Why one is soaring and the other is plummeting
As turbulence in Canada’s commercial market continues, lenders are taking a rosy view of the industrial sector – but are unsurprisingly giving the office space a wide berth.
That’s according to the latest Lender Sentiment Report released by commercial brokerage Crete Capital, providing a snapshot into the current lending habits and market outlook of leading lenders in British Columbia.
The report listed owner-occupied industrial real estate as the asset class that lenders are showing greatest appetite for in the current climate, in stark contrast to an office sector that “poses red and yellow flags.”
Joey Tai (pictured top), managing principal at Crete Capital, told Canadian Mortgage Professional the survey reflected the continuing resilience of the industrial space in spite of the uncertainty that’s engulfed the commercial sector in recent times.
“Owner-occupied industrial real estate is probably on top of the list. You have an operating business that’s proven, that’s established, it’s got history, it’s the user and the corporate covenant supporting the loan,” he said.
“Historically, the default rates for owner-occupied real estate loans are quite low and the loss rates are even lower.”
With entrepreneurs and operators generally highly committed to that type of business, the sector is marked by a heightened willingness to work through challenges and downturns in the market compared to traditional investors, he added, who are more likely to be purely motivated by profit.
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Lenders increasingly cautious on the office front
Fully 100% of respondents to the survey indicated that they were seeking to increase exposure or expecting to compete on opportunities that arise in the industrial space – a sharp contrast with the office sector, where 55% of those surveyed said they had no to low appetite for financing.
“More than half of our respondents said they had no appetite [for office], and the balance of respondents said, ‘Hey, it’s cautious. It’s a yellow-light sector,’” Tai said. “So they’re a lot more careful. When lending into the office sector, it’s going to be a lot of due diligence and scrutiny.
“And those are definitely harder deals to get through – they’re harder transactions to get approved and to get credit for.”
Lenders on those deals are likely to adjust the structure to ensure they’re getting paid for the risks but also guarantee proper backstops and strong covenants, support and sponsors – with much less competition and activity also evident in the space.
“We see this day to day when we go to market as advisors and brokers on an office asset: you’ll have a lot fewer lenders pitching on it,” Tai said, “and a lot of aggressive terms and conditions versus when we go to market for an owner-occupied program, you’ll have a lot more interest in term sheets and more competition, to compete on and bid on that business.”
Which lenders will consider investing in the office sector?
Some observers may be surprised the percentage of respondents who indicated zero to little appetite for the office sector isn’t higher, given the fact that the space has been embroiled in such chaos in recent years.
Those difficulties have arisen in the wake of a work-from-home revolution that gathered pace from the onset of the pandemic, with high interest rates and market volatility also seeing office demand plummet.
“The balance of respondents that said, ‘We’re open to it,’ [are really saying] ‘Hey, we’ll look at it. Send us those deals, we’ll look at it,’” Tai said. “But they’re looking at it with a magnifying glass. Just because they’ll look at it doesn’t mean necessarily that they’ll do it – versus 100% of respondents that are saying, ‘Yeah, we’ll get industrial – please send it to us.’
“So that’s the difference. Even though just under 50% said they’re open to it, they don’t like it as much as industrial.”
The report also showed that against the backdrop of a rise in cyber crime and financial fraud emerging from the pandemic, lenders are increasingly focused on Know Your Client (KYC) requirements.
“Some of the other themes from an underwriting standpoint and from a diligence standpoint were that lenders want to be paid for their risk,” Tai said. “That’s the focus, and lenders want to really understand who they’re dealing with through KYC requirements.”
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