BMO Real Estate Forum: BC Outlook
November 29, 2024
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Commercial Real Estate
BMO’s Commercial Real Estate team offers an insightful virtual discussion on the BC housing market, regional market trends and economic outlook. Featured panel speakers include:
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Beau Jarvis, President and CEO, Wesgroup Properties
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Sal Guatieri, Director & Senior Economist, BMO Capital Markets
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Mike Lynch, Regional Vice President, Real Estate Finance, BMO Commercial Bank, Canada
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Rolf Neufeld, Director Credit Structuring, Real Estate Finance, BMO Commercial Bank, Canada
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Greetings, everyone. I'm Mike Lynch, regional Vice President of the BMO Real Estate Finance team for the Province of BC. Thank you all for joining us today for this event. We are excited to be joined by industry leaders who are actively involved in the Canadian housing market and have perspective on trends and outlook for what is ahead. We have a lot to cover over the next hour or so. I will walk through the agenda quickly and then we will get started.
We'll start with Sal Gutierrez, who will kick us off with an economic update. Sal brings over years of experience as a macroeconomist, but BMO since . His main responsibilities include analyzing and forecasting the US economy, Canadian and US. housing markets, and commercial real estate markets. Following Sal, we will then have a round table covering key topics and answer questions that were submitted by the audience during registration.
For that, we'll be joined by Beau Jarvis, President and CEO of West Group Properties. His diverse real estate background consists of acquisitions, development, construction. Leasing and property management, he has significant experience in the execution of master planned and mixed use communities. High and low rise condo rental developments, retail, industrial parks and office buildings in addition to overseeing W groups real estate portfolio and operations, both responsibilities also include government relations. Finally we'll be joined by Rolf Neufeld, National director of credit structuring for the BMO Real Estate Finance team. Rolf has been an employee of email for years, which has created a lifetime of experience in the real estate market and the various cycles that go with it is an institution in the real estate financing market locally with that, I'll turn it over to you Sal.
Thanks, Mike, and good afternoon everyone. So he's back and for both good and bad for Canada's economy, the good f course, is that Donald Trump is proposing pretty aggressive fiscal stimulative measures largely via tax cuts, both on the corporate side ands so on the personal income side. And couple that with less regulation should give the economy, U.S. economy, a bit of a boost and what's good for the US economy tends to be good for Canada's exporters and economy as well. Now the problem. The bad thing is that the price of those exports might be going up because Donald Trump is
proposing an across the board a tariff increase somewhere in the to % range, not just against a few countries, but basically all countries, even those in which the US has a free trade agreement with such as Canada and Mexico.
So obviously that's not great for Canada and then we have this normally would be just a review of the USMCA. The free trade agreement by Trump wants to actually renegotiate that agreement. So, you know, hopefully they'll come to some early truce, I think things won't get too wild there, but clearly all that uncertainty could be bad for Canadian business investment
So you know, again, we'll have to take the good with the bad we haven't changed our forecast for Canada's economy yet. Even though we bumped up US growth a little bit because we are waiting to see.
The timing and the substance of Trump's policies, both on the tax side but more importantly for Canada, I think on the tariff side before we make any adjustment to our forecast now so far this economy I would say has been a godsend for Canada's economy because we did come pretty close last year to a recession. You can see in this chart here of real GDP Canada’s economy basically stalled for a couple of quarters last.
Here came close to tipping downwards but we had our major trading partner, the US just keep rolling along that resilient American consumer just kept spending supporting our exports, along with some help from a very weak Canadian dollar. So that really did help us continue well pull out of that slump and we've been growing at a rate ever since.
Now we have been challenged by the fact that Morgan ain't households are paying more for their mortgage the resetting at higher rates and that's dipping into or cutting into discretionary spending power in particular that will be an ongoing headwind for a couple more years even as mortgage rates are coming down because they're certainly not going back to those lows we were at a couple years ago now going forward, we do think the US economy hopefully will be a bit of a tailwind.
For Canada's economy and we're also getting some support from stimulative fiscal policies we're not running. Budget deficits either at the federal, provincial level anywhere close to what the US federal government is running at close to % of GDP, we're running closer to - to / percent of GDP. That at least, is giving the economy a bit of a boost. But most importantly, most importantly, we will be riding on the back of these interest rate reductions. And we do expect further reductions by the Bank of Canada, so we've been kind of crawling along.
For the past couple of years now growing at just over a % rate. More normal growth is close to % and we should get there next year on the back of rate cuts. British Columbia's economy has been growing pretty pretty well in line with the national economy we estimate for this year. It is underperforming, we believe Alberta and several Atlantic Canada provinces. But for the most part, if it grows just above % this year. That would basically fall in line with the national average but much like for the nation, we do expect B CS economy to pick up to a more moderate healthy pace of just under % for next year. So again it will get help from those rate cuts also we'll get a bit of help from the Premier's plant cuts to middle income taxes everyone likes a little more money in their pockets to spend, so that will help.
