Vancouver Commercial Real Estate Podcast

Who is Jon Switzer?

I’m a partner and commercial mortgage broker at Impact Commercial; I’m not technically a founder but I’ve been around since the early days. I have a wide breadth of experience in a lot of markets which is good in times like these. Like many people, I seem to have come into real estate by accident but I’m loving every minute of it.

What is happening with interest rates right now?

We send out a regular newsletter to anyone who wants it. In our latest addition, we talked about the divergence between variable rates and fixed rates. But no one else seems to be talking about this!

The bond market is what determines fixed interest rates. The Bank of Canada is driving variable interest rates. That is a very misunderstood aspect of what’s going on right now.

Back in October, the Government of Canada bond yield was just under 4% and the Bank of Canada overnight rate was at 3.75%. Since then, the Bank of Canada overnight rate has gone up to 4.25% and the bond yield is just under 3%. The bond yield going down a whole percent is really important.

The bond market is usually way ahead of the game in predicting the moves of the Bank of Canada. We’re seeing that the bond yield has made up its mind about where the market is heading. We believe that will lead to a lower cost of capital in the spring for fixed rates, discounts in the real estate market (which we’re already seeing), added stability and market balance.

“If I had to make a prediction, I wouldn’t be surprised to see the tide on interest rates turn in the spring. There will be cheaper money out there to take advantage of the good deals.”

Should we follow the bond market for information about fixed rates?

Investors and owners should be more focused on what the Government of Canada bond yield is up to. Anyone at the mercy of variable rates, like land and construction financing, will need to pay attention to the Bank of Canada overnight rate.

There is continued pain in the variable lending space. If this is the top, that variable rate pain might be there for another year. But we do expect to see significantly lower fixed interest rates in the next 12 months.

What does a lower bond yield mean for borrowers and mortgages?

There is a lot that factors into the mortgage rates available in the market today. The rates we’re being quoted haven’t changed since October; we’re still in the 6.5% range for commercial lending. But as the bond yield falls, lender spreads are widening. Lenders are not passing on that discount to end-users but that is a temporary thing.

As time goes on and the Bank of Canada stops raising rates, competition will increase and that will translate to a decrease in the lender spread. If lender spread comes down from 350 basis points to 250 basis points, without anything else happening in the market, fixed rates will be 1% below what they are today.

In times of uncertainty, lenders will tack on a risk premium for the average buyer. If you’re a tier one builder, you might still get an enticing interest rate. But the average person would be subject to a heightened lender spread – aka a risk premium.

But when we get more certainty in the market and lenders want to start lending again, we’ll see those spreads come down. Lenders will have to get more competitive.

Why is the bond market so good at predicting the Bank of Canada’s policy change?

The bond market largely flies under the radar; it’s considered the boring publicly traded market. The stock market is where the sexy money is. But the bond market is actually twice the size of the stock market and is guided by the smartest money out there.

They’re so good at it because they know that when the Bank of Canada makes a large move, it’s going to have massive effects down the line. It will take time, but the effects will trickle down through the economy. On the other hand, the bond market can trade minute by minute, so they can price in these fall-outs immediately.

If someone is taking out a mortgage now, should they assume they’ll pay high interest for a year but get a better rate a year from now?

It would depend on how and when your asset gets repositioned. If you get some really strong leases in, maybe six months from now we could put you into a one year fixed rate mortgage. Anything we’re putting people into now is a maximum of two years.

We have an inverted yield curve right now. What that means is that a major bank just gave me quotes for 1-5 year terms, one year at 6.85% and 5 years at 5.95%. Everything is flipped on its head right now. I don’t want to lock my clients into a five year rate but I also don’t want them to suffer under 6.85% for a year. So we landed on 2 years at 6.3%. That’s kind of the sweet spot right now.

What does an inverted yield curve mean for the larger economy?

We’re all hearing about an upcoming recession. And historically, a recession almost always follows an inverted yield curve. That makes sense because the central bank has artificially jacked up the short end of the yield curve very quickly. The market doesn’t believe that’s here to stay. So when capital costs go up that quickly, a recession usually follows.

“It’s like the Bank is taking a taser to the economy. They probably should’ve acted sooner and done this more gradually. But now they’re playing catch up and have had to take this drastic action. Everyone is feeling it.”

Is Canada’s economy headed towards a hockey stick recovery?

The recession we’re likely going into would be a manufactured or policy-induced recession, not one driven by a sudden catastrophe. The central banks usually know we’re heading into a recession and know they’ll need to cut overnight interest rates. With depressed asset prices and cheaper capital, that could turn the ship around very quickly.

