Like ripping of an old Band-Aid, it's always best to get the worst of it over with right away. For commercial mortgages, the initial pain is that loans based on retail have completely dried up, A-lenders have moved way up the credit quality scale and borrowers are being forced to pay higher fees with private lenders just to prevent from foreclosing. In fact, one broker who CMP spoke with on background received this luminous warning from an industry insider 10 months ago: "You will not even recognize the commercial landscape coming up."
In many senses this inside information was totally accurate, but not in a completely negative way. There is, after all, that sigh of relief once the band-Aid is finally off, and in this case it is that rates have never been better.
How two years makes a difference
Not unlike the rest of the mortgage industry, the last two years have been particularly challenging for commercial brokers. Bill Edmunds, senior vice-president, credit and chief risk officer at Equitable Trust, traces the beginning of the problem back to September of 2007.
"The collapse of the Commercial Mortgage Backed Securities (CMBS) market really limited commercial lenders as far as gaining funds," he says, adding that "we're a trust so we have no problems raising GICs, and out west credit unions are very aggressive, as are the big banks. But for anyone who relied on the CMBS for funding - they are shrinking."
Since the CMBS collapse many large institutional investors, such as insurance companies and big pension funds whose investments were hit hard by the stock market meltdown, have left the market completely, and for the ones that are left, rising cap rates are cutting into total returns.
And as cap rates keep going up, property values are on the decline - a trend that is expected to continue, according to John Geha, president, Canadian operations, Coldwell Banker, the largest commercial Realtor in Canada. This all translates into much more work to get a commercial loan approved.
"There was less due diligence on assets before, says Edmunds. "Now we're looking at the building, whether the operator is a good one, the immediate neighbourhood, everything. Then we're sending our guys out there to check it out, so appraisals have become a lot more important as well."
Andy Bennett, president at the B.C.-based Nexus Investment Corporation and commercial broker of the year nominee at this year's Canadian Mortgage Awards, feels the effects firsthand.
"The only way loans get done, conventional uninsured loans, is if the lender holds on to their own balance sheets," he says. "And of course they underwrite it a lot more. Their sphincter muscles have definitely tightened."
Dale Bilton, CMA commercial broker of the year for two years running, agrees, in so many words.
"It's much more challenging than it was a year ago," he says from his Kitchener, Ont. office. "There is lots of inventory, but sales are soft. The bank will only cover so much and the vendor is expected to jump in for the remainder."
Eric Healey is with DLC Sterling Financial in St. John's Nfld., a real estate hot spot in comparison to the rest of the country, but one that isn't immune from the commercial slowdown.
"The general consensus last year is that it was overheated and needed to slow down," he says, noting that he's seen it all before. "The same thing happened in 1979. Prices skyrocketed, and then bottomed out. What we're starting to see today is the exact clone of '79, but this time banks pulled out early."
Without getting into too many details, he recounts a loan application he brought to a few chartered banks. "This one was a no-brainer and everyone still said 'no,'" he says. "One of them actually told me that six months ago we would have been fighting over it. The clients were top-notch business people in town, too."
He says that while offshore oil, which has been a profitable niche, is now stagnant, owner-occupied offices are a little better off, if the client puts up to 50 per cent in it. That said, "Nobody is doing LTVs over 65 per cent. Two years ago is was around 75-80 per cent."
Retail has been the worst hit though, which is the case all across the country, so large retail plazas have very soft appeal, says Edmunds. He gives as an example the case of Best Buy and Future Shop, stressing that the same could be applied to any large chains that own more than one brand.
"What if Best Buy decided to amalgamate the two and close the Future Shop locations?" he asks. "That's a lot of vacant space to fill, so it's a lot riskier."
While he says there is still appetite for industrial buildings, the appeal is diminished greatly if it's tied to the automotive industry. And as far as downtown core office space in places like Toronto and Calgary, there was such an influx of them in recent years that the market is now seen as being too saturated.
As far as the funds based on the now defunct CMBS, those loans are going to be turning around in the next few years, so brokers will be busy trying to find new homes for all those clients.
"We haven't got to that point yet," says Bennett, who predicts it will happen in late 2009 and 2010. "What happens then?"
And now for the good news
If every storm cloud has its silver lining, then this one is coated in CMHC-approved rental apartments.
