CategoriesAdvice

Central banks, interest rates and the cascading effects on real estate

This year’s battle of the central banks against inflation started with the Federal Reserve in the U.S. with rate hikes in March and continued on Nov. 2, with the latest increases pushing the Fed’s rates from their low of 0.25 per cent to four per cent, a 16-times appreciation.

It is one of the steepest and sharpest increases ever seen.

The central banks from countries that did not follow the U.S. Fed (the Bank of Japan, for example) saw their currencies devalue significantly against the U.S. dollar (JPY lost over 30 per cent value from March 2022). The Bank of Canada kept pace with the U.S. Fed with the policy interest rate climbing 7.5 times from 0.50 per cent in March 2022 to 3.75 per cent, yet the Canadian dollar still lost over 10 per cent versus the U.S. dollar during this time period.

Arguably it could have lost a lot more had Canada taken a different approach to interest rates.

Spinoff effects felt in Canada, around world

These rate hikes by the central banks have also sparked a horrible escalation in the bond markets, destroying the prices of the existing bonds and, of course, causing havoc to both the short-term and long-term borrowers.

The strong U.S. dollar also caused significant damage to sovereign nations, with Sri Lanka going through a major economic crisis and the United Kingdom (a G7 country) seeing its pension funds get stuck in a “doom loop”, where banks had to sell government bonds (known as gilts) to meet their cash calls on the leveraged investments.

The commercial real estate industry in Canada is of course impacted by the macro world around us.

The five-year mortgage rates spiked from less than two per cent to five per cent, causing borrowers to lose over 30 per cent of their borrowing power “overnight.” This translates in it being impossible for properties to retain their sale values from 2021 to today.

For the sellers who were aware of the price they could get in 2021 but need to sell today, the decision becomes convoluted: either sell today at lower values, or hold on hoping interest rates will go lower over the next 12 to 24 months.

Unfortunately, no one seems to know where we are going from here, not even central banks which are using rear-view-looking indicators such as unemployment data or inflation numbers to assess their current and future policy rates.

If you’re a buyer or a seller . . .

The sellers / owners who are over-leveraged are best to take longer-term loans (five-plus years) so as not to risk getting washed out in the event the rates go even higher over the next 12 months.

Those who have low loan-to-value rates of 30 per cent or less can probably take the risk of waiting this out another year or two while hoping for a policy reversal by the central banks.

For the property owners in the mindset of selling their properties over the next 12 months, it is probably best to go with loan terms that are either open variable or less than 12 months.

This would limit the bank fees associated with loan cancellation in the event the purchaser is not willing to assume an in-place mortgage.

For buyers, on the other hand, probably the best time to acquire is right now, as cap rates are higher than 2020-2021 and fewer buyers have capital to buy in a higher-interest-rate environment.

Therefore, there’s less competition for assets than over the past few years.

The key will be working to find the best assets and most motivated sellers in today’s economic environment.

Baron Realty specializes in matching buyers and sellers of apartment buildings. Ramona works in partnership with Mikael Kurkdjian and a team of real estate professionals to bring the best boutique-brokerage services to the apartment transactional space in Ontario and Quebec. 

Work with Baron Realty. Reach out today!

CategoriesAdvice

A slowdown in transactions, ‘real’ sellers and the new normal

The loan available against a property is highly affected by interest rates: the higher the rate, the lower the loan available and hence, the more down payment a buyer needs to complete a purchase.

With interest rates rising significantly and virtually overnight at the beginning of the year, we saw two significant and immediate changes in the transactions market.


Market conditions have changed rapidly

The first one has to do with the fact that any apartment building transaction requires preparation.

One must review and analyze the vendor materials; prepare the marketing; and sometimes in parallel, complete the environmental assessment (a two- to three-month delay) without which banks would not lend against the property.

These coupled due diligence items mean that for the vendor who decided to list the property in late 2021, when the interest rates were at their lowest, the spike hit during the listing and marketing process.

This caused some deals to fall through and buyers to backpedal on conditional commitments, and/or reconsider the value of the asset.

Hence, many of the properties listed for sale never traded and/or are currently still sitting on the market at reduced prices (for some, there have been multiple price reductions).

Who are the “real” sellers?

The second change in the market is the immediate identification of “real” sellers versus owners who would have otherwise sold, but do not have to.

“Real” sellers are owners who want or need the asset sold at a certain moment in time (within the calendar year). This could be due to a variety of situations:

– dissolutions of partnerships;

– lack of interest or ability to continue managing the asset;

– changing family dynamics (many rental assets are owned and managed under private family ownerships); or

– financial inability to keep up with rising mortgage payments (for the loans that came due during interest rate spike) and building maintenance costs.

The transactions we see getting done into 2022 involve sellers who understand that neither the seller nor the broker determine the price – it is determined by the market.

The market is always affected by much bigger dynamics than the buyers’ interest in owning investment properties.