And the provincial government is running of the more stimulative provincial budgets, essentially the most stimulative budgets at just over % deficit to GDP ratio. So that will give the economy a bit of support as well. Now it does come with the longer term risk that BC which is the only province with a AAA credit rating at least by one credit rating agency, Moody's could at some point.
Lose that rating now the headwinds, the challenges for BC’s economy there are a couple. Number one, many people are leaving the province for more affordable housing. Surprise, surprise. And many are going to Alberta or the Prairie provinces, for example, that's been a trend in place for a couple of years now the bigger challenge for BCS economy could be a hit to its population growth.
Because the federal government is targeting basically temporary residents, so international students foreign workers for the most part, and the plan is to get that the current ratio nationally is just over % of the population, down to Well, BC has one of the highest proportions of temporary residents, about % of the population, so if the government focuses those cuts in BC as well as in Ontario, that's.
For most of the pain will be felt and just to get a sense of what the federal government is planning because we now do have the details of its immigration curves and they're much more aggressive than we than I think anyone anticipated including a reduction in permanent resident target. So the plan again to get the number of temporary residents down from over now to about two million. So that's a reduction over two years.
That's a half a million per year outflow from the country, offset for the most part by permanent residents. But that target is now lowered to just under. So you do the math and it could mean a net outflow of about A, people from Canada in each of the next two years. So a slight drag on our population growth going from % annual population growth to basically zero, maybe a slight decline now.
Mark us down as skeptical as to whether the government will actually. Be successful in curbing immigration to that extent because many temporary students, even some temporary workers, will try to extend their visas when they expire by claiming refugee status. And because there's such a tremendous backlog, years or so they could stay remain in the country until that.
Process is completed. And for many or most of them, they would end up being deported. But again, for a couple years, they could stay here and the other problem is that Donald Trump is proposing or trying to deport he's saying, about ,, undocumented workers per year. Many you believe, would be headed towards the northern border not the Mexican border. So that could make it pretty challenging for our government to hit its immigration.
It's like it's suffice to say that does suggest a slower population growth, does suggest bit of a downside risk for our economic outlook and certainly a downside risk perhaps for the housing market. Now the one good thing about slower population growth is that it will relieve pressure on our unemployment rate. It's gone up / percentage points from its lows. Now it's .%. B CS unemployment rate is still under %.
But it's gone up about / percentage points as well, so the good news here is that even though the jobless rate might take up a bit more, it should level off at around % nationally, % or so B in BC, and then start to come off as population growth, labor force growth weakens and as the economy picks up a little bit. And I should make it very clear that the increase of the unemployment rate is not due to layoffs.
In fact, nationally we've we're still creating over jobs in the past year. B CS been a bit of a laggard, I think only or jobs .% or so growth. But suffice to say no net layoffs. It's all on the back of that excessive labor force population growth. The good news about the increase of the unemployment rate is that it has helped relieve.
Any lingering inflation pressures in Canada's economy so the low hanging fruit was picked when commodity prices came down pretty sharply, including oil prices. Global supply chain started to run as smooth as ever after the massive disruptions during the pandemic, but we did need to see some pain in labor markets, a loosening of Labor markets and that's exactly what we got so inflation now in Canada is below the two target, might take up a little bit in tomorrow's October report because of a pick up in gas prices but it look like inflation will remain close to the % target for the next year now, so if anything, the Bank Canada might be a little more worried now about inflation staying below the target, not going above it.
And that of course has big implications for monetary policy and the Bank has made it pretty clear it continues it, it's planning further interest rate reductions now, maybe not another basis point reduction as the last time. In fact, we think it will. Back to your standard basis point reduction in December and then four more reductions in the first half of next year, so we are looking for another basis points of rate cuts from the Bank Canada taking the policy rate down to / percent by June of next year, not back to prepandemic levels, but back to stimulative levels that will give our economy a bit of a boost.
Now longer term rates the policy rate declines will drive down variable mortgage rates. But the fixed mortgage rates will be a little stickier because they're driven more by what happens in the bond market and we know what's happened in the last couple of months the so-called Trump trade, more stimulus, threat of terrorists raising US inflation has pushed up US interest rates. And some of that spilled over into Canada. So we won't see long term rates.
And fixed mortgage rates fall nearly as much as short term rates and variable mortgage rates. But we do expect another basis points, maybe basis point reduction. In say the five year mortgage rate or so over the next year or so, assuming the Bank Canada does cut rates as aggressively as we anticipate over the next year or so.
So that's going to help housing affordability and the other thing that will help is the new mortgage rules by the federal government that become effective in mid December. So the main thing I think that will give the market a boost is the extended amortization period by Uninsured mortgages that effectively will reduce more monthly mortgage payments by about %. It's equivalent to about a one percentage point drop in mortgage rates, so pretty meaningful And then in the high priced regions, BC, Ontario the increase in the cap on home values for insured mortgage to one and a half million dollars also result in the need for lower down payments.
Because you can get an insured mortgage, you don't have to save up % for a down payment. So that's going to going to give the market a bit of a boost too and both of those lower mortgage rates, the new mortgage rules will help to improve affordability. You can see in this chart here it's basically effectively the percentage of household income for the typical household that's required to cover mortgage payments. At today's prices, At today's interest rates, for example.
