Canadian Commercial Mortgage Rates: Trends, Insights, and Projections
During recent times, commercial mortgage rates in Canada have had quite a fluctuation based on many macroeconomic factors, such as policies set by central banks, bond yields, and the general status of the economy as a whole.
As of the second half of 2024, a number of indicators point out the direction and give insight into what to expect for investors, businesses, and owners of commercial real estate in the coming years.
In this article, we shall discuss current mortgage rate trends, projected Canadian mortgage rates for the next five years, and any potential risk that will be associated with the modification in interest rates.
Discussion will focus on mortgage term interest rate risk and how to hedge it and fixed and variable rate mortgage options.
Projected Mortgage Rates in 5 Years Canada: What to Expect
The question on every investor’s mind is: What are the future directions for commercial mortgage rates over the coming five-year period?
Starting with its monetary policies, the Bank of Canada exerts a profound impact on the forces that shape the Canadian mortgage market.
Going back to the old days, that is, the central bank set the overnight rate, determining how much it costs to borrow.
Mortgage rates-those of fixed-rate and variable-rate varieties-are therefore influenced by these costs of borrowing.
Recent data indicates that commercial will flatten out, but at a much more moderate pace compared to the pre-pandemic levels.
We expect the BoC prime lending rate to remain high, considering the prevailing inflationary pressures.
On the other hand, forecasts are for the rates to decrease gradually over the next five years partly due to an economic slowdown and lower inflation.
They also add that the neutral rate range is when monetary policy neither gives a fillip nor puts a drag on the economy, and interest rates on mortgages may start drifting toward that.
Putting an increasing focus on taming inflation, the central bank the previous month it might cut the key interest rate in the next couple of years, provided the inflation rate heads south and the economic growth becomes more measured.
15 different factors of mortgage
1. Property Type
Different property types (office buildings, industrial spaces, retail centers, multi-family units, etc.) come with varying levels of risk. Lenders may charge higher interest rates for properties perceived as riskier investments, such as hotels or restaurants, compared to stable, income-producing assets like multi-family apartments.
2. Loan-to-Value (LTV) Ratio
The LTV ratio is the ratio of the loan amount to the appraised value of the property.
A lower LTV (e.g., 60-70%) usually results in lower interest rates because the lender’s risk is reduced. Conversely, higher LTV ratios (e.g., 80% or more) may lead to higher rates as the lender assumes more risk.
3. Debt Service Coverage Ratio (DSCR)
The DSCR is a measure of a property’s ability to generate enough income to cover its debt obligations.
Properties with higher DSCR (indicating strong cash flow) are seen as lower risk, which may lead to more favorable rates. Lenders typically prefer a DSCR of 1.2 or higher.
4. Creditworthiness of the Borrower
A borrower’s credit score and financial history play a significant role in determining rates. Strong financials, including a high credit score, low debt, and reliable income, can lead to lower rates.
Borrowers with poor credit or a history of defaults or bankruptcies are likely to face higher rates or even rejection of the loan.
5. Term Length
Shorter loan terms (5, 10 years) typically come with lower interest rates compared to longer-term loans (20, 30 years).
However, shorter loans also mean higher monthly payments, so there’s a trade-off between loan term and monthly costs.
6. Market Interest Rate
General market interest rates, such as those set by the Bank of Canada, play a direct role in influencing commercial mortgage rates. When the Fed raises rates, commercial rates generally increase as well.
Lenders may adjust rates based on broader economic trends, inflation rates, and the overall health of the credit markets.
7. Fixed vs. Variable Rates
Fixed-rate mortgages offer a constant interest rate over the life of the loan, while variable-rate mortgages fluctuate based on market conditions.
Variable rates tend to start lower than fixed rates, but they can increase over time, leading to higher payments if interest rates rise.
8. Loan Size
Larger loan amounts typically have lower interest rates due to economies of scale and lower relative administrative costs for the lender.
Smaller loans may come with higher rates because they are seen as less profitable for lenders.
9. Location of the Property
The geographic location of the property can affect interest rates. Properties in economically stable or growing areas (like major cities) tend to have lower rates compared to properties in less desirable or economically distressed areas.
Lenders may view properties in volatile markets as higher risk and adjust the rates accordingly.
10. Occupancy Rate & Income
For income-generating properties (such as rental or multi-family units), occupancy rates and rent income are critical factors.
A higher occupancy rate and stable rental income reduce the lender’s risk and can lead to lower rates.
Newer properties or those in good condition typically come with lower interest rates compared to older properties that may require significant maintenance or renovations.
Lenders may factor in the risk of depreciation and the cost of repairs or upgrades when setting rates.
How commercial mortgage rate is determined?
The commercial mortgage rates are established by means of a comprehensive evaluation that integrates the borrower’s financial characteristics with the overall market circumstances.
The borrower’s creditworthiness—which includes their credit score, credit history, and the financial stability of their company—is one of the main factors taken into account.
Higher risk profiles may result in higher rates to make up for the additional risk to lenders, but strong financial histories typically translate into more favorable rates.
The property itself is another important consideration.
The kind of property—whether it is an industrial facility, office building, retail store, or warehouse—affects the rate because different kinds of properties need different amounts of upkeep or carry different risks.
The property’s location affects the rate as well because properties in affluent, high-demand areas are typically viewed as less risky.
Another significant factor that affects rates is the loan-to-value (LTV) ratio.
This ratio evaluates the loan amount in relation to the property’s assessed value. Because it lessens the lender’s exposure to risk, a lower LTV ratio—which shows that the borrower is making a larger down payment—usually results in lower rates.
Another major factor influencing commercial mortgage rates is the state of the market.
Rates can fluctuate due to a number of factors, including inflation trends, central bank-set interest rates, and general economic conditions.
Interest rates on commercial mortgages typically drop in an expansionary economy. On the other hand, mortgage rates usually rise during times of economic instability or when the hike interest rates to fight inflation.
A factor in determining the rate is also the loan’s terms. A shorter-term or adjustable-rate mortgage, for example, might have a different rate structure than a longer-term or fixed-rate loan.
In addition, lenders take into account the overall stability of the business applying for the loan as well as the anticipated cash flow from the property, particularly in the case of commercial real estate that generates income.
The final commercial mortgage rate that is offered to the borrower is decided by adding up all of these considerations
Interest Rate Risