Alan Haigh, a Founding Partner at Impact Commercial, discusses the lending environment and what could be in-store for the market now that interest rates have reached their peak and are expected to further decline over the medium term. Citified.ca
Q&A with Impact Commercial's Alan Haigh on interest rates, lending opportunities and what's in-store for borrowers
Ten on the 10th
Published June 10, 2024
Citified's Ten on the 10th is a monthly question-and-answer segment connecting our readers with the insight and knowledge of Victoria's top real-estate and business professionals.
Ten on the Tenth's June, 2024 segment features Alan Haigh, Founding Partner at Impact Commercial, a commercial mortgage broker.
Asking the questions is Ross Marshall, Senior Vice President of the Victoria offices of commercial real-estate brokerage CBRE. As a leader in facilitating large-scale commercial real-estate transactions throughout the Capital Region – which include apartment complexes, industrial retail and office properties, and land/development opportunities – Ross and his team are at the forefront of market-leading real-estate transactions on Vancouver Island.
Would you like to be featured as part of a future Ten on the 10th Q&A? We'd like to hear from you.
Please tell us about Impact Commercial, and the services your firm provides.
Impact Commercial is a boutique commercial mortgage brokerage offering an extensive range of services and lending options tailored for commercial borrowers. We specialize in Investment, Construction, CMHC, and Owner-User mortgage financing, ensuring our clients receive exceptional experiences and results. Our success is driven by our strong relationships with a diverse array of lenders, enabling us to meet all our clients’ needs along the risk curve. We have strong and trusted partnerships with industry stakeholders and consultants across BC and can efficiently manage the financing needs of our clients in a timely manner.
What sets us apart from other brokerages is our deep understanding of what lenders require to obtain financing terms, expertise in analysis, file structuring, and risk management, all within a supportive team environment. If you know us well, it’s not unusual for two or three of us to work collaboratively for our clients as the complicated transactions require a team effort to be successful!
With your exposure to the markets, is this the right time to be borrowing?
This is a great question, and my answer is it’s always the right time to evaluate how borrowing can support the long-term investment objectives of a purchasing group. To give a full answer, let’s break it down into the following sub-items:
1) Real estate investment has a longer-term investment time frame. For those expecting great financial returns from real estate over a shorter-term period (1 to 3 years), they’re really speculating and not investing. Our largest and most successful clients invest in commercial real estate with a 20 year plus investment time horizon and are laser focused on increasing the net cash flow from their properties. Growing net cash flow, over time, provides the opportunity to utilize greater leverage in the long term expansion of their real estate portfolio and with the added benefit of providing inter-generational wealth transfer.
2) Canada’s banking system is one of the best in the world and the envy of most of the developed and developing countries. Regulated by the Office of the Superintendent of Financial Institutions (OSFI) and myriad of provincial regulators, our banking system is largely safe, stable and liquid. This should give all borrowers comfort in the long-term stability of their mortgage debt.
3) Borrowing (aka leveraging) on real estate, is the same with all other types of investing, in that it magnifies gains AND losses. When borrowing on a property, a prudent investor must have done their homework as it relates to their investment objectives. For example, on an owner-occupied property, does the business have clear sight on their income forecast to confidently make the required monthly mortgage payments over the term of the mortgage? Another example on income property purchases, does the combination of purchase price, lease income, mortgage interest rate, etc. meet the desired return metrics of the purchasing group?
To expand on the above, is this the right time to be buying or investing in the real estate market?
My answer is YES, it’s absolutely the right time to assemble liquid cash equivalent resources and be reviewing purchase opportunities. The Bank of Canada dropped their policy rate 0.25% last week and has set the expectation of further decreases over the coming year or two. The path to lower interest rates will be bumpy but for the time being, it looks like we’re past peak interest rates and continuing to decrease.
Is there a ‘sweet spot’ to transitioning into investments, now that rates are likely on a downward trajectory?
When looking back over the past 20 plus years I’ve been in this industry, my most successful clients have obtained the best results when deploying their hard-earned capital in the 6 to 12 months after the first Bank of Canada rate cut of the current easing cycle. Seller’s pricing expectations are much more reasonable during these transitionary times and experienced investors understand they’ll be able to get improved borrowing levels from Canadian lenders in the coming year to two years.
