Vancouver Commercial Real Estate Podcast

After the Bank of Canada surprisingly raised rates in June 2023, we’ve sat down with Jon Switzer to find out what in the world is going on with interest rates in 2023 and beyond. Where are rates headed and when will they come down?

Who is Jon Switzer?

Prior to getting into the commercial mortgage business, I was on the finance side dealing with municipalities and some larger institutions in cash management. I made it through some of the most challenging times in the financial sector since 2008. I brought those tools over to Impact Commercial in 2013. It’s been a wild ride ever since!

Last week the Bank of Canada raised the overnight rate by 25 basis points. What is going on now?

At one point we were talking about a rate cut towards the end of 2023 and then all of a sudden we’re back talking about rate hikes. It was a major 180 on the messaging from the Bank of Canada and a surprise up until the day of the hike. Some people thought they would hike in July but they jumped the gun and hiked in June.

The raise made some waves on the global bond market because it was such a surprise. The Big 5 bank economists are now saying they expect another hike in July, though it always depends on the data. There are head games going on with central bankers; it’s how they keep things in check. So we have to be careful that we don’t follow the language too closely.

I think the Bank of Canada is purposefully overshooting here – taking a bazooka to it – to make sure they can get a handle on inflation.

I believe the Bank of Canada waited too long and kept rates too low during and after the pandemic. They would rather mislead the market and say they’re not afraid of raising rates, but go back on that, then drop the ball on fighting inflation.

Why and when will we see the next interest rate hike?

Nothing would surprise us now. If they raise another 25 points in July, that wouldn’t be a surprise at all. But it would have been a few months ago. The bank is trying to spook the market into submission.

We still have persistent strength in employment. Core inflation in the US is still very strong, despite the CPI coming down. A lot of data is coming in showing that the brakes are starting to be applied in the economy. We’re seeing a decrease in disposable income and record low mortgages. When inflation starts to grow slower – which is what we’re hoping for here as opposed to negative inflation – we could see the Bank of Canada change tactics very quickly.

They’re overshooting. They haven’t given enough time for the crazy increases in rate hikes to work into the economy. Economists say it takes a long time, 8-14 months, for a rate hike to work its way through the economy. The rate hikes that happened in March 2022 only kicked in this March 2023. So to keep raising now without understanding the long term effects is really interesting. They’re taking a massive club to inflation.

How much does the US impact Canadian interest rates?

There’s the old adage: When the US catches a cold, Canada gets pneumonia. The average American feels an interest rate hike way less than the average Canadian because of their 30 year mortgage terms. They can raise their rate more aggressively than we can.

Because Canada is so real estate dependent and we have less economic diversification, we feel the impact of the interest rates more strongly than Americans.

The US Fed did hold rates this time but hinted at raising them in July. Most people think they’ve dropped the ball and also left rates too low for too long. They think Jerome Powell is overshooting as well.

What does the bond market impact? What does the overnight rate impact?

The overnight rate drives the bank prime rate. The spread over the overnight rate is 2.2%. So if the Bank of Canada has raised rates to 4.75%, that means the prime rate is 6.95%.

You then have the spread over or under prime. In residential real estate, there’s often a discount under prime and in commercial it’s usually above prime. The average spread in commercial real estate is 1% over prime, but there’s a huge range there.

Fixed rates are measured over the Government of Canada bond yield. If you’re looking at a two year mortgage term, you’re looking at the spread over the two year bond yield. In Canada, we’re usually looking at the five year bond yield.

We have seen lender spreads go up. In March 2023, we were looking at a spread over 2% with our lowest cost lenders and now we’re looking closer to 2.35%. We have higher bond yields and a higher spread. It’s compounding pressure on borrowers.

Where do rates go over the next year? When do interest rates come down?

It’s hard to say for sure but I can share my opinion. We’re watching GDP and core inflation more so than the CPI. We’re also looking at employment. Those have all been stubbornly high, though GDP is showing some signs of cracking. We don’t want to see a recession, but we do want to see some economic weakness so the central banks can stop raising rates.

The first thing that should happen is bond yields come down very quickly. The bond market almost always predicts where the Bank of Canada is going in the long term. That’s what I would watch for.

Some of the US pundits are expecting the first rate cut in the middle of 2024. But keep in mind that everyone has been so wrong in their predictions. Some economists were calling for 2% as the max but we’re not heading towards 5%. It’s tough to say!

My gut keeps coming back to how wrong the central banks got it leading us out of the pandemic. They shouldn’t have cut as much as they did. They overshot on the down side so will probably overshoot by as much on the up side to get control of this. I think that will last for a while, into the next economic cycle.

What happens if interest rates don’t come off? Is there a doomsday ahead for mortgage renewals?

It depends who you talk to; some people are already living that today. The Bank of Canada is predicting that some people will be renewing their mortgages at a 40% increase this year. We’ve also heard that the banks are increasing the spread on lines of credit.

If you can weather the storm, you won’t feel the doomsday effect of interest raises. But some people are there already. The bank isn’t stupid. They know they can’t raise rates indefinitely.

The longest period of plateau before a cut is usually 6-18 months. I have to think we’re not far off from the top. But take that with a grain of salt!

Have deals been affected by higher interest rates? Are any asset types stronger than others in a high interest rate environment?

There is still strength out in the market. It’s very property and asset class dependent.

In the multi-family class, you can go with CMHC and still see rates in the mid 4s with longer amortization and terms. That can help make the numbers work. With the incoming immigration wave, it’s arguable that rent prices will go through the roof. So lenders still want to lend on multi-family and there’s still good product out there.

In industrial, anytime you have record low vacancy rates, you have strength. People need this product. Price growth and stability is being led by owner-users, not investors. They need the property to operate their business.

So it’s the same old story of “beds and sheds” being very strong in multi-family and industrial real estate.

Open-air retail with redevelopment potential and strong holding income in the meantime is attractive. Everyone wants to lend on those deals because they understand them. You can debt service the mortgage and have a huge lift down the road when you develop it or flip it to the final developer.

So yes, there’s still lots of liquidity out there amongst the big lenders. There’s money out there for the right asset and the right borrower.

The 6 Pack: Getting to Know Impact Commercial Managing Partner Jon Switzer

What is a quote you live by?

“Perfection is the enemy of greatness.” I really do try to live by that. I’ve struggled with perfectionism in the past.

What is one book you recommend our listeners read?

With interest rates going up at a record pace, I’m revisiting The Art of War by Sun Tzu.

Post pandemic, what are you wearing to the office?

Right now I’m wearing a golf shirt. I can’t remember the last time I wore a tie and suits were infrequent even before the pandemic. We’re business casual here at Impact Commercial.

With unlimited funds, what’s your dream car?

I’m a big car guy so that’s a head spinner! The Aston Martin Valkyrie is a nutty car. I highly doubt you can buy one but in the private market it would probably be $4-5 million.

What is something you’ve purchased recently for under $1500 that has had a positive impact on your life?

I’m working on an older BMW and recently bought some parts for that. I always get pleasure out of working on that. It’s a 2008 wagon – the wagon is a nice in-between for me being a car guy and a family guy.

Favourite sports team?

I have to go with the Canucks as painful as it’s been. We’ll stick with them and hope for the best!