It it's telling you # we're coming off a generational low for affordability now. This is not across the country. This chart even though it's a national chart, applies just to BC and Ontario, the too expensive.
Regions does not apply to the Prairie Province's relatively inexpensive, so it applies to Ontario, BC and
you can see from this chart. We've we've seen some progress, affordability has improved because mortgage rates have come down by at least a percentage point in the past year and house prices have come down in British Columbia and in Ontario, especially Ontario. So that's gone some ways to improving affordability, but you also will notice that even when we factor in our forecast of mortgage rates coming down a bit more.
And house prices, we believe, rising very modestly, but incomes catching up a bit.
We don't get all the way back to normal levels that what that would take is a bigger drop in mortgage rates. Bank of Canada cutting rates basis points or more for or example, or house prices continuing to
fall in BC and Ontario. But that's not what we're seeing right now. We are seeing a stabilization in the housing market. In fact, the markets are starting to awaken. your left. After a year slumber. You can see in this chart here on. For existing home sales nationally they were depressed for a couple of years. They came off their bubble highs and they were depressed at well below normal levels.
But the last couple of months now especially in response to the bad Canada's latest basis point chop to rates, we saw a big jump in in home sales in October.
Even in Ontario and BC, except the issue there is that home home sales are still below normal. In BC and Ontario, it's only in those other more affordable provinces that we're seeing home sales back to normal levels. But again, we're seeing, seeing widespread progress now or improvement in the housing market for house prices. They basically have stabilized down in BC and Ontario. You can see in this that chart on your right there how much house prices have fallen in many regions from their peaks of early and basically the declines are centered in not surprisingly.
Here's Columbia and Ontario, specially Ontario, Toronto, and Southwestern Ontario as you can see in that chart there. That's where we've seen the biggest house price correction because prices went up so much during the pandemic. BCs actually weathered the storm. Not too bad. You can see Vancouver’s house prices are down only four from their peak. They're down % in Toronto, so BCS gotten up pretty lightly.
The fact that supply is much more constrained. There than in Toronto or in Toronto in particular is one reason for that, but the other story is that in the affordable regions, house prices really never did correct. In fact, prices are hitting new highs in places like Calgary, Halifax, Moncton, Montreal Even so it's a very it's a very much a bifurcated housing market across Canada in In our view, it means that we will see a recovery.
But that recovery will be more of forceful in the less expensive regions. But Ontario, BC will recover, it just won't be AV shaped recovery either in sales or especially in prices. We need a period where incomes can catch up to these house prices. Prices can rise, but not faster than incomes in BC and Ontario. So just to wrap up.
BCs economy, we believe, is on the mend. It will pick up moderately in response to. Interest rate cuts and some personal income tax cuts in your province. Home sales should improve on the back of lower interest rates the new mortgage rules and some pick up in BCS economy. The big headwind will be those immigration curbs and weaker population growth. We'll see how that plays out and for the most part we could we should see house prices. Rising modestly across British Columbia, but just modestly.
Again, because of poor affordability we will need to see several years where incomes can catch up to those higher prices. So I'll leave it at that. I'll stop sharing the screen and turn the floor back to Mike.
Thank you, Sal, for your insight and the update we're now going to move on to the round table. So thank you for all the questions we received during registration we'll try to address as many as possible. So let's get started.
Hosting affordability continues to be a contentious topic and a major concern in the GDA market. Although home prices over the last months have nominally declined or remain flat, depending on the region, the historical growth rate for homes has materially outpaced both inflation and range growth.
Rental rates seem to plateaued, but this comes after a three year run up of ±% while it remains to be seen what the combined effect will be with the forecasted decrease in interest rates, versal higher demand and tempered immigration with revised targets lower demand, the main issue to tackle affordability is with supply. So the first question is to you Bo what can various levels of government, federal, provincial, municipal due to alleviate the supply issues?
And then what can builder developers, stakeholders do to help this issue?
Thanks, Mike. So I'll kind of start broad and drill down to the more nuanced things, I think first thing the government broadly should do is is acknowledge and actually say out loud that the private sector delivers % of the housing in our country. And I say that because when politicians say things out loud, it seems to have a habit of making it into policy.
And I think that what we're calling for. So that's the first thing that should be done is truly acknowledge that it it's a private sector model in our country and let's figure out how to enable the private sector, our sector, our industry is calling for a policy moratorium in our industry. That is of the things that I think is low hanging fruit for government is to just stop policy for a minute and allow the industry to breathe.
Over the last five years, we kind of we're, we're pretty heavily in terms involved in government advocacy and so we have a tracker. Over formal consultations from all levels of government over the last five years. And there's been policies, formal consultations on policy from all levels of government that our industry has worked hard to try and engage in and which which is virtually impossible when an analogy I use we're currently building.
A building under code A. And that we are designing the next building under code B and policy makers are creating code C and this is all happening at the same time and that is not a sustainable sort of way to move forward if we're gonna try and create an increased supply of housing and work on the affordability problem, the next thing is is taxes on housing.
Many reports it's widely known that up to % of the cost of new housing is in the form of taxes.