Historically and more broadly speaking, is appetite currently high, low or average for investment property acquisitions and development properties?
Appetite and investor liquidity is very high for both income and development properties. The issue is as it has been over the past couple years, an insufficient return for the investor group to deploy their capital.
It’s been really challenging for sellers (who want the price from three years ago) to get to the price current buyers want/need it to be (based on double/triple the borrowing costs). The return metrics simply haven’t been at the level required for transactions to happen at the same pace as three years ago.
That being said, we’ve recently seen some thawing in seller expectations and have supported several clients on the acquisition of income properties with acceptable levels of mortgage debt. We hope this will continue as it’s great to see positivity return to the market!
Regarding lenders for income properties, there is no shortage of lender liquidity to support new purchases. The question will be only how much of a mortgage can a borrower obtain and at what terms (interest rate, term length, amortization).
What about development property transactions? We continue to hear how stressed the financials are for land development, including homebuilding.
Development property transactions haven’t returned quite as nicely as income properties and that is to be expected. Development is highly sensitive to interest rates and proforma assessments (financial projections) simply don’t provide the necessary returns to cover the carrying costs (from property acquisition to shovel in the ground), a two-year construction timeline, stubbornly high hard costs and a challenged borrowing market for end-users. Harder financing for individuals on the purchase of their new condos compounds the issue as their ability to afford their home mortgage goes down as well. The combination of all these conditions limits the mortgage amount developers can obtain on their finished residential condo building, industrial strata building and others.
We expect the development market to increasingly come back over the coming 12 to 24 months once additional rate cuts occur and financial projections show sufficient profitability for developers to invest. Regarding lenders for development properties, lender liquidity did retreat over the past two years with only proven developers of a certain quality able to obtain mortgage funds at an acceptable rate. We anticipate lenders to gradually increase their exposure to more development projects, but it will be measured.
In response to today’s lending conditions, are lenders willing to loosen their purse strings to assist clients with their lending needs?
Ouch! That is a shot across the bow isn’t it! As mentioned earlier, the Canadian banking system is one of the best in the world and it’s similarly led by some of the best executive teams. With this background, I can confidently say most of our lenders have done an admirable job over the past two years supporting our clients with lending solutions of all different kinds. Were they perfect? Absolutely not, but they were very good.
The issue over the past several years was the unexpected spike in our inflation rate and corresponding equivalent counter measure by the Bank of Canada to increase their policy rate at a pace not seen since the early 1980’s.
These unanticipated increases absolutely stressed the banking system as it forced a massive and expedient repricing of borrowing and savings rates. Borrowers were hit by massive increases in mortgage rates requiring a myriad of solutions to deal with, such as much higher equity injections, lower profitability expectations, and in some cases, stalled projects or foreclosures.
Savers in GICs and other cash equivalents were rewarded with some of the best interest rates in generations and did amazingly well.
Now I don’t know if this is the right place for this comment, but I feel I have a duty to represent the best interests of my clients all day and every day. Under our current Federal Government, we’ve had a ten- year expansion of higher taxes (bigger government and ‘hello higher capital gains inclusion rate’) and massive deficits with no balanced budget in sight (inflation, anyone?). Most businesspeople can understand higher taxes as we all need to do our part, but the Bank of Canada’s aggressive rate hiking was required to offset the Federal governments unmanageable spending splurge over the past decade. If this spending was curtailed by even 25%, the Bank of Canada wouldn’t have needed to act so aggressively, but alas, they were forced to, and we just lived through one of the most challenging borrowing times in generations.
Lenders are here to support Canadian businesspeople and they’ll increasingly be lending more funds once financial metrics of investment decisions make sense for purchasers to invest their capital. Getting our 5-year fixed commercial mortgage rate down below 5.00% will be huge for the industry!
What challenges are you and your clients running up against with the banks?
As we’ve discussed, our main challenge in financing more property purchases relate solely to the investment rationale of the purchasing group. When interest rates are 2.50% for a 5-year mortgage term, lenders can finance up to 75% of the purchase price on an income property. When these rates over the past 2 years were upwards of 7.00% (almost 3 times the rate!), lenders were forced to lower the mortgage amount to close to 40% of the purchase price to align with required debt servicing ratios.
