that prices were at all-time highs, and even in a no-growth environment, there is a negative outlook on the incentive for buyers to want to continue deposits and take possession of the unit. Similar to current completions, the sentiment seems to be that time is on our side here, and delays may be a blessing in disguise, as these projects could require some time to catch up to the future value they’re chasing.