Jeremy Wedgbury, Senior Vice President, Commercial Mortgages at First National Financial, and a financing industry veteran, leads a team that serves many of Canada’s largest real estate developers and owners. As such, he is uniquely positioned to comment on trends affecting the commercial property industry across Canada. In this interview, we ask Jeremy to share his thoughts on current market conditions and the outlook for commercial mortgage financing.
Jeremy, 2019 is now well past the half-way mark. What kind of year has it been so far?
Incredibly productive. Here at First National, we’re experiencing record volumes. In our second quarter, commercial segment originations of $2.6 billion were 50% higher than a year ago reflecting strong market demand and First National’s leading market position. Commercial renewals of $664 million were about 2.2 times higher from a year ago on the same fundamentals. As a result, our total commercial book of $29.3 billion makes First National, by far, Canada’s largest commercial mortgage lender.
Is there a demand trend between insured and conventional origination volumes?
Interesting, we’re seeing a 50-50 split between the two. Honestly, I didn’t think we’d ever get to an even balance like this and it’s been accomplished even as demand for both insured and conventional has continued to rise.
What’s driven that mix change?
We’ve expanded our lending platform and brought even greater focus to the needs of the market. Compared to the past, we’re getting far more inbound calls from institutional investors who want to partner with First National on conventional deals. That’s a testament to the strength of the commercial property market and our alignment with the highest-quality, most experienced commercial borrowers. We also continue to explore new areas for insured lending.
We’ve done three fairly large student rental projects in Ontario and Alberta with CMHC this year, two term and one construction. That doesn’t sound like much, but student rentals are a complex asset class for lenders and mortgage insurers because they feature four or five-bedroom pods per unit. In the case of a default, this means they can’t be easily converted to conventional apartments. Undeterred, we really dug into CMHC’s student rental program and developed cash flow models that were able to satisfy CMHC that these were excellent deals worth insuring. What was really interesting was that we structured one of these projects such that the borrower got both an insured first loan and a conventional second mortgage behind it and on a combined, weighted basis, the interest rate was lower than what they would have paid for a pure conventional loan. I think all three examples demonstrate that it pays to have a lender that is able to innovate and willing to present different financing options. It also shows that CMHC is always willing to listen to a sound business case. Now that we’ve done these deals, we have a proven template we can apply to do more.
Has First National’s evolution as the market leader led to financing larger commercial deals than in past?
I would say so, yes. Our ability to assess large deals and structure them properly creates ready access to large capital flows, which in turn positions us to do ever-larger deals. It’s a shift for sure in our business and reflects the maturity of our processes and capabilities and our growing reputation for taking smart risks only. As an example, we recently financed a portfolio of properties across a number of provinces. It was a complicated, complex transaction valued at hundreds of millions of dollars with A and B tranches and several partners. First National’s ability to do the risk analysis, to amass the capital, and service the loan demonstrates the strength of our platform.
What markets are hot and not in Canada right now with First National and your partners?
Let me answer that question first from an overall perspective. By that I mean that the large institutional financing partners we work with seek to take large debt positions in diverse real estate assets and they do so by assessing in-market risk and projecting that risk out over future years. That being the case, our approach is that even in markets where there are challenging dynamics today and heightened risk, we look to structure deals that compensate for that risk – say by offering a lower leverage point or putting A and B tranches in place – and we align ourselves with very strong, experienced borrowers in every market. Doing this means we are able to satisfy local borrower demand while also delivering the risk-adjusted returns we seek for First National and our financing partners. This is how we’ve built a national market presence and become known as an all-weather lender. In terms of hot markets, commercial real estate as an overall asset class is hot, apartment properties pretty well anywhere in Canada are hot, and Montreal is very strong and I think it will be for the next three to five years and beyond. In terms of challenging sectors, retail is difficult because of changing industry dynamics and we see a continuation of economic challenges in some regions in the West.
Have you strengthened your local market presence to ensure you can properly capture demand?
Absolutely. We’ve added and appointed several highly experienced senior leaders to our offices across Canada. For example, Michael C. Williams joined us last year as Regional Vice President, Quebec Region. Michael is a Montreal native with a 17-year track record in commercial real estate financing who served in leadership positions at two large Schedule I banks before joining us. In Vancouver, we recruited Michael Yeung earlier this year to serve as Regional Vice President, Commercial Lending, British Columbia. With 25 years of experience in the B.C. market earned while serving three Canadian banks, Michael is driving the expansion of this important business operation. And in Halifax, we have Jody Comeau who leads our Atlantic Canada region as Assistant Vice President, Commercial Financing. Jody is a 16-year First National veteran who served originally in residential underwriting where he closed more than 21,000 deals, collectively worth in excess of $3.6 billion. Under Jody’s management, First National has grown to become the Maritimes largest multi-unit commercial mortgage lender. Each of these professionals brings years of local market credit expertise, broad connections and has enhanced the volume and quality of business we’re doing. Overall, we have great people in place coast to coast watching out for our borrowers and investing partners.
