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By Lou Iafrate, Executive Vice President | September 18, 2020

The 2009 recession saw lenders abruptly tighten the purse strings, depriving commercial real estate investment markets of the leverage and fuel it needed to maintain its momentum. It seemed sensible to assume this situation would be repeated as the world economy dealt with the unknown risks and volatility brought about by the COVID 19 pandemic. Canadian debt market dynamics have evolved significantly over the last decade and today’s leading financial institutions are facing the current crisis with less fear of the unknown than in 2008-2009 recession.

When the financial crisis hit in late 2008, the amplitude and intricacy of bad debts from CMBS contamination was unknown. It turned out to be worse than expected for banks, especially for those outside Canada that could not cover their toxic loans. This time around, the external factors are different. While we are currently facing a global health risk, its evolution is being monitored and tracked mitigating volatility risk. As such, the economic impact is more readily quantified.

Lenders are well capitalised, and funds are available. Canadian banks are in good shape – and were in good shape in 2009 too, which is why we went through the crisis then relatively better than the US and Europe. Lenders are not drastically tightening credit availability and we see no liquidity issue on the horizon.

The economic impact of COVID-19 does pose higher risks of borrowers’ defaults at the moment, but unlike in 2009, the government of Canada is pumping enough money in the hands of consumers and of tenants. This supports our real estate sector, with surprising productivity, considering white collar government and private sector workers are still mostly working from home. According to Altus Group’s National Debt Parameters Survey of leading financial institutions conducted in Q2, only 1 out of 5 respondents reported more than 15% in incremental volume of default monitoring being tracked since the outbreak and an equal number reported monitoring less than 5%. When facing problematic mortgages, the majority of lenders offer deferred payment for either interests only (90%) and/or principal and interest payments (56%), should the current crisis be prolonged much longer.

Credit conditions will vary according to asset types

Asset classes are not equally impacted by the COVID-19 crisis and some segments are proving to be quite resilient, causing little or no concern to lenders and investors. Altus Group’s National Debt Parameters Survey confirms that the cost of conventional debt outlook is currently favourable to borrowers for multi-residential and industrial assets.

In addition, availability of non-recourse conventional debt, typically reserved for the strongest sponsors and the lower LTV ratios, was qualified by almost 9 out of 10 respondents to be good or excellent for multi-family and industrial properties. Lending activity shows that availability is good for retail but only for the right format (grocery or pharmacy anchored) – otherwise, it is rated as poor. As for office, there is no consensus, as every asset is analysed case by case.


Do you expect the cost of debt for conventional first mortgages to increase, decrease or stay the same in the next 3 to 6 months for each of the property types below? 

Source: Altus Group

How would you rate the current availability of non-recourse conventional debt for the following asset classes?

Source: Altus Group

Comparing current lending parameters with previous periods, we note that average minimum spread over 10-year Canada Bond rates has moved upward, above the 150-200 bps range of the last decade. Despite this hike, caused primarily by the decline of policy interest rates, spreads remain lower than their Q1 2009 peak. Rate spreads from our June survey for single tenant industrial and food anchored retail strips, two segments not covered by the quarterly ITS results, stood respectively at 264 bps and 230 bps. Despite the spreads being wider than the historical norm, the total interest rate cost to the borrower is still historically low ranging from 2.6% to 3%.

In terms of loan to value ratios, lenders are reacting differently based on asset class. Not surprisingly, LTV levels for multi-residential, which have remained stable over the last 20 years, seem unimpacted by COVID-19, based on the National Debt Parameter Survey. As for other assets, while LTV ratios have caught up from the Q1 2009 drop to hover around 70% since recovery, only industrial assets have maintained a stable LTV ratio between the Q1-2020 Investment Trends Survey, conducted in March, and the special COVID-19 survey. Over that short span, the LTV ratio declined slightly from 72% to 68% for downtown class A office and from 71% to 63% for regional mall. In comparison, the food anchored retail strip average stands at 68% and single tenant industrial at 70%.

Minimum spread over 10-Year Canada bonds

Minimum spread 10-year bond historical trend

Source: Altus Group

Maximum loan to value ratio

Minimum spread 10-year bond historical trend

Source: Altus Group

Lenders have an appetite for lending

According to Altus Group’s National Debt Parameters Survey, over the next 12 months, over 50% of mortgage lenders and funds are aiming to issue the same volume of debt or more debt than they had planned, while 28% are undecided and only 21% intend to scale down. The proportions are similar for construction loans issuance, with a clear preference for purpose built multi-residential projects. And while most lenders expressed intent to maintain volume of debt, loan approvals are proving to be challenging for Western markets.

What is your institution planning over the next 12 months for mortgage on income properties and land/construction loans? 

Source: Altus Group

Tighter loan approval criteria may create a narrower band of potential borrowers with a focus on relationships and sponsor covenant. Lenders surveyed clearly indicated being more discerning on the sponsor and local market conditions.

Increased scrutiny on sponsors profile and riskier asset classes provides an opportunity for secondary lenders to take on loans that were traditionally serviced by institutional lenders. Secondary lenders have already increased their activity in mezzanine debt and there has been a creation of more “opportunity funds” by institutional lenders for borrowers without a proven operational and credit history.

The unforeseen longer-term benefits and drawbacks of this pandemic

Market perception is that the COVID-19 crisis could accelerate the economic obsolescence of certain assets, indicating a longer-term concern for depreciation of real estate values and its impact on debt service. The cultural shift on how we use space and technology in our daily lives, and the impact on location “pull” and investment appeal is still theoretical. We are just beginning to assess unforeseen collateral damages, drawbacks, but also benefits and opportunities that are gradually emerging from the haze.  

Any material impact on loan portfolios will not be fully comprehended or assessed for another 4 to 5 years, as leases roll over. If real estate values were to decline over the next 5 years, it would lead to debt service and loan to value issues, leading lenders to reshuffle allocation by asset classes and adjust their exit strategies. In such circumstances, trust in a borrower’s credit history and proven operational ability to reposition assets and re-purpose sites is the best insurance against risk.

Notwithstanding the reliability of our banking system, the importance placed on loyalty and business relationships across the Canadian real estate market, which may be considered a constraint by some, has provided the stability needed to navigate through financial storms. There are no signs that this will change. 


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