Opportunities opening up for high- and ultra-high-net-worth investors who can provide bridge financing
David Israelson • Financial Post Jan 10, 2023
After a steep rise in lending rates, with more rate hikes still expected, the market for investing in offices, industrial properties, retail and apartment buildings is still going through a period of “price discovery,” according to Colliers Canada’s 2023 Global Investor Outlook.
It is not surprising that this is happening, given that the Bank of Canada has boosted its key rate seven times in 2022, most recently on December 7 when it set its benchmark policy rate at 4.25 per cent.
“Patience during this time of uncertainty will be a real virtue,” says Emerging Trends in Real Estate Lenders 2023, a report released in September by PwC and the Urban Land Institute.
“Lenders have been tightening borrowing requirements, which, along with higher financing costs, are making it harder for [real estate] companies to raise capital and move projects forward,” the report says.
While this may be challenging for developers, it opens opportunity for high- and ultra-high-net-worth individuals and families and other lenders who can provide bridge or “mezzanine” financing for real estate projects. “Both equity capital and debt capital are undersupplied,” the PwC report says.
Developers will find that they can’t borrow as much as they might need from banks and commercial lenders, and that they need to come up with as much as 20 per cent of a project’s cost, says Emeka Mayes, Head of Canadian Capital Markets, Brokerage, at Colliers Canada.
“There are groups of lenders popping up to provide this,” she says. This kind of bridge financing can command lending rates as high as 9 per cent, Mayes adds.
There is a consensus that, rather than rushing into real estate, it is better to wait until the middle of the new year, to see what happens with inflation and interest rates and how they affect property prices.
“Overall, Colliers’ consensus is that the stabilization of the global real estate market will take hold by mid-2023 as more certainty emerges around the interest rate and economic outlook,” the firm’s global report says.
“A recalibration of the global real estate market is underway and we anticipate the stabilization to take hold [by the middle of the year]. The velocity and timing of this stabilization, repricing, and recovery will differ across markets and sectors,” it adds.
“Everyone seems to be cautiously optimistic. There’s just a bit of a pause going on today to weather the [economic] storm,” says Tom Rothfischer, Partner and National Industry Leader for KPMG in Canada’s Building, Construction, and Real Estate practice.
“There are clearly challenges ahead, but the industry is well capitalized and well managed. This is not the same industry as in the 1990s when debt levels were extremely high. There is significant capital waiting in the wings, ready and willing to invest,” Rothfischer says.
It’s worth it for family office managers to consider investing in real estate midway into the year because over the long-term, property acts as a hedge against inflation,
says Arthur Salzer, Founder and Chief Executive Officer at Northland Wealth Management
“It’s not 100 per cent correlated and it does take time, but it does produce better inflation-adjusted returns than bonds over times when inflation is higher,”
Statistics Canada said that Canada’s year-over-year inflation rate in November was 6.8 per cent; economists consider 2 per cent to be a tolerable rate for stable growth.
Property investment opportunities look particularly promising in the southern United States, Salzer adds. “There’s huge immigration and growth, and they’re very pro-business in states like Texas, Florida, Tennessee,” he says.
Investing in multi-family residential buildings also looks promising, given the acute shortage of affordable housing in Canada, particularly in populated areas such as Ontario’s Greater Golden Horseshoe (including Toronto, Hamilton and Niagara) and Vancouver’s Lower Mainland.
Multi-residential investing is complicated, though, by rent controls, which limit investors’ returns but which appear to be here to stay as Canada’s housing shortage continues, Salzer says.
“Rents are capped in places like Ontario unless there’s turnover [when a tenant moves out]. When there is turnover we see rent increases of more than 30 per cent. This lets [owners’] cash flows improve and helps compensate for higher interest rates,” he says.
In Ontario, investing in housing is further complicated by Premier Doug Ford’s moves to allow building on previously protected greenbelt land — a move that has seen widespread opposition and which critics say will lead to urban sprawl and possible costly court battles.
The pause in frantic dealmaking and the ongoing price discovery may provide investors with a much needed breather for a few months to consider longer term moves, experts say. “Now is the time to invest in solutions to create value beyond the short-term uncertainty,” the PwC/Urban Land Institute report says.
For example, investors will need to look more carefully at how they deploy property technology (proptech) in their buildings as “smart buildings” that are managed and monitored remotely become more and more the norm. KPMG in Canada recently surveyed 17 of Canada’s biggest property companies representing more than $160 billion in assets and found that 80 per cent do not proactively monitor their networks or devices for cyberthreats.
These kinds of issues can’t be overlooked by those who invest in real estate, Rothfischer says. Nevertheless, it’s okay for investors to be both cautious and optimistic, he adds.
“If you’re a developer, you have to be optimistic. It comes with the territory,” he says.
It’s a time to stay calm and carry on for those considering real estate, PwC and the Urban Land Institute say.
“The key to navigating this complex and volatile environment is a mix of patience, agility and a willingness to take bold actions to deliver sustained growth and outcomes in 2023 and beyond,” their report says.