I Love Student Housing in Canada, but the Game Has Changed and Only the Best Will Survive

I absolutely love student housing. I think it will be the best performing real estate class in Canada over the next decade.  

My goal here is to simply make you aware of some of the realities that are going on in the market and hopefully help you navigate some of the challenges that lie ahead in our industry.  

When I was first asked to speak at SHURE-Vancouver, the global macroeconomic factors in play at the time were the global economy in a post-covid environment, the war in Ukraine and the myriad of outcomes associated with it and inflation - something that's on everybody's mind.

This led to a four and a quarter percent increase in the Bank of Canada rates in the past 12 months. And as it relates to real estate, specifically, a rise of 2 to 2.5% in the all-in mortgage rates. In the past month, we've had the collapse of the 16th largest US bank. We've had the historic bailout of Credit Suisse, a 150-year-old institution. We now have a US Federal Reserve that is struggling to figure out how to prevent a catastrophic collapse of its financial system, while at the same time listening to leading economic indicators that are continuing to point towards a higher interest-rate path.

So why is this relevant to you?

First of all, we have lived in a prolonged period of low interest rates. So, whether you've owned residential real estate, commercial real estate, private investments, alternative investments, the odds are that your net worth has gone up significantly in the past decade - and that might be about to change.

The second reason is that as real estate owners and developers, we have benefited from low interest rates, a good selection of lenders, an abundance of equity capital, and excellent liquidity on the sell side.

What happens if interest rates don't come back down?

I know that when I talk to people everywhere, everybody's convinced interest rates are going back down, and my question is what happens if they don’t? And how do we continue to bring much needed supply?

How do we continue to bring much needed supply into the market in the face of lower returns driven by higher interest rates, increased construction costs, longer development timelines and potentially different sources of equity capital?

My point is to emphasize how badly we need supply on the apartment and the student housing side. So how do we take advantage of these incredible lucrative opportunities in the face of extreme market uncertainty, hidden risks and incredible volatility?

I have never seen anything like this in my 21 years: ThERE is incredible volatility, but let’s look on the bright side

We have great opportunities in front of us, but how do we take care of this and how do we navigate all these hidden risks?

We live in a great country (Canada). I'm an immigrant. I came here when I was 14. I am very grateful for the opportunities that my family and I have been given in Canada. When I look at Canada, I think it's a great place to live in, a great country in which to own real estate. We have a stable government. We have a strong economy and dynamic cities. We have access to healthcare. We have access to a sophisticated workforce. In addition, we're one of the most multicultural countries in the world, and as it relates to you student housing investors, we have incredible universities that are much sought-after by Canadians and international students. Canada is the third largest international destination that ranking is about to get better because of our favourable immigration policies and the anti-immigration policies in the U.S. brought on by the Trump administration.

The fundamentals of the industries are strong. The buildings are beautiful. They are well taken up. The demand is excellent. We recently financed two student-centric buildings: one in Halifax and one in Montreal. They were fully leased long before construction ended and they're already fully leased for next year. So, the demand is there. 

Canada has an excess demand equation that is clearly in favor of the purpose-centric student class

When you own and operate multiple buildings, you have excellent synergies that you create on the operational side.  It’s exciting to see the combination of public and private partnerships and how universities are starting to use developers and vice versa to create more supply. The one reason that I'm most excited about in this asset class is really the fact that it is the best real estate class to have an inflation hedge. Because of the 30 to 40 or even 50% annual turnover, this asset class is best positioned to deal with inflation.

Student housing wasn't always loved in Canada

This is important because we've come a long way. Originally, the buildings weren't very nice. In fact, they were  similar to rooming houses which would be difficult to convert to apartment buildings in case of default. There weren't self-contained units. Owners and managers had issues with tenants treating their apartments poorly, creating more turnover, adding wear and tear resulting in  more repairs and maintenance. 

As a lender, we were always concerned about the fact that you had interruptions in the cash flow. You had 6 to 8-month leases and not the full 12-month leases that we see today.  The gross rents also resulted in valuations that were not in line with traditional apartment buildings. 

Canada, let's not forget, has a very, very conservative lending system.  This is something we're grateful for right now when you look at what's going on in the U.S. and what their lack of regulation and oversight has led to. I'm grateful for this conservative system, but with that comes drawbacks. And the drawbacks were that traditionally we only liked multifamily, office, retail and industrial real estate.

Then, COVID hit, and nobody liked retail anymore, and now nobody likes office. In fact, there's zero liquidity for office. And, so now student housing is embraced and so are data centers, life sciences buildings and self-storage.   

Student housing in Canada has come a long, long way

When we look at how student housing has evolved to today, the buildings are beautiful. They have proper self-contained units. We have bedroom bathroom parity. The buildings have beautiful amenities, be it gyms, study rooms, theatre rooms or lounges. As a parent, you look at it and you say, my kid has indoor parking and 24-hour security. These buildings are incredible.  They are professionally managed and we no longer worry about the wear and tear to the units because the buildings are in so much demand that students would be silly to do something that gets them kicked out.  They know how difficult it is to get in there in the first place. They also know landlords have parental guarantees.  Equally important from a lender perspective are the 12 month duration we see in leases.  This guarantees the cash flow disruption issue is now mitigated.