"The conventional market has really evaporated," explains Jeremy Wedgebury, managing director, commercial mortgages, First National, adding that "in a secondary or tertiary city, the likelihood of financing is very challenging. But right now apartment buildings, insured and government-backed, are the safest."
Not only are they the safest, from a lender's point of view, but with rates the way they are (around four per cent on five-year deals), never has there been a better time to look at insured loans, he says.
"In a normal market you would choose between CMHC or conventional, but now you can't think other than CMHC. While there is a 1.75 to 4.5 per cent premium for them, there is a 200 basis point difference between that and a conventional loan, so it's very attractive," he says.
So attractive, in fact, that they now make up the bulk of First National's financing. The only problem, if you could call it one, is that the government insurer is so flooded with applicants that it takes a little more time to process a deal.
'We've never seen apartments for under four per cent except for in the last few months," adds Bilton. "It's a small bright spot compared to how challenging everything else is."
In fact, rates are so good (for the right client) that Bennett says this is the busiest his office has been in the last 10 years. He says other niches, such as seniors' care facilitations, rentals, medical buildings and local strip malls with decent tenants (i.e.: not the giant big box stores), are also areas still performing, even if there is limited money to loan.
And as perhaps a sign that when things get bad, people turn to their faith, Bilton says that established churches have been doing well also.
From the lender's point of view, at least the ones that are still around, the effects of the economy have been extremely positive.
"All the balance sheet issues faced with lenders created a market we've been able to step into," says Wedgebury. We stepped right into a void. In fact, 2008 was our best year ever. Now we're the largest CMHC lender in Canada."
Edmunds also likes the way things are working out, but for an entirely different reason.
"There is more sanity now, and more return because things have slowed down," he says. "Before it was so fast that good deals were getting priced the same as bad deals."
He also points out that things are beginning to look better already, as investors who were previously sitting on the sidelines waiting for things to get cheaper are beginning to feel things have bottomed out and are finally acting.
"The lenders that are here are stable and in it for the long haul," he says. "The market is picking up, interest is good, liquidity is getting better and confidence is coming back."
In fact, Canada's commercial properties performed much better than many other countries, including Australia, U.S. and Britain, says Geha.
"Although there will be fewer buyers/investors for major commercial deals, those who get the financing will benefit from historically low interest rates," he says.
Packaging it right
What this all means, more so in the commercial market than any other, is that while deals are still going to get done, mortgage professionals have to be performing their due diligence on each and every application. That means knowing what type of building it is, providing a proper description of the building, having the rent rolls and a list of tenants and pictures (see "Commercial broker checklist" for more details).
"And that's just the start," says Edmunds. "There are going to be opportunities coming up as those CMBS-funded deals are coming to maturity, but it is going to be more work. There was cheap money before and it was all about how fast you can push money out the door. Now brokers need to spend more time on putting together a really good package."
While there seems to be no formal training available for residential brokers who are thinking of diversifying into the commercial realm, Wedgebury suggests calling the underwriters and having them walk through the process first. You don't need to be an expert, but in the case of insured apartments, it helps time-wise if you "don't leave them asking any questions", he says.
It's a sentiment that Edmunds also shares, adding that most lenders will even get back to brokers if it's not in their "sweet spot."
"We have a mutual respect for the amount of time that these things take to put together. But once you put that together and send it to us and it does look interesting, we would reply and say 'Here is what we would need to go further.'"
Healy, who has been doing about 50 per cent residential, 50 per cent commercial for the past two years, says the work has become so cumbersome that he's considering sticking primarily to residential for the time being.
"I have the possibility to make 30K on one deal," he says. "I've been working on the files now for six to eight months and still nothing. It would be great if I could find a home for it, but with that much work into it so far there is still the potential that it could go in the toilet. That's just how commercial is."
That said, a lot of brokers CMP has spoken with over the year who juggle both commercial and residential say that while one deal may take months to fund, having it in the background while they focus on residential is a great way to pay the bills. And when that commercial deal finally does go through, the return is worth all that extra work.
"I have one client with a $5 million building, who owes $1 million, but lost money for two years," says Bilton. "Regularly they would get refinancing to be injected back into the business, to cover the losses, but now we've had to ask for extensive business plans for how to get back to profitability in two years."
And while Bennett asks for three years of income and expense statements from his clients at Nexus, out in St. John's the banks just want more - period.
"They've got to want something more than just a mortgage, like investments, accounts, etc..." says Healy. "If the statements are good, someone will take a crack at it, but you just have to find that carrot."