And we have to think about that for a second when we're trying to enable the private sector, when we're trying to enable supply to be created and look at it within the context of how we treat other crisis we call housing a crisis in our country when there's an environmental crisis, we start to engage with manufacturers that build electric vehicles and battery plants and we figure out a way quickly in fact, to provide mass subsidies and tax credits.
We do the same thing with agriculture again mostly private. When there's a drought, what do we do? We wrap our rents around the industry and figure out how to sort of enable and stimulate, and I think that the government has yet to get there with housing for various reasons, so I think that sort of what government can do at all levels is really start to be honest with themselves about what we're trying to do and how we do it in our country.
Next, builders and developers. What can builders and developers do? We're too fragmented, if you think about it. The largest builder in Canada probably builds of the housing stock on an annual basis. And so it's not like auto or big whatever in terms of advocacy efforts we're seriously fragmented down from the single family home builder to the large builder like ourselves and I think that we need to that's worked against us for a long time and we need to collectively advocate better and we need to get engaged.
And start to really meet and collaborate with all the levels of government in an effort to create sustainable policy.
So that's my quick answer to your question. I could speak about that for an hour though.
No, thank you. That's a good start. I know you guys and West Group are very involved in navigating. We appreciate it everyone does we all have a part to play in the solution. OK, The next questiongoes to Sal in the federal budget, the government laid out an ambitious plan to unlock . million homes by. Given it took two decades to construct . million homes in Canada, is this a realistic target and does Canada even have sufficient people power and skilled trades to build more?
Units, well, they're simple answer Mike is no way that I mean that works out to roughly half a million per year and we've never built even , homes in any single year Basically we would need to double the number of construction workers given, you know, fairly stagnant productivity in the sector.
That's why it was so important for the government to realize that this was partly a demand side problem. Which required a demand side solution and that is more sustainable immigration so at least other government has realized that and has taken measures to correct that issue.
Perfect. Thank you for your answer. So another unrealistic goal by the government and people reading the papers like this is a viable plan but in reality there's no chance. So thanks for the answer there.
Moving on, the ongoing transformation of the province of BC continues with NDP in for another term, the construction development industry continues to be challenged in the face of rising construction costs, labor costs, regulatory hurdles delay, fee increases, financing costs, Nimbyism and ever changing unfavorable municipalities policies. Similar to what Bo said with building under A, planning under B and buying under C. So Bo, how are developers responding to these constraints and overcoming barriers to.
Thanks, Mike. I mean, I think the quick answer is some developers are insolvent unfortunately, I think the Bureau of Bankruptcy, Federal Bureau of Bankruptcy is reporting that we have the highest levels of real estate related insolvencies and bankruptcies since the Great financial crisis. Another thing and we also have been tracking receiverships and court ordered sales in our market we estimate that there's plus sites that are in receivership or court ordered sale right now.
We tally that to be a potential of , housing units. And another thing developers are doing is leaving the market many of Canada's largest home builders are currently building more homes in the United States than they are in Canada during a housing crisis in Canada and I think we really need to stop and ask ourselves why and politicians and policy makers will be quick to say, wait a second you know, let's tax them. Let's stop them from doing that rather than.
Why is that occurring and so that's those are the some of the more significant ways that developers are responding to sort of the aforementioned points you made. What is West Group doing we're spending % of our time on government advocacy and I mean that honestly we it's unbelievable I got off the phone with the Ministry of Finance today to talk about this new vacant land tax concept.
As if we're all sitting here on our vacant land.
And servicing our land loans for fun and not advancing projects and that we should be taxed into doing that operationally we are taking this time as the market soft to make investments in our processes and our people leadership our technology so that as the market cracks and we find ourselves hopefully soon in a more robust environment to do business, we're coming out more efficient. And kinda and ready to operate. So that's sort of broadly speaking how developers are responding and then how we at West Group are responding.
Perfect. Hopefully the others on this call can kind of mimic what you guys are doing to help create or build out of this problem. So let's move on to the residential market, Vancouvers multi residential market has been challenged and although , of the thousand or % of released units consisting of concrete, wood frame, condo and townhomes have been absorbed, this remains well off historical norms, total unit absorptions for Q three was under noting the average quarterly.
Absorption rate for the previous ten years was . Market condo projects are still being delayed, canSaled repurposed to rental. Investor buyer is on the side of a milk carton and there's a year high standing inventory tolling totaling almost units available
So Bo this question goes to you as one of the largest and most active billers in the region, what do you see as the main catalyst for return to historical norms in the pre-sale of activity? And secondly, do you envision on as a reset with more normalized conditions returning in
Yeah, we've, we've been sort of taking I think a saying that has been throughout is that we've been saying is survive to .
And that's honestly sort of what we've been doing in is finding efficiencies and working on ways to extend our ability to weather the storm. And so I think the main catalyst for a return to historical norms.
Is it's going to be interest rates, right? I mean, I think that that's the main catalyst we obviously have this fundamental imbalance between supply and demand as a result of immigration and yeah, we were making some changes to immigration on a go forward basis, but we still have a massive imbalance as a result of frankly a normalized building program over the last several decades or even an under building program.