When a purchaser must put down so much more cash equity into the deal, the return metrics collapse below the perceived “risk free” rate of government bonds or bank GICs.
So, it’s not the lenders restricting their support of new mortgages as they’re very liquid these days and ready to deploy for good borrowers. We’re very happy to advise our lenders have stepped up with almost all our clients and are thankful for this.
As we transition to lower rates and higher mortgage amounts, we’ll see many more real estate transactions come together!
How much is politics and a 2025 federal election playing into Bank of Canada lending rate decisions if at all, and has this effected lending at a local level?
Alright, see above as that indicated my opinion of our current Federal Government. The one last item I’ll leave as it relates to Canada’s productivity levels (which pail to those in the US) is that the current proposal to increase the capital gains inclusion rate to two thirds (66.67%) is completely counter to fostering greater productivity. Reducing the incentive for Canadians (already viewed by the world as excessively conservative in our risk profile) is only going to drive investment to other jurisdictions and we’re all going to be worse off. A stark example is our tech industry where stock options / grants are used in their compensation model to attract and retain key talent. Tech talent is the most mobile out there and we’re going to realize in a few years that most have left to the US, so we’ll again miss out on our next Research in Motion (aka Blackberry).
Local level governments continue to fight the good fight but are often falling behind due to staffing shortages, imbalance in skillsets between public/private enterprise and inefficient entitlement timelines. As an example, it’s taken a client of mine almost three years to get a development permit on a desperately needed affordable rental project. From time of acquisition to first tenant, he’s looking at 6 to 7 years!
Should Borrowers ‘lock in’ for a 5-year rate or should they go shorter term now?
We’re getting this question a lot these days and our best answer is “it depends.” If you were to go back three years ago and look at what the top economists were predicting for inflation and interest rates, you’d see all of them at less than half of what they ended up being. A lot of the most knowledgeable people in the industry didn’t see the extreme rate hikes until it was too late.
When deciding if you should go long or short, it’s important to understand that every borrower has different risk tolerance levels, investment timelines and knowledge levels.
For those less experienced, there is absolutely nothing wrong with committing to a 5-year mortgage term if that makes them sleep better at night. The “set and forget” path is often the right choice for long-term holding income properties and we’re very comfortable supporting our clients with this approach.
For those more experienced and/or more risk tolerant and/or having higher cash flow outside of the prospective property investment, going with a short term solution at this time can be a wise decision. The below graph shows the Bank of Canada’s Overnight Rate (their policy rate) overlayed with the 5-year Government of Canada Bond Rate. When you look at all previous tightening/easing cycles back to 1995, you’ll see the 5-year rate drop from the time the Bank of Canada first drops it’s Overnight rate. If you believe in the principle history repeats itself, we’re happy to proceed with a short-term mortgage and are doing a lot of 2- and 3-year mortgage terms with the hope rates at maturity will be lower and we’ll renew for the long term.
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Now and if the past three years haven’t demonstrated enough, materially lower rates at some point in the future is far from a guarantee. We’ve already seen, as shown in the graph, the 5-year bond has dropped in advance of the Bank’s Overnight rate meaning the bond market is already factoring in an approximate 1.00% in the Overnight rate over the next six months or so. The bigger question is, will we have a nice soft landing (aka no recession and low growth) or are we going to have a harder landing (aka recession with negative growth)?
The jury is out on this and only time will tell. What a lowly commercial mortgage broker can advise is if we didn’t have such substantial Federal government spending, we’d likely already be in a recession as the private sector has materially pulled back. We believe this trend will continue until the “risk free” returns from investing in Government Bonds and Bank/CU GICs fall enough to warrant the allocation of capital back into riskier but higher returning commercial real estate asset class and/or other commercial investment opportunities.
Thank you all for reading and we’ll leave you with the note the team at Impact Commercial are always here to jump on a call to discuss how we can help our clients, new prospective clients, industry partners, and colleagues to help them achieve their goals. Sometimes, it’s just a quick chat to get a 2 nd opinion on a current financial proposal, other times it’s a full relationship transfer, or it can be anywhere in between!
Lastly, we wish you all good fortune with your commercial real estate investing and ensure you surround yourself with only the best industry experts. Teamwork makes the dream work!
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