Rising interest rates aren’t just being felt in the wallets of Canadian consumers and mortgage holders -- today’s steeper cost of borrowing has significantly hiked costs for the residential development industry, with deep implications for the creation of affordable housing units.

Jacky Chan, CEO of BakerWest, says higher rates have effectively doubled the financing requirements for developers looking to get shovels into the ground on new projects, and could even potentially overturn existing approvals for projects underway. The Bank of Canada, which entered a monetary policy hiking cycle in March to combat soaring inflation, has since increased its trend-setting Overnight Lending Rate three times, bringing it from a record-low 0.25% to 1.5%. At least three more hikes are anticipated before the year is through, to bring the rate close to the 3%. 

READ: Today’s Mortgage Costs Have Hit 1980s Levels: BMO

That spells challenging days ahead for new housing creation, says Chan, for both new and existing projects. According to him, commercial real estate lenders are now in belt-tightening mode following two years of aggressive lending approvals. He says in some cases they’re holding off on accepting, or even reviewing, new deals. As well, projects that have only recently achieved their pre-sale requirements may also face challenges getting construction loans, as they now enter underwriting in a tougher rate environment.

“How [this] is going to affect all the developers is the changing of the performance of all the development projects across the board in terms of the pro forma, which will then require all the developments [to be] re-looked at and re-examined. Potentially the most dangerous point would -- for some of these anticipated mortgages from certain lenders -- to be re-looked at and [result in] the requirement of re-application,” he tells STOREYS.

“The condition of the lender has changed, the costs have changed, and the interest costs have pretty much doubled, so the qualification or the debt servicing of the actual project for the developer is entirely different. That will greatly impact the possibility [of having the project continue to be built] for the same developer, with the same development, who has already achieved the amount of sales to achieve these construction loans, and if they cannot, that poses a huge problem,” Chan says.

This will become a “real gatekeeping measure” for developers once the requirements of the Real Estate Marketing Act (REMA) are factored in; in British Columbia, all pre-construction projects must achieve their pre-sale requirements within a 12-month time period. Should they miss this deadline, they must then stop all sales and marketing activities until they can prove to the Superintendent of Real Estate that further construction financing is approved and in place in order to move forward.

“Should this [interest rates] continue the way they are, it won’t just impact the strata market condos, but it will also impact the affordable rental projects, which [are] greatly needed by the cities, and across the nation. That’s the real challenge that we’re dealing with,” Chan says.

Affordable Units On the Chopping Block

Affordable housing projects, such as those that are brought to fruition in partnership with federal government programs, are especially vulnerable to the implications of rising interest rates. For instance, the Rental Construction Financing Initiative (RCFI) -- a program that provides below-market financing for the riskiest phases of rental construction for 10 years, amortized over 50 -- has seen its interest rates nearly double since the Bank of Canada first started its hiking cycle.

In a recent article in the Globe and Mail, Shawn Bouchard, Vice President of Quadra Homes, said, “It will stifle supply in those [rental] marketplaces because people will cancel their projects, en masse. I’m not talking a small amount, but a very large amount of projects will be put on hold or completely cancelled.”

Following Quadra’s success last August using the RCFI to finance Harbour Ridge -- a five-storey, 120-affordable-housing-unit project in West Kelowna -- Bouchard hit a roadblock trying to do the same on an upcoming Langley initiative, as rates have spiraled much higher than his initial pro-forma’s 2%. (Current RCFI rates, which are based on a 30 - 50-basis-point spread from the Government 10-year bond, are approaching the 3.5 - 4% range.) The new project would have brought 410 affordable units online across four buildings -- but that’s since been cut in half.

Bouchard told the Globe that the situation could have been avoided if the government capped borrowing rates for affordable housing projects, and committed to the 2% he had initially been offered mere months ago.

“The RCFI is such a great program and one that developers are super excited about. And tenants and renters and those without real estate ownership are also very excited about it…  it’s very beneficial to both industry and the end users,” says Chan. However, going from a simple 2% to a 4%, or even 2.5% to 4%, that’s a very significant change that would throw everything off,” adding that “100%” of all projects will be greatly impacted “one way or another.”

“At the end of the day, it would probably just require more cash up front and a bigger monetary stress for the developer and the development projects themselves, which creates a situation where these projects are not feasible anymore because the developers do not have double the money to pay for the same type of projects. You can’t value-engineer projects so much it will be able to offset this huge change.”

He concurs that, given the federal government’s aggressive mandate to create more affordable housing, it warrants re-assessing how today’s tougher interest rates development is impacting that plan, and to put measures in place to project the feasibility of projects.

“I think there definitely could be a special program or rate lock for the RCFI. The bank rates are going up, and they have to combat inflation and what’s been happening in the market and the economy, but if it’s impacting the RCFI program to a point where even if 25 to 50% of the projects that are in the works [have a greater than] 50% probability [of] be canceling or not be feasible anymore, then it would obviously make sense to segregate this sector of projects and lenders and specific lending,” he says.

“It’s very easy, actually, to change the rate offer specifically for this program. Instead of plus 50 basis points, they could do minus 50 basis points -- that would solve a lot of problems, right away.”

Affordable Housing