The foreseeable future

We believe the current market is here to stay, with the interest rates at the same level now as they were in 2008.

The U.S. Federal Reserve has clearly indicated it plans to continue to fight inflation by keeping the interest rates at these levels or higher. Other central banks need to follow the U.S. in keeping their rates at similar levels in order to avoid currency devaluations.

What this means is the record low “pandemic-level” interest rates we had in recent years are a thing of the past and we are now in the “new normal.”

Both sellers and buyers should get used to these interest rates and focus on increasing the property values by providing more services to the tenants, increasing rents and decreasing the expenses in place.

We remain available to advise on these strategies.

Baron Realty custom-tailors each marketing process, and brings the right buyers based on the asset and vendor requirements for deal timelines. We have generated 5-12 offers on each of the listings we have taken over the last 18 months. *Ask us why; we are happy to talk to you about how to best navigate the current environment to achieve your end goal.

Baron Realty specializes in matching buyers and sellers of apartment buildings. Ramona works in partnership with Mikael Kurkdjian and a team of real estate professionals to bring the best boutique-brokerage services to the apartment transactional space in Ontario and Quebec. 

Work with Baron Realty. Reach out today!

CategoriesAdvice

Apartment buildings: Fighting rising interest rates

Interest rates are the lifeline of our real estate world. Without the lenders and financial leverage, all investors would have to buy any investment properties in cash, completely removing the whole concept of leverage, ROI and yields from our business.

Real estate ownership is generally a long-term play, however, and an owner will see rates go up and down during the duration of asset holding. Managing the financial aspect of leverage (debt) can make the difference between winning and losing the game of returns.

Currently, the central banks have made the unfortunate decision of fighting inflation by penalizing the debtors and hence we have seen a massive push of rate hikes since last year.

A five-year insured mortgage would have had an interest rate of 1.80 per cent in June 2020, 2.30 per cent in June 2021 and 4.60 per cent as of June 2022.

Not only will these rate hikes cause problems to the cash flow of the borrower, but they will also significantly impact the financing obtained, as the loan amount obtained will be lowered by 33 per cent, which has to be made up by either lowering the sale price or providing a higher down payment.


The solution

How should multiresidential owners combat this rate hike?

The only property owners who will be able to navigate properly in this kind of environment will be those able to increase their net operating income to make up the difference (net operating income is the income left after all the fixed costs like property taxes, insurance, utilities are removed from the gross revenues), since one of the most important criteria that the lenders use when evaluating a property is its net operating income in place.

These solutions that follow will seem very basic to the experienced landlords, yet in our brokerage business most properties that we sell are hardly optimized.

There are three main ways to increase the net income:

Renovations of units

Beautifully renovating one unit and increasing its monthly rent by $200 per month seems trivial, yet this means an increase in the property valuation by approximately $50,000. Repeating this process four times gives $200,000 of increased asset valuation.

Property insurance

Each dollar saved monthly on the insurance bill will potentially increase the property value by $240. This by itself is a 1,900 per cent return on investment annually, and it does not cost anything more than shopping around for the right insurer or the right insurance broker, because there are major discrepancies between insurers in terms of rates.

Energy costs

Energy is an entire other problem we are seeing these days.

The high prices paid by all of us at the pumps are a real problem, but a bigger problem is natural gas prices year-over-year. The average natural gas bill has gone up approximately 25 per cent in 2022 versus 2021.

If the natural gas bill in 2021 for a given property was $20,000, that same property is now going to pay $25,000.

This $5,000 increase in the gas bill means a $100,000 decrease in asset valuation. This issue cannot be left uncorrected.

The owner must know all the energy programs available to perhaps change the in-place heating furnaces to more efficient ones, or learn about the various CMHC energy programs, which are always updated and changed and may provide high benefits to the landlords based on specific situations.

In conclusion

We have seen a significant change in the capitalization rates between 2021 and 2022. However, the capitalization rate is not the only measuring factor in property valuation. The net income of the property remains the most important element.

By doing the needed renovations to the units when they become vacant, by managing the property expenses including insurance and energy maintenance, the prudent property owner will come out much ahead versus those that are not pro-active in our current higher interest rate environment.

More details in an interview with STOREYS: Interview Link 

Baron Realty specializes in matching buyers and sellers of apartment buildings. Ramona works in partnership with Mikael Kurkdjian and a team of real estate professionals to bring the best boutique-brokerage services to the apartment transactional space in Ontario and Quebec.

Work with Baron Realty. Reach out today!

Québec

Baron Realty / Immobilier Baron
400 – 6500 Transcanadienne
Pointe-Claire, Québec H9R 0A5
Telephone: 514 932 9000

info@baronrealty.ca

Fax : 514 221 2221

Ontario

Baron Realty, Brokerage
303-225 Duncan Mill Road
Toronto, Ontario M3B 3K9
Telephone: 416 301 3931

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