Floor rates an increasingly crucial factor in commercial mortgages

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The continuous plunge in bond rates has made floor rates an increasingly important factor in Canadian commercial mortgages, according to a long-time industry professional.
 
In a contribution piece for Property Biz Canada, First National Financial business development manager Adam Powadiuk said that the historically low Government of Canada (GoC) bond yields have led to 5-year commercial mortgages with interest rates at a rock-bottom 2.85 per cent (as of July 20).
 
“This is why many commercial mortgage term sheets will contain language that set a floor rate slightly above 3.00%. This means that even if the GoC plus the spread total an amount is less than 3.00%, the interest rate will not be allowed to go below that,” Powadiuk wrote.
 
The prime motivation for the rates is maintaining “liquidity in the debt market,” although at a higher price point than expected.
 
“The obvious answer is that it could potentially cost a little more to borrow money for your commercial property,” Powadiuk stated.
 
“For every property owner that wants to borrow money, there needs to be a mortgage investor to supply the funds. They need to be incentivized through yield to continue investing in mortgages. In today’s mortgage climate, they are seeing yields getting lower and lower,” he elaborated.
 
“Mortgage investors must contend with 3.00% returns for the same product, albeit from a safer position in the capital stack. Floor rates help preserve mortgage investors interest in providing capital, and that availability is good for the market.”
 
In addition, floor rates restrict the further decline of interest rates and cap rates, according to Powadiuk.
 
“[Most] would agree that cap rates tightening further does not contribute to a healthy real estate market. At some point in the murky future, interest rates will have to rise and push cap rates back up,” the manager explained. “The further they have fallen, the messier it will be when they rise. Floor rates are just one factor that can help put the brakes on.”

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