And so we sort of we rely on that fundamental, I think sort of like there's a pot of soup that's on the stove and it's been simmering and that's demand and there's been this sentiment where there's been a reluctance to jump into the market for we'll call it it consumers, but you know, occupiers, users, purchasers, renters of housing and so we are we're optimistic that in as interest rates start to decline, that there's going to be.
A sentiment shift and we'll start to see activity again. Indeed, I think it was reported in the resale market for the month of October the newspapers use the word surge. There was a surge in property sales on the resale market and I usually use, I use that as a bit of a Canary in the coal mine often to usually following that type of activity in the resale market. We'll start to see increased traffic in our sales centers.
And indeed, increased contracts of purchase and sale being written.
So that's sort of what I see happening as the main catalyst or a return to historical norm. Hope isn't a strategy. So we'll see what happens. But the other thing and you mentioned it, I think in your question is we need everybody's favorite villain to return to the market and that is the investor.
You, I think you said the investors on the side of a milk carton, which means they're missing. And that is indeed the case, but we've we've, we, they're not. They haven't disappeared. We pushed them out. Our policy has pushed out the investor. We have demonized, villainized the investor with a complete lack of understanding of how the investor helps to stimulate supply of housing in our market here in Canada.
You know, if you want to talk about CMH CS. Estimates of what we need to build by to return to some semblance of affordability.
That's three, three and a half million homes the capital that's required to instigate that supply delivery is estimated to be between . and $ trillion and to put that in perspective, trustee pension funds in our country have a market cap of around . trillion and all of that capital is allocated. So where's this capital coming from? It's my big question and I think that that's really the elephant in the room. So I think we really need to figure out how we're going to invite.
Investors back into the market and if you're an investor, why would you come to Canada when there's so much uncertainty?
There is no recognition for the amount of risk that you need to engage in or to when you're building housing or engaging in real estate development. And so we need to create a paradigm that draws that capital in, understands that there's risk there's an accepted reward for that risk.
And I think that will be helpful at some point in time to stimulate the market. No, I totally agree. I think the investor has been piled on for too long, whether it be the Airbnb, the flipping tax, we need them to come back. They build up supply, they're the shadow rental portfolio that we're missing as well. OK, next question goes to Sal at the darkest hours in late Canadian mortgage rates were pushing, pushing towards % with the ongoing case forecasted by Bank of Canada.
Where do you expect the fixed rate mortgage rates to fall in coming quarters? Will sub % rates for a five year term become the new normal? I think it's quite possible. We will see five year mortgage rates below %, Mike, another half percentage point drop in mortgage rates as is very feasible just given how low inflation is in Canada right now and there doesn't seem to be any inflation pressure either in the labor market or in the economy.
Per SE and with the Bank of Canada now striving not just to get policy rates back to neutral, that might be the Fed school, but it's also trying to get, it's trying to get rates below neutral to stimulative territory to give our economy a jolt. And you know if they do cut interest rates and basis points over the next eight months or so, that could you get mow, get five year mortgage rates below %.
I don't think much below % though, I think rates will settle out closer to % than closer to %. We're not going back to the pre pandemic.
Lows for interest rates because there is some inflation risk now in the US economy. It's been growing stronger. Its labor markets are tighter Trump's policies both on the tax cutting and tariff increasing side can be inflationary and some of that can spill over to Canada.
But and if those pressures put more downward pressure on the Canadian dollar, which already at a four year low, that will tie the Bank of Canada's hands a little bit. In cutting interest rates, so and possibly create a little inflation pressure in Canada so the bank Canada will need to be careful in cutting rates, but if our base case plays out, inflation remains calm and the Canadian dollar doesn't weaken too much further, I think it is quite possible we will see the five year mortgage rate just below % sometime next year.
Excellent. I think once people see rates are as low as they go, that will hopefully spur up some resales which is the market could use. There's a lot of standing inventory out there as previously noted and let's what the CBC policy plus rates lower hopefully. That will drum up some demand.
OK, next to next question goes to roll. So with over years of experience at BMO and having lived through many real estate cycles where did today's challenges place on a historical scale and then finally, what is BMO doing to help our clients through these times particularly in the market condo segment?
Yeah. Thanks Mike. So hi to all the clients that I know and hi to some new clients that I hope will come to the bank. First of all, this cycle is uniquely different and I think we've all heard it so far. It's a cycle of property type for those of us or clients alike and bankers are like that were diversified in different types of properties and across different regions.
You've we've all fared. In some areas and not so well and in other areas, and of course we the consumer has flipped from home ownership to home rentals and that's helped that side of the market. But the home ownership, the condo market has been specifically hit hard, especially in urban areas, not so much in suburban areas, but in the urban areas and I think at our bank I think.
I pride myself in saying that we're not a fair weather banker.
We recognize these are tougher times for the for the condo developers and it's not so easy to achieve your pre sale levels that historically you would sell out within a month or two and you would start within six months of filing your disclosure statement. That's not the case anymore and it's taking a year to sometimes up to a year and a half up to two years to start the project. So you know, I think we pride ourselves on understanding, we pride ourselves in trying to think like the client does and if it means starting the project with less than historic or normal presale levels will accommodate that will we can tier financing we can you know perhaps you need to put in a little more equity to get the project going, but you can earn out your equity once you reach certain pre sale thresholds you now lower deposits.
I mean nobody likes to hear that bankers traditionally love to see % but you know that's a now, that's a distant memory now. The deposit ratios or deposit levels have dropped dramatically over the last months and I think we the consumer and when you understand your target market and you understand your buyer, if you're prepared to accept that as a pre sale then I think the bank has to acknowledge that and you some of the other things that we've done again you know, we inventory loans is something that I go back many, many years we were doing inventory loans in the Oil prices and that's probably going to have to come back and it is in fact coming back where we'll lever up your unsold inventory to provide that equity to start the next project.
So and loan extensions, land loan extensions know that's become accepted practice and we have to acknowledge that that's the reality and hopefully interest rates are coming down a little bit so that's lessening the burden. But yeah, nobody likes to pay interest on.
That that's not generating any cash flow, but we acknowledge that and we appreciate the business that we've had so far and hopefully we'll stick it out. And as Bo said, we strive for . That's our ambition as well. So good luck everybody.
Thank you all, truly an honor to have you on this call. You have infinite wisdom and I'm sure if there's people on this call, you probably know each one of them. So thank you.
So I'm going to shift our mindset to rental now, so our client BMO had to pivot our focus and appetite to continue to support our borrowers and projects. Historically, we would finance one rental project for every market condo projects over the last months, we have seen the opposite ratio with four rentals for every one market. For perspective, the BMO real estate finance team in BC Finance plus or minus a billion dollars in new rental construction deals conventionally and through C.
MLI selected financial so Bo this question goes to you. Although rental rates are up over % over the last few years, they have stagnated and have declined in certain markets. Do you anticipate more growth in rental rates in the Vancouver market or do you anticipate vacancy rates to rise and rents to further compress?
I think that I would say that rates have definitely peaked in Metro Vancouver as you've stated, we're seeing some declines in some sub markets. Over the long term it's I could say yes, I see perhaps some growth in rates, but I think the days of sort of running a performance and trending your rents up to sort of cover yourself on the back end when you go to stabilize the asset, I don't think that's a safe strategy any longer. I think that rates have definitely peaked I think vacancy, I always look at the it's a story of sub markets. So when you look at a sub market, you know the West End of Vancouver is always an example I use there was as a plan that was put in place by the City of Vancouver about or years ago
Actually maybe it's years ago now. Big, big plan with talking about all the different amenities and different buildings that can be built and all that kind of stuff. And a few years ago we saw that plan start to deliver buildings and a lot of rental was embedded in that plan.
And we had a number of older rental assets in that sub market that when the new rental assets came online, people left our older assets with inferior amenities and they didn't have solid surface countertops and things like that to jump and go to the nicer assets, the nicer rental units and we were left to not only.
We were inducing tenants to come into our. So there's this sort of in a submarket, this idea of supply and demand and its impact on price and vacancy. And so when you see that happen in sub markets where there's a bulk of supply that kind of quickly comes on, you see a lot of movement in rental rates and vacancy for that submarket and we and we've seen that consistently in some of these sub markets so over the long term though, I we're not even coming near building enough.
To meet the needs of housing supply for the people that are here.
And so I don't see too much change in overall vacancy rates and where rental rates are today ish in the short term of the long run. Long run, do they grow more? I don't know tough to say. It's also really important to understand like, yeah, there's a whole bunch of groups like ourselves in fact, that are shifting from a strategy of merchant or condo to purpose built rental either for, you know, selling, forward selling to more institutional actors or keeping for our own portfolio.
So and what I think a lot of people sort of don't talk about enough is the capital requirements to execute on those large projects. It is a very, very different story from a capital perspective to engage in purpose built rental construction than it is the pre sale sort of condominium strategy. This is far more capital efficient than another and so I think that that's something that is going to always prevent a large amount of rental from coming into the marketplace. It's just it's not capital efficient. So yeah, that's I hope that answers the question no it it does and it talked about capital ties into our next question, so this one's to roll.
So there's been a balancing and active weather a customer proceeds with MLI select construction which locks in the NOI years in advance or they approach lenders with a hybrid conventional strategy.
What is BMO strategy in looking at rental assets from a conventional basis and where can we provide additional flexibility?
So again, as Bo aptly described, I mean rental real estate, I always say real estate it it's the most expensive to finance when it's brand new and that's years from now you can refinance it it and take out equity. But when it's brand new, it takes an incredible amount of capital and know CMHC was quick to help in that market by ensuring construction loans and getting leverage up to % of cost and where that made sense in a lot of regions they did quite well outside of probably BC and Ontario, there was a lot of rental housing built under insured construction loans in the Prairie regions and in Eastern Canada or Atlantic provinces.
So I think going forward they the government just needs to be even more creative to attract that capital if it's going to entice developers to build rental but I know in our case, I mean, we've done a lot of construction financing, conventional financing and we'll continue to do a lot of that uninsured.
And leverage ratio % loan to cost is the norm, but that's a lot of equity in certain instances, we may go slightly higher than that in the the right markets.
And into the rights developer, but it's incredibly expensive you you're parking % capital in there and hopefully with rates coming down by the time you get to your take out, you'll be able to take out some of that equity. But it's going to be, it's going to be a challenge if CMHC backs away from underwriting construction.
Apartment buildings, Mike and if I could just jump in on what Ralph was saying there regarding CMHC, because I think it's important to provide positive reinforcement to our government sometimes too, and that is the CMHC has really stepped up to the table. I think the RCFI programs were one of the largest recipients of the RCFI program on the West Coast, which is now the ECLP program, but it it's probably one of the most guess, stimulus programs that we've seen in our time certainly since the s and s in terms of creating new supply of purpose built rental.
And so it's it, I think that we certainly have to encourage the federal government to not only double down, but triple down on those efforts. And so I think that that's been a very, very successful program for the supply of purpose built rental.
Excellent. Good insight by all. We're going to shift to another asset class, so let's talk about industrial. So prior to COVID industrial real estate was already a hot commodity the pandemic accelerated leasing, investment, development activity and the adage of beds and sheds had never been through. Now market sentiment remains subdued with less demand compared to last year. They can they can see rates increase to asking net rents down %.
Leasing and sales activity has slowed significantly with transactions. Longer to close tenants and buyers are cautious to commit to long term lease or sale agreements, so Bo this goes to you. What is West Group's perspective on the local industrial market today and in the foreseeable future?
So today are the short term, I would say we're seeing what you've described an overall softening we’re seeing upward movement on cap rates, downward movement on lease rates and we're starting to see land come off that strata buyer so that the developer of strata industrial that was really pushing the land market has all but disappeared that performance no longer working. And so it's you're looking at these assets in this land based on an income basis.
For the most part. And yeah, we're seeing that income start to go down because lease rates are softening and you're also seeing there was for a long time in the market in industrial, if you think about it for years and years, industrials lease rates were in the single digits and then within like a, it was like a very small period of time, even a window of two to three years, you saw them just jump right up into the double digits. And so when land was being offered for sale or assets, there was sort of this in particular with the assets there is this story of.
In rent, which was quite factual and so you saw a cap rate compression where you could absorb a lower cap rate because you knew in a year, two or three years some of these assets were going from a single digit to a double digit rent. That's not the case anymore. In fact, what we're seeing is again rent starting to decline. So I think that that's what's going on right now. But as as the Metro Vancouver industrial market and the long term sort of outlook, I think the long term outlook is quite healthy and really it comes down to geography, well geography and policy. So on the geography side we obviously have the ocean and the mountains here in Metro Vancouver and on the policy side we have the agricultural land reserve. And so that leaves us with an industrial land reserve that's actually mostly built out.
And until and I don't think the ocean and the mountains are moving, but until policy changes know around agricultural land reserve and how u have a serious scarcity issue on industrial land and so long term in our market I think that we're gonna see a fairly healthy sort of industrial market are stabilized. Let's use the word stabilized, yeah but it's different in other markets right across Canada where land isn't as scarce but that's sort of our view I think on our view I think on industrial.
OK, great. Now we'll move on to another challenge asset class, which is office downtown Vancouver has the lowest office vacancy rate amongst major cities in North America at % in Q three. So for perspective, it was % just prior to pandemic and a balanced market is deemed between and although . million square feet of new office space was added to Metro Vancouver.
In the past three years, the development pipeline has slowed with only three large scale projects currently under construction. Other projects are undertaking conversions into hotel space or delayed financial institutions have been reluctant to increase exposure to the office asset class uniformly across the board. Despite all this, the first half of recorded several large scale transactions totaling million Bo. This question goes to you, does Vancouver have an office dilemma coming to a head or is there enough positive signs to be optimistic in the future?
I wouldn't say that there are generally positive signs just yet. Or on the transactions you noted, I'd point out that those were unique in the sense that regardless of income and cap rate and dollar volume, they all traded well below replacement cost. And I mean below in some instances, which is something I'm increasingly becoming fascinated with in terms of a market metric that I think we ought to be paying attention to.
And currently when you look at when you add up. The direct available space for lease as well as the sublease space there's over square feet of office in the metro Vancouver market. And a note almost % of that's Class A and so I you know that's a unique situation to work through I think our absorption.
Year to date is just over , square feet according to Collier's Q market report.
And so know there's a lot of space to absorb there and I don't think that that's happening necessarily on a very robust basis right now in terms of absorption. And so I would say short term there is a dilemma.
You mentioned financing, that's another issue in our portfolio of office assets, we have a high ratio of government tenants and institutional quality tenants and when we're going for refinancing, you know all you guys are still giving us lots of trouble.
And then I would argue finding attractive financing to build new office. Is probably non-existent so not that anybody would want to do that. So yes, I think there is a dilemma right now we are on the long term side. I think we're starting to see governments, institutions, companies, private companies publicly traded companies start to call their people back to work and you know we can debate as to.
What that's all about. But that's a long debate. But we're seeing that happen and so we're going to start to slowly see.
I think space occupied again and then filled so and of course, one has to remember that Vancouver, we're not like a head office market here or anything, right? And so even when people are trying to attract people workers to come and work in offices in metro Vancouver, it's an expensive place to live. There's an affordability issue and so, you know, all of those things I think play into how that ,, square feet in Metro Vancouver will absorb.
And then the last issue I would say with Office is the cost to build new space, in particular tenant improvements and landlords work it to build out new office space. It is never been more expensive. It's actually unbelievable and so I think that that's becoming a little you increasingly prohibitive in in terms of trying to absorb new office space.
OK, so. No, it definitely does. There's basically there's still lots of hurdles and challenges ahead of us on office. So there's minutes left. Let's try to squeeze in two questions. They're both gonna be to you, Bo. So one’s about sustainability. There's no denying impacts of climate change or dramatic weather events. And this can impact the real estate market. That is why sustainability is more than an idea. It's crucial for long term resilience of real estate. With all the challenges you've already mentioned, how does West Group manage this process? Balancing measurable results in sustainability, but at the same time managing bottom line profitability?
Yeah, it's a really good question actually. I think that there's a lot of organizations that have made big announcements and created big sustainability plans, and I think there's many of those organizations have really had trouble executing in a meaningful way. And at West Group, what we do, and I joke we kind of always build the plane while we're flying it. And I guess what that means is we have a bias towards action and sort of learning along the way.
So the journey becomes the big plan. If that makes sense. An example of this is building out the largest rooftop solar array in British Columbia.
In that instance it was with an institutional quality tenant that had also an interest. You know they had an ESG strategy, a sustainability strategy, and we were aligned in that sense and we were able to make that whole deal work and it and it's a really, it turned out to be a really interesting and cool project.
And it was a learning for us, and it didn't come out of an overarching strategy. It came out of let's just do this and try it.
I could give you so many other examples of what we are doing as an organization in that regard, and don't get me wrong, like we have a sustainability division and we're focused and an ESG. I wouldn't call it an overarching strategy, but the strategy is we want to do stuff and try stuff. Another thing we did is we became the only private sector development company to submit to GRESBA. And we were put against.
All every single other submission was an institutional organization, a publicly traded company, or a pension fund from around the world. And we were the only private sector developer to submit. We absolutely got you know, the crap kicked out of us in terms of a scoring and so the next year we submit it again and we improved our score and we've just submitted again. And we're as we that we know of, we're still the only private sector company to do that.
So we just try and do things like that We're monitoring all a lot of our assets for energy consumption, water consumption to set baselines in terms of where we can improve from on an annual basis, but I think that you the idea is always seems to be to form a big strategy and create a big document and put it out there for public consumption and that's absolutely not what we do at West Group. We just kind of again biased towards action try stuff iterate. Outcomes and then a plan gets formulated based on that.
Perfect. Thank you for that. So last question. Bo, what property class will offer the best possible return to and beyond?
What property I mean?
I That's a really tough question to answer because land is land is out right. There's that market is not, I don't see a big change there for quite some time there's too much policy and development cost fee sort of uncertainty in the land market and so so you're seeing that that's a dumpster fire.
Retail is an interesting story know you're seeing a lot of on renewals right now. We're seeing a lot of rate increases on retail. I think they were fairly stagnant for a while and years ago the story of going for a refi on office right now with the banks was the story on going for a refi on retail. or years ago it was far more challenging, but now it's an asset class that seems to be. I think certainly in our portfolio and others that I talked to performing.
Quite well. And you strial, we talked about that already. You could also take a contrarian approach with office. Again, I've become quite fascinated with this. Below replacement, below replacement concept and now might be an interesting time to in fact again on a contrarian basis analyze opportunities in the office sector that are well ated in urban centers close to transit and t and how much below replacement cost.
Can you acquire those assets for because replacement costs I don't see our construction costs. I certainly see them stabilizing a little bit right now, but I don't think they're going down anytime soon, in fact over the long term, I suspect they're probably going to continue to creep up with our labour shortage and the price of goods and materials and the time it takes to build out these assets. So yeah, I mean, I think what I to summarize there, I kind of focused in on retail. Retail on this sort of emerging market that we're observing and then office if you're a contrarian at the moment. Awesome. Thank you very much. So in closing, thank you again for joining us. We hope you enjoyed today's session.
As a reminder, today's call was recorded and is available for playback you will receive details on how to access that in an e-mail. This concludes our call today. And so thank you and take care.
Thank you.
BMO’s Commercial Real Estate team offers an insightful virtual discussion on the BC housing market, regional market trends and economic outlook. Featured panel speakers include:
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Beau Jarvis, President and CEO, Wesgroup Properties
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Sal Guatieri, Director & Senior Economist, BMO Capital Markets
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Mike Lynch, Regional Vice President, Real Estate Finance, BMO Commercial Bank, Canada
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Rolf Neufeld, Director Credit Structuring, Real Estate Finance, BMO Commercial Bank, Canada
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