by Danny Iannuzziello
For the past several months, we have all been watching the economy intently, trying to decipher the mixed messages we would receive from the media. From day to day, we would listen to economists and strategists warn of an impending recession or depression. How do we interpret the signs of these times and more importantly determine how it will affect our multi-unit residential businesses?
Just a few short months ago, we watched as the U.S. economy nearly collapsed on itself, seeing its effects trickle into our Canadian economy. From the automotive industry, to the stock market, to the drop in the price of oil and the Canadian dollar, we are witnessing the results of a recession. Some experts believe this current recession has already been in effect for the past 12 months though, it seems, public awareness has only started to catch up to that reality.
Even though we may be surrounded by a lot of negativity in the apartment building industry, it is my experience that, unlike previous recessions, we may not have need for panic. I believe, this time around, we may be embarking on greater profits for us in the multi-residential industry.
One of the privileges of working in this industry over the past three decades has been the perspective I am able to obtain from Skyview’s own real estate transactions, my ownership in buildings across various markets in the Golden Horseshoe, and our variety of contacts within our industry. I have noticed some interesting trends develop over the past few months.
Sales and Values
First, while in years past there has been a flurry of activity around almost any new property listing in the market, lately we are seeing an attitude of cautiousness among buyers. This was most evident six months ago as we saw a significant drop in marketing responses on new listings, unrelated to the location of the building. Shortly after, however, we saw responses rise back to average levels and even exceed our expectations, given the state of the overall economy. While smaller properties have been seeing less activity, rightly-priced buildings of any size (especially mid-large size properties) are still very much in demand and continue to offer great return on investment. In the past recession, in the multi-unit residential market specifically, values dropped significantly and there was, on the whole, a lack of money in the marketplace. In the late eighties, buyers were purchasing properties at approximately 7% CAP rates with mortgage rates approximately at 11%, thus creating negative cash flows. This time around the lesson was learned, availability of money continues to flow into the market and values remain virtually unchanged.
Properties with little-to-no mortgage against them are having the most success in a sale. Buyers are now coming through the “wait-and-see” period and are taking advantage of the lower overall, all-in interest rates being offered by lending institutions. At time of publication, rates had dipped to less than 3.75% for a CMHC 5-year term.
The second trend we’ve noticed at Skyview relates to financing of buildings. In 2008, an unprecedented 100% of Skyview’s listing transactions and refinancing projects were financed through CMHC versus a conventional mortgage. It is clear that CMHC has become the frontrunner as a financing option for investors of apartment buildings. This is because the conventional rate is significantly higher than the CMHC rate, especially on a 5-year term. Ten year terms have become almost non-existent and the spread on these 10-year terms has become unattractive. The payback for the premium paid for CMHC financing now has approximately a 3-year payback versus 4 to 4.5-year payback in recent times.
A negative change that I am noticing in the area of financing relates mostly to the overall availability of lending funds in the market. The conduit money, for example, has basically dried up during this economic downturn meaning there is less available for financing projects. This cannot be translated to mean that financing is problematic, especially for our multi-residential industry.
While lending institutions are now charging larger spreads to obtain financing on a project, multi-unit investment properties are still favoured amongst the wide array of commercial properties.
There are a few myths surfacing around financing practices at this time. They suggest that CMHC are forcing owners into greater holdbacks when financing a property and undervaluing buildings overall. This, however, is not the case. Holdbacks, like properties themselves, are dealt with on a case-by-case basis. CMHC continues to look at each property on an individual basis and qualify them for financing based on the building’s financial performance, structural
soundness, and the buyer’s covenant.
We are, however, experiencing greater delays for obtaining financing and lending institutions are telling us when they will be closing the transaction based on availability of funds. While one could interpret this to mean there is a lack of funds, the fact is that financing is still available in the market though your patience may be needed in order to complete the process. Funds are available, as in the past 60 days, the Canadian government has been buying back the mortgage securities from lending institutions - specifically the 5-year terms - freeing up more funds in the market for lending institutions to draw from.
Another sign of stability in our market relates to vacancy rates. CMHC just released its Fall 2008 edition of the Ontario Rental Market Survey. In the survey, it shows a trend towards lower vacancy rates overall, especially most markets residing in the Golden Horseshoe. The majority of rental markets report vacancy rates dropping and hovering around the 2-3% balanced market rates. Combine these lower vacancy rates with average rental rates on the rise and we could see building values increase during this economy. Also, with the overall cautiousness in the economy, more and more potential home buyers are opting out of ownership and staying put in rental housing. This will only help to stabilize the multi-unit residential market all the more. There is always the possibility of tenants losing jobs which could increase the possibility of the bad debt factor, but overall other operating costs should be somewhat stable.
Heading into these turbulent times, one could assume the multi-unit residential market is safe. To ensure that this investment vehicle is indeed safe, it is important to make sure your business is not overly leveraged.
As we look to the year ahead, I feel confident that towards the end of 2009 we will start to see a turnaround in the overall economy. When we emerge from this recession, it is my perspective that we will experience lower
financing rates, lower vacancy rates, and greater values for our properties.