Rising interest rates aren’t just impacting the wallets of Canadian consumers and mortgage holders – today’s steeper borrowing costs have pushed up the cost of the housing industry significantly, with profound implications for the creation of affordable housing.
Jacky Chan, CEO of BakerWest, says higher interest rates have effectively doubled funding needs for developers looking to dig deep on new projects, and could potentially even nullify existing permits for ongoing projects. The Bank of Canada, which entered a monetary policy tightening cycle in March to combat rising inflation, has since hiked its benchmark overnight rate three times, taking it to 1.5% from a record low of 0.25%. At least three more rate hikes are expected before the end of the year to bring the rate close to 3%.
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That means challenging days for new housing creation, says Chan, for both new and existing projects. According to him, after two years of aggressive lending approvals, commercial real estate lenders are now in belt-tightening mode. He says that in some cases they are reluctant to accept or even review new business. Even projects that have only recently met their pre-sale requirements may also face challenges in obtaining construction loans as they now enter lending in a tougher interest rate environment.
“As [this] will affect all developers, the change in the performance of all development projects is flat rate in relation to the pro forma, which will then require all developments [to be] looked at and checked again. Possibly the most dangerous point would be – for some of these expected mortgages from certain lenders – to revisit and [result in] the requirement to re-apply,” he tells STOREYS.
“Lender terms have changed, costs have changed, and interest costs have pretty much doubled, so the qualification or debt service of the actual project is completely different for the developer. That will greatly affect the possibility [of having the project continue to be built] for the same developer with the same development that has already made the volume of sales to get those construction loans, and when that’s not possible, that’s a big problem,” says Chan.
Taking into account the requirements of the Real Estate Marketing Act (REMA), this becomes a “real gatekeeping measure” for property developers; In British Columbia, all pre-build projects must meet their pre-sale requirements within a 12-month period. Should they miss this deadline, they must cease all sales and marketing activities until they can demonstrate to the Superintendent of Real Estate that further mortgage lending is approved and in place in order to proceed.
“Should that [interest rates] going on as they are, it will not only impact the condos in the Strata market, but also the affordable rental projects that [are] much needed by cities and across the country. That’s the real challenge we’re dealing with,” says Chan.
Affordable units on the chopping block
Affordable housing projects, such as those implemented in partnership with federal government programs, are particularly vulnerable to the effects of rising interest rates. For example the Rental Financing Initiative (RCFI) — a program that provides 10 years of below-market-value financing for the riskiest phases of rental housing and is written off over 50 — has nearly doubled its interest rates since the Bank of Canada began its cycle of tightening.
In a recent article in the globe and mail, Shawn Bouchard, vice president of Quadra Homes, said: “It’s going to stifle supply in these [rental] Marketplaces because people will cancel their projects en masse. I’m not talking about a small amount, but a very large number of projects are being put on hold or canceled altogether.”
Following Quadra’s success last August in using RCFI to fund Harbor Ridge — a five-story, 120-unit affordable housing development in West Kelowna — Bouchard hit a roadblock trying to do the same on an upcoming Langley initiative, since interest rates have risen higher than its initial pro forma 2%. (Current RCFI rates, based on a 30-50 basis point spread from the 10-year Treasury, are approaching the 3.5-4% range.) The new project would have brought 410 affordable units online in four buildings – but that has now halved.
Bouchard told that globe that the situation could have been avoided if the government had capped lending rates for affordable housing and committed to the 2% it had been offered just a few months ago.
“RCFI is such a great program that developers are very excited about. And tenants and tenants and those without property ownership are also very excited about it…it’s very beneficial for both the industry and the end user,” says Chan. However, going from a simple 2% to 4% or even 2.5% to 4% is a very significant change that would throw everything off the rails,” he added, adding that “100%” of all projects are “one way or the other ” Be heavily influenced Another.”
“At the end of the day it would probably just require more cash upfront and a greater financial drain on the developer and the development projects themselves, leading to a situation where those projects are no longer viable because the developers don’t have twice the money , to pay for the same type of projects. You can’t add value to projects enough to offset this huge shift.”
He agrees that given the federal government’s aggressive mandate to create more affordable housing, there is justification for reassessing how today’s tougher interest rate environment is affecting that plan and taking action to project the feasibility of projects.
“I think there could definitely be a special program or rate lock for the RCFI. Policy rates are going up and they have to fight inflation and what is happening in the market and in the economy, but if it affects the RCFI program to a point where even 25 to 50% of the projects are in the works [have a greater than] 50% probability [of] cancel or no longer be viable, then of course it would make sense to separate this sector from projects and lenders and specific loans,” he says.
“It’s actually very easy to change the rate offer specifically for this program. Instead of plus 50 basis points, they could do minus 50 basis points – that would solve many problems immediately.”
Penelope Graham is the Editor-in-Chief of STOREYS. She has over a decade of real estate, mortgage and personal finance experience. Her commentary on the housing market is widely featured in national and local media including BNN Bloomberg, CBC, The Toronto Star, National Post and The Globe and Mail.
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