In a previous article, I examined the maximum leverage available via CMHC-insured mortgages in several Ontario markets.
The data set used was all apartment purchases financed by First National via CMHC in 2013. I’d like to revisit that analysis with the complete 2014 figures to see how the apartment finance landscape has shifted year over year.
The premise of the previous article was to express the maximum allowable CMHC financing as a percentage of the purchase price, or loan-to-purchase ratio (LTP).
Many investors value and use leverage as a means of improving yield, so the goal was to identify the markets with the highest average leverage.
CMHC relies on a historic view of cap rates, which means they will typically use numbers for underwriting that are higher than current transaction cap rates.
Gap causes varying maximum loan amounts
The gap between the two is why you can’t borrow 85 per cent of the purchase price for an apartment building and causes varying maximum loan amounts.
Back in 2013, the city with the lowest average LTP ratio was Toronto. You could expect to achieve a loan that was 70 per cent of the purchase price. That result was not surprising, as insatiable demand and limited supply had driven cap rates incredibly low.
The following year, nothing had changed to alleviate the downward pressure on cap rates. The Q4 2013 Cap Rate Report from Colliers International indicated a range of 3.75% – 5.25% over the asset class.
One year later, in Q4 2014, the range identified in the updated report was identical.
The results from the 2014 data followed a similar pattern and revealed the LTP ratio was also unchanged. You could expect the same 70% loan, although the range was wider this year.
The second-lowest LTP can be found in the suburbs surrounding the GTA. In 2013 it was only marginally higher than downtown Toronto at 71%. Investors seemed comfortable with a similar return on apartment assets outside of “old Toronto.”
LTP ratio increased to 73%
The 2014 results also placed the suburbs in the same ranking but the LTP ratio had increased to 73%.
Ottawa received its own category, as it’s the second-largest city in Ontario and isn’t comparable to GTA suburbs or smalltown Ontario. The average 2013 LTP available to investors here is slightly higher than suburban Toronto at 73%.
This took a jump to 76% in 2014, not an insignificant amount. It would lower a borrower’s equity contribution requirement by 11%.
Did market cap rates move higher towards CMHC underwriting cap rates? Could this jump be from a changing apartment sale market? Not according to Colliers. Its Q4 2013 Cap Rate Report cites the Ottawa range as 4.50% to 5.50%. In the following year the range is identical.
The secondary Ontario markets offered the highest LTP in both 2013 and 2014. Places like Collingwood, Hamilton, Orillia, London and Windsor. The average in 2013 was 76% but moved to 79% in 2014, a similar increase to Ottawa.
Speculating is tougher
Speculating on the cause of the movement in this category is tougher, as the “secondary Ontario market” is really dozens of small markets with different forces at play.
What can we infer from this? That there is a definite trend upwards of LTP in all markets outside Toronto. The movement isn’t earth-shattering but the effects on investment IRR should not be ignored. Deriving substantial yield from this asset class has been tricky for several years now, but at least in this one small variable there was some relief in 2014.
The apartment financing landscape shifted in 2014, and it was to the benefit of those seeking higher leverage. Even those borrowers who structured lower leverage mortgages would see a benefit.
The insurance premium charged by CMHC diminishes as leverage decreases, which means apartment investors could moderately lower that cost for the same loan amount in 2014.
The end of 2015 is quickly approaching, and with it will be a fresh data set to examine. Did these trends continue? Is the apartment market getting more highly levered on acquisitions? We will have to wait until January to find out.