We also have institutional investors that have discovered this asset class. Everybody knows about Blackstone buying American Campus Communities for $12.8 billion last year. That's a big purchase. We know about CPP and other pension funds investing heavily in UK and US Real Estate, we know about other pension funds that are starting to discover this asset class. Canada was traditionally segregated, so there weren't big portfolios available.

Today, you have the likes of Harrison Street, Woodbourne or Alignvest who have built beautiful, high-quality portfolios, and they are now much more attractive to these institutional investors if they were ever to sell.  

The Gloom: The challenges coming up in our industry

First of all, we have interest rates. Interest rates have moved up substantially. So, what does that mean? That means that debt coverages are much more difficult to achieve. Loan values are now lower. We have large existing portfolios where borrowers are rolling over mortgages that had much lower interest rates into now, much higher interest rates.

Cap rates are going to move up. If interest rates have moved up as much as they have, you cannot possibly keep cap rates at the same level where they have been.  We're now at the point where the cost of debt has moved up substantially, but cap rates have not. Unfortunately, as the lender, I have to say cap rates are going to move.

What's going on in the US is important as it relates to Canada. We started with, Silicon Valley Bank and First Republic, and there are a lot of other banks that have these issues. First of all, they had short term deposits that they invested long term at low interest rates.  These investments are now worth a lot less - that's problem number one. They have unrealized losses. Problem number two is the depositors have lost confidence in them, and so now they're pulling the deposits out, which means those banks have no money to land.  Problem number three is commercial real estate. There is roughly $1.5 trillion of commercial real estate debt that's rolling over in the next few years. In the United States, most of that is at the regional bank level. There are banks that can't really roll over loans. There will be defaults because much of the debt in the US is non-recourse, cash flows at the property level have dropped off significantly and in many cases borrowers cannot service the debt.  Furthermore, values are eroding to the point where debt exceeds the value.  When you see Brookfield defaulting on a $750 million loan a few months ago, and we see them defaulting on a $121 million loan two days ago on an office portfolio, you start thinking, well that's a big player. However, that's just the name you hear in the news because they're a big name.  What about all the small and mid size landlord that have the same issues? 

How does this impact Canada?

It impacts the liquidity because my job as a lender is to go out and source loans. And I come back to the office and have a huge credit department whose job it is to turn down these loans and to poke holes in my analysis and in my underwriting and find reasons why they shouldn't approve these loans.

When my credit guys hear about all this stuff that's going on in the US, they say that's why we shouldn't be doing non-recourse loans. That's why we shouldn't be doing interest-only loans. That's why we should keep the leverage at 50% or less. All of that to say that there is a lot less liquidity in the Canadian market and we've already seen it already, and in my mind it's just the beginning of what's going on in the US.  

The second component of an interest rate is the credit spread.  The credit spread is the risk premium that we take to do these loans, and it's driven by what's going on in the world economy, the banking sector and the war  in Ukraine. All of these factors play a part in determining that risk premium that makes up the credit spread.

I’ll give you a specific example. RioCan REIT, one of my excellent clients who has an excellent high-quality portfolio and an investment grade rating, just issued a corporate bond on March 1st. It was issued at a rate of Government Canada Bond yield plus 2%. 30 days later, that bond was trading at the corresponding Government Canada bond yield plus 2.5%. In the span of a month, the spread on the bond has widened by 50 basis points. This has to do with the overall risk embedded in the market.

As a lender, do we do corporate bonds or do we do mortgages?

You’re locking your money up because if I’m lending Harrison Street money on a five-year mortgage,  I don’t get that money back until the end of the term. But if I do a corporate bond, I can sell that bond, and recoup my liquidity.  Then, I would think that mortgages would have to be priced at higher than 2.5% over Canada bonds. Now, this is a snapshot in time, but my point here is that everything around the world including the US banking issues, the world economy, the war and all the geopolitical issues affect risk and impact the pricing of mortgage rates. 

This to say, I’m not sure that mortgage rates are necessarily coming back down, even if you’re of the opinion that inflation has peaked and bond yields will decrease because the elevated risk around the world will keep spreads high. 

Industry Challenge of Supply and New Development

Excess demand and a lack of supply lead to development. However, development carries a lot of risk. We have interest rate risk when you don't really know where interest rates will end up at the completion of the project. 

At the end of your 3, 4, 5-year development, you have valuation risk because interest rates drive cap rates, which drive values. And again, you don’t know where that valuation will be when your project is completed.

We're heading towards deglobalization and higher costs

Deglobalization means higher construction costs, higher everything. Everything will cost more. I’m not convinced construction costs are coming down, but the issue I have with the construction industry is that productivity is dropping every single year. We have older trades that are retiring. They’re being replaced by younger people that don’t work as hard and are not as experienced; they’re not as productive. Across the board, First National has a $3 billion construction financing pipeline - we talk to all the best builders across the country and all the developers. 