The effects of a recession and recovery will also depend where you live in Canada. BC may avoid the recession altogether thanks to immigration and the fact that we’re a central hub for the global supply chain.

I do agree that this is an artificial recession but I would be careful about calling it a hockey stick recovery. I don’t think we’ll go back to the good old days but I do think we’ll see steady growth coming out of this. As a long term investor, that’s what you want.

Is now a good time to buy commercial real estate?

I do think now is a good time to buy, though don’t get anything under contract between now and the end of the year. There’s a lag in real estate, especially in commercial real estate. If you enter into a contract on January 15th, you probably won’t be closing until March or even later.

But I am bullish on the spring 2023 commercial market. So yes, now is the right time to try and find a deal.

“If you wait another six months to find a deal, the market will have gotten ahead of you. I believe the right time is now.”

Cory Wright: I agree with Jon. Look at Kelowna for example: Cap rates got down to 4% after they were at 5.5% a few months earlier. If I can get into that market now at a discount, I’ll gladly pay more in interest if I believe the market will come back. Some people are turned off right away by the higher interest rates. But if I can get a lower sale cost, I’ll pay the higher interest because of upside in the market or upside on the property.

During the height of covid, we saw a very small spread in cap rates between Vancouver and Chilliwack. But that was when money was almost free with a lot of external factors driving the real estate market. I don’t think we’ll be going back to that. But if you believe in your market and the cap rates, now is the time to buy.

“The rich get richer in down markets. Some people have to sell now because they’re being forced to. So now is an outstanding time to buy if you believe in the market you’re going into.”

Where are the exciting real estate markets with good cap rates in BC?

Cory Wright: I’m a big believer in the secondary and tertiary markets of BC. Covid put a bigger emphasis on these markets thanks to remote work models. For example, Nanaimo is a place to watch. The fast ferry coming in 2023 will make Nanaimo a very attractive place for people who want affordability and access to Vancouver.

Not a lot of lenders are excited to go into these smaller markets, but there are some good deals to find. 24 months from now, you’ll be the smartest person in the room if you buy now.

Industrial lease rates in Nanaimo are $13-16 per square foot versus $18-22 in the Lower Mainland. In fact, the highest industrial lease rate in BC is on Vancouver Island. So there’s no massive discount anymore between Vancouver and these smaller markets. If I can get a better cap rate in a market with higher population growth, I’ll take that deal all day long.

You have to know the markets you’re going into. If you look at markets with a higher cap rate and a good runway on lease rates, that’s the way to go. If you look at Nanaimo, Kelowna, Kamloops, and Victoria, you are going to see a once-in-a-generation bump in rates. We saw the same thing in Yaletown when people signed $30/square foot lease rates and renewed at $80.

We had clients buy something at $12/square foot in Nanaimo and renew tenants at $19-20/square foot. That’s a massive bump that they probably won’t see again. If you can find it, that’s where the value is. Although the numbers don’t seem as impactful in the smaller markets, there are opportunities. But you need to buy them at current income, not based on what tenants might pay in the future.

“If you find something with a market cap rate and below-market lease rates, that’s an opportunity.”

Jon Switzer: If lenders are willing to lend in these secondary and tertiary markets, absolutely go for it. But with elevated real estate values and elevated interest rates, you need more money down.

Most places around the Lower Mainland need 60% down, which is actually less risk and more money for the lenders. The money is there, but lenders are pickier in smaller communities. They only want the best borrowers. The majority of lenders are looking to lend, it just has to be the right fit.

“If we’re correct and rates come down next year, lenders will be more competitive. It won’t take long until the money is flowing because there is still a lot of money in the system.”

What is your favourite holiday drink?

That’s an easy one! Rum and eggnog.

What is the best holiday party you’ve been to in 2022?

I haven’t been to that many so it would have to be last night’s William Wright Commercial party!

Gingerbread cookies or sugar cookies?

I’ll go sugar all the way.

What is your favourite holiday vacation spot?

Honestly, I love being around here at Christmas. Being in the sun at Christmas isn’t very festive. I know a lot of people love Christmas in Mexico but I prefer to be here. I’ll go out of town in the fall.

Favourite holiday song, album or artist?

All I Want for Christmas by Mariah Carey is up there but I’ll have to go with the soundtrack for National Lampoon’s Christmas Vacation. It’s incredibly nostalgic.

Favourite holiday meal?

Let’s stick to the classics: turkey, mashed potatoes and stuffing. Plus lots of gravy!