3 considerations for rental construction financing

Nov 23, 2016

New rental construction is a hot topic these days with the media hyping apartment builds as the “big thing” in Canada. While there are some people realizing great returns from new rental construction, the headlines don’t necessarily tell the whole story.

Construction financing is complicated, with a lot of intricacies involved. And, it’s only a small percentage of deals that are truly viable. For any new rental construction, there are three key financing considerations that govern all successful outcomes:

1. Quality of the site
Site quality comes down to where the property is located and what’s around it. Quality increases with proximity to transit, good schools and major highways, and if the neighbourhood is known for its attractions, amenities, walkability, retailers and restaurants.

In one example of a recent deal, the proposed property met all the quality criteria listed above. It was located in an established rental node, right on the subway line in an upper-end rental market perfectly suited for a new development. For that deal, we provided $100,000,000 in construction financing.

In another example, the building was going to be the fourth in a cluster of rental buildings First National had previously financed. The property was located across the street from a mall, on the subway line and two minutes away from two major highways. Site quality was indisputable.

2. Quality of the borrower
The quality of the borrower comes down to several factors. These include:

  • An existing apartment portfolio, indicating experience with the asset class
  • Strong net worth, showing a solid financial foundation
  • Liquidity, showing that the borrower is able to infuse cash quickly to cover unforeseen costs that come with construction
  • Developing experience; however if lacking, the borrower can mitigate lack of experience by partnering with a more sophisticated high rise developer/builder
  • Sub-market smarts, showing the borrower is knowledgeable and experienced about markets as a result of other apartment buildings owned

We once worked on a deal in Western Canada, where the site was decent, but definitely not five star. It was just on the periphery of the ideal location of downtown. However, in this case, the strength of the deal came from the quality of the borrower — an asset management company backed by institutional investors. That strong financial foundation gave us the confidence of knowing that any cost risk would be mitigated without issue.

3. Market feasibility
When contemplating any build, it is critical to determine if proposed rents are suitable for the target market. Understanding the market provides insight into rent values, but also helps to inform the breakdown of units and ensures that building design suits the target.

We worked on a deal with a high quality borrower. He had a significant apartment portfolio and an existing apartment building on the site already. The site itself was a B+ location. It was suburban, and even though it wasn’t downtown suburban, it did have proximity to transit. The existing building on the site had done well historically. However, the borrower was looking for CMHC financing, and CMHC turned it down. The reviewers didn’t agree with the market feasibility study and the building’s ability to achieve the designated rents.

Meeting the considerations
If you’re looking to secure CMHC financing, it’s critical to be prepared to meet the three financing considerations to the letter. When reviewing deals, CMHC executes on those considerations strictly and conservatively. You have to meet all three – site quality, borrower quality and market feasibility – with no exceptions.

Conventional financing offers a bit more flexibility for slight variables. And I mean slight. The considerations do apply, but there is a bit of room for interpretation.

In conclusion, for anyone looking to build a new rental construction, my advice is always the same: be realistic about the opportunity and your capability to build. If your strategy is to build and hold for the long term, then I suggest evaluating your opportunity with the intent of securing CMHC financing, so you can get the interest rate advantage.

The opportunities are out there, and the media is insistent that now is the time to build. In reality, the truly viable opportunities that conform to the critical financing considerations – site quality, borrower quality and market feasibility – are harder to find but infinitely more valuable.