The same refrain from everybody is, every builder has A teams, and they have C teams and D teams. There's no bench depth any more.  And, if you don't get the A team on your site, that's just too bad for you, right? You're only as good as the team that's on your site.

Two more risks and then we move on to positive stuff, I promise

This is the most difficult time I've had in my 21 years. I take a lot of pride in providing my clients with a good roadmap as to how their financing will play out. They'll come to me predevelopment and they say I want to build this project, how do I do it? And we offer multiple options of how they will do it. 

At this point in time, I can tell you I am very concerned about what we can show them as a clear roadmap because things are changing all the time. CHMC has provided amazing liquidity on the construction side for apartments. They're changing their programs. They're very concerned about where they are in terms of the market and how much exposure they have.  On the conventional side, there is limited liquidity.

So, for the first time ever, I can say I don't have as good visibility as to what financing will look like.

Another concern is equity calls not anticipated at the onset.  If interest rates rise substantially during construction, developers will be required to contribute additional capital as the end loan could end up lower than the construction loan.  Most developers have multiple projects on the go which potentially multiplies the amount of additional equity needed.

A Positive: I’m Not Concerned about Leasing Risk

There's incredible demand out there for good product and we're seeing excellent leasing velocity and strong rent levels across the country.

Suggestions Going Forward

The student housing industry (much like the apartment industry) is in dire need of new supply however construction costs absolutely must come down.

I know that everybody in the construction industry thinks that the magic solution is to eliminate HST self-assessment. And get rid of development charges. The reality is that just cannot happen, but they can certainly be reduced dramatically. 

At the federal level, CMHC has done a great job over the years of coming up with new programs like the MLI Select. The MLI Select is changing. Liquidity will be changing. On the CMHC side, we need to have continuous programs that are coming up. CMHC needs to also embrace student housing more, which traditionally they haven't done as much. At the provincial level, we need higher densities. We need land subsidies. We need less bureaucracy. 

At the municipal levels, we need a faster approval process. I'm sure as a developer, you're looking around and saying there's no chance that I can be in pre-development for years. Right? If we can fast track that and get these projects approved in three months or six months, that will reduce financing and construction costs  and it will mitigates your future interest rate. 

Build energy efficient buildings

This will help you with your financing, it will enhance your long term returns and help you with all your investors who all have ESG initiatives and requirements. Put the extra time, extra money in, and build the most energy efficient buildings that you can.

Back to discipline: Real estate is now a different game

Stress test your underwriting.  Challenge all your revenue and expense assumptions.  Every expense item that I see in all the completed buildings that we have financed across the country seems to have overshot the proforma.

We know taxes are going up. In most cases, you can't even get insurance. Wages are higher, cleaning costs more, utilities only seem to go in one direction.  In most cases, every line item on the expense side is higher.   

Stress test your construction and term interest rates as well. Be disciplined in how much you pay for land or your acquisitions. We're back to real true real estate fundamentals. 

When I started 21 years ago, apartment cap rates were 7.5%. I worked on a $700 million portfolio acquisition in 2004 where my client paid a 7.25% cap rate. All the buildings were in Toronto and Montreal and people thought they lost their mind paying a 7.25% cap rate on apartments. Office and retail were 9%, and industrial was well over 10%.  And the reason for this is because interest rates were 5 to 5.50%.

Today, if you can get CMHC financing, which is just for apartments, your rate is 4%. The conventional interest rates right now in the market are somewhere around 5.25% to 5.50%, and as high as 6 to 6.25%  just a couple of months ago.  We're back to interest rates from 2001 or 2002, but our cap rates are still in that four to five percent range, whereas they were 7.50% to 11% back in the day.

We need to get back to real estate fundamentals, which means disciplined acquisitions, lower loan to values, equity in that 30 to 40% range and real cash returns on these sizeable investments. 


Understand who your partners are.  How strong are their balance sheets? Can you count on them to contribute further equity if needed? Is their guarantee strong enough to help you achieve an optimal financing solution? How will you navigate multi-phased developments? Do you have lenders that understand your business and your value-add proposition? Can they offer you flexibility and help you mitigate your risks? We are going back to a lending environment that is relationship based where only the best borrowers and developers will have access to debt and equity capital.  

STRONG PARTNERS: We are now in a position where only the best WILL survive

The bottom line is student-centric housing is an amazing industry that has incredible fundamentals. However, we really do need to focus on those risks that exist out there and make the best of it.

Get the best operators. Get the best managers. Get the best developers. Get the best builders. Get the best advisors. That's the best advice I can give you.

Andrew Drexler

Andrew Drexler is First National Financial's Assistant Vice President and Team Director in the commercial financing division, and delivered remarks at SHURE-Vancouver on April 20, 2023.

Often described as one of the most trusted individuals in a dynamic industry, Andrew’s clients seek him out not only for financing solutions but also for his depth of knowledge and experience. Andrew brings this experience to both term and construction financing across several asset classes including apartment, student housing, retail and industrial. In this capacity, Andrew has originated over $10 billion of loans over the course of his 21-year career.



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