You mentioned that multi-family apartments are a popular asset class. What’s driving its popularity and is it sustainable?
There is a tremendous undersupply of new apartment stock in Canada at a time when there is significant demand coming from those who cannot afford to buy a home and those who previously owned a home and wish to cash in their equity to fund their retirement lifestyles. I think this dynamic is going to continue playing out likely for the next 10 years, not necessarily in every Canadian city, but certainly in many communities.
What cities are moving toward balance between apartment demand and supply?
We’ve seen a considerable amount of apartment construction in Victoria, Halifax and Edmonton. In the case of Victoria, a lot of people are moving there, so I think the demand will continue to take up the supply but it’s becoming more balanced. In the East, apartments were being built in Halifax 10 years ago when comparatively little was constructed elsewhere in Canada, so it’s reaching a more balanced level. Edmonton has quite a bit of product coming on stream, and there is concern about the level of demand because of the state of the provincial economy and unemployment. What may happen there is new product attracts renters who are currently in older units. If this happens, it could have a detrimental effect on occupancy rates in older stock, but we’ll need to see how it plays out. All of that said, we are very comfortable with all three of these markets at the present time.
A couple of years ago, you mentioned seeing some condo developers move into apartment construction. Has that move continued?
It has depending on the region. In Alberta, we’ve seen a move to rental construction because demand in the condominium market is depressed. In Toronto, the demand drivers are different. Here we see developers choosing to build rental rather than condos because in many cases they want to hold on to the property for the long term rather than selling it off. Many second and third generation developers in Toronto tell me they’ve built lots of great condos but lament the fact that they no longer own them. It’s a pretty attractive proposition to build an apartment, collect the cash flow for the long run and at the end, still own a property that will appreciate in value if it’s well located in the city.
First National has made no secret of the fact that you favour lending to builders with experience. Is this still the case and how much experience is enough?
Experience is key and the more the better. We have many borrowers who have been building for 20 and even 30 years and you can see it in their ability to manage risk and respond quickly to changing circumstances. These are the professionals who know the best tradespeople to call to get high quality work done on time and on budget. Managing budgets is incredibly important and more challenging in the past year due to rampant inflation in construction costs. Inflation of this magnitude did put the brakes on some developments. As a result, cost consultants are speculating that we may see a levelling off of cost inflation, but we’ll have to see. And, of course, any discussion about inflation also has to take into account municipal development charges. Depending on the municipality, these can represent a significant and rising cost of doing business for builders. We track the impact in First National’s Development Charges Index and the most recent changes in that Index were most pronounced in Ontario. I always advise our clients to follow the Index carefully as they plan their developments.
Speaking of inflation, one of the attractive features of owning an apartment is the increase we’ve seen in rental rates. Is that trend continuing?
Yes, although I think in some markets we are pushing the upper limits of how much renters can afford to pay. One of the interesting things we’re seeing in large cities is new rental units shrinking in size, which allows the monthly rental rate to be more affordable. At the same time, developers are investing more in common spaces like party rooms, games rooms, exercise areas and so forth which add more value to tenants with smaller units. It’s a creative solution.
First National is known as Canada’s apartment lender. What about other asset classes?
We’re very active in self-storage, both construction and term. It’s become a large business for us over the past five years or so. As I mentioned, we’re also active in student housing and we look to do more. We’ve also become a leader in affordable housing, retirement housing and nursing homes.
Thinking about the commercial financing market generally, have you seen any changes?
Not really. There’s lots of capital available, lots of liquidity and a good level of competition for high-quality assets.
Interest rates have changed pretty dramatically over the past year. How is that playing out with borrowers
Correct, we’ve seen more than a 100-basis point drop off in Canada Mortgage Bonds and Government of Canada bonds since September 2018 and it’s really changed the conversation we have with borrowers. It’s given rise to healthy discussions about the merits of taking much longer-term loans and it’s created exceptional demand for 10-year CMHC money in such quantities that we believe demand is outpacing supply industry wide. As a reaction to that demand and to balance availability, on a limited basis, First National has started to offer 15 year and 20-year insured financing. With these additional options, we’re able to offer terms from 1 to 20 years, plus insured construction financing. I would say that this is the point in the cycle where it really pays to be proactive about rates and to strategize with one of our First National advisors who are empowered to structure the best deals for our clients.
Last question: is now a good time to be a commercial property owner and a lender?
There’s never been a better time generally, but I will also qualify that by saying it’s important to look carefully at the asset class, the location and the deal fundamentals before jumping in. We make it our business to do that and we’re always happy to help borrowers size up opportunities in advance to ensure they secure the very best financing structure available and avoid unnecessary risk.