Major lenders to the real estate industry are getting pickier about the deals they back, some are stress testing their loan portfolios and, overall, capital is becoming “a little more scarce.”

That was the general consensus among executives representing five big lenders at the RealCapital conference in Toronto this week. Top projects and deals will continue to get funding at rates they have in the past while riskier, less attractive ones will likely face more scrutiny and higher costs.

The length of the real estate bounce back since the financial crisis is one concern cited by Jeremy Wedgbury, managing director of commercial mortgages at First National Financial LP (FN-T).

“We feel that the cycle is getting long,” he said. “Even removing the trouble spots like Alberta and maybe St. John’s, (N.L.), I think that we worry about where the cycle is now.”

The fundamentals across the country

“On the one hand we are very positive about where interest rates are right now and it is going to continue to drive success in commercial real estate but that being said, we do have some concerns about the fundamentals right across the country.”

Wedgbury zeroed on the rapidly changing retail sector. “There will be changes in retail, the biggest question for us is how do we choose the winners and losers?”

He added the amount of due diligence his firm is carrying out today is greater than in the recent past.

“The reality is that in the last 10 to 15 years, you didn’t have to be that great an operator to look good in commercial real estate.  This is the point in time when great operators will become the best retailers going forward.”

Stress tests

Michael Andrews, Sun Life Financial’s (SLF-T) national managing director and head of its Canadian mortgage team, noted that for the past year Sun Life has been stress testing its lending practices for a rising interest rate environment. 

“Nobody is thinking that they are going to rise but, of course, as always we are going to be surprised when it actually happens. We have been stress testing our transactions, especially at the time of financing, and also refinancing.

“That is something that we have been doing probably for a year or two now. It is getting more heightened given other stresses in the marketplace.”

Andrews told Bloomberg News that Sun Life has stress tested about half of its $8-billion loan portfolio to see how it would fare if property values were to fall by 25 per cent.

“It fared pretty well,” Andrews said of the test during the panel discussion.

Alberta, geographical diversity and asset class

Mark Achtemichuk, vice-president and managing director of CMLS Financial noted “Alberta is in everyone’s consciousness” and is impacting potential deals in the province. It is also making lenders and their clients look at other parts of the country”, he added.

“They are looking at their (geographical) balance, where they are heavy, where they are light and using that as a guide to say ‘Where are we going? Are we light in Quebec or B.C. and do we want to rebalance our portfolio? ‘ ”

Sun Life’s Andrews said it is often more a case of property type than geography, citing the length of the real estate cycle.

“With the exception of Alberta, there is nothing that is of great concern to us. We are more mindful of certain property types than geographic regions. All the property types are transitioning, they have been transitioning over the past few years.”

“Everyone is talking about office and new office supply and what does the backfill look like for B and C buildings and B and C locations? We are more mindful of the changing retail landscape and the urbanization of retail.  Big box is a concern.”

John Miron, RBC Capital Markets‘ (RY-T) managing director and head of Canadian real estate corporate banking, lumped Saskatchewan with Alberta as another tough province to currently do business.

“B.C. we’re also keeping an eye on . . . it is just the valuations there are astronomical, low cap rates and numbers on acquisitions that are hard to fathom.  A lot of foreign investors coming in with a very long view, a 30- and 40-year view, so that is very tough to lend against.”