Commercial gains?

With commercial mortgage capital flooding back into the market from all sources, 2010 was an exceptional year for borrower's in the commercial real estate industry.

Banks, pension funds, life companies, trust companies and private lenders were active in commercial mortgages vying to do commercial loans that were commensurate with their yield requirements (interest rate targets). Long-term commercial mortgages are typically priced as an interest rate spread over the corresponding Government of Canada Bond Yield.

The spread represents the lender margin on a particular deal and the bond that is selected is in line with the duration of the term of the mortgage.

Throughout the year, Government of Canada Bond Yields has flirted with all-time lows as uncertainty in the economy has put downward pressure on bond yields.

As a result of "all-in" interest rates (lenders spread + bond yield) at historical lows, borrower's have raced to lever as much as they could and for as long as they could as a means to hedge against interest rate risks on their long-term, income-producing assets.

There was strong demand and plenty of interest in commercial mortgage capital across all four of the main income-producing asset classes of commercial/office, industrial, retail and multi-residential.

Key lending fundamentals including location, tenant quality and borrower strength continued to play an integral role in dictating the level of pricing (interest rates) a particular asset would command.

The better quality the asset is, the more aggressive lenders got in terms of pricing the interest rate. 2010 also saw capital available for lesser quality assets and commercial real estate product for assets in secondary markets (smaller markets).

With the additional capital that re-entered the commercial mortgage market, lenders were not only competing on the merits of interest rates, but rather, on the basis of structure and underwriting parameters.

Borrowers enjoyed more aggressive loan-to-value ratios, tighter debt-service ratio requirements, and longer duration on amortizations.

CMHC-insured loans on multi-residential properties continued to be a highly desirable loan product in 2010 as lenders in the market were attracted to the government-guaranteed return and the defensive nature of this particular asset class. The CMHC-insured lending market benefitted from lenders who continued securitizing loans through the National Housing Act Mortgage Backed Security Programs (NHA-MBS) and who priced their loans over CMBs (Canada Mortgage Bonds).

Introduced in 2001, the Canada Mortgage Bonds (CMB) Program has provided a continuing investment opportunity for investors and provided a cost-effective source of funding for mortgage lenders.

The objectives of the program are to help ensure Canadians have access to affordable mortgage financing and to improve the competitiveness of the Canadian mortgage market.

Investors in NHA MBS purchase undivided interests in the pool of mortgages and receive monthly installments of principal and interest from the cash flows of the underlying mortgages.

Through the CMB Program, Canada Housing Trust (CHT) sells CMB to investors, and uses the proceeds to purchase mortgages packaged into NHA MBS from financial institutions. CMB investments offer investors regular semi-annual coupon payments and a single repayment of principal at maturity.

CMBs are guaranteed as to the timely payment of interest and principal by the Government of Canada through CMHC. As a result of the rampant activity in the NHA MBS program, liquidity within this asset class was abundant and readily available with effective rates as low as 3.10% for five-year loans.

To get the rest of this story, download a copy of our May 2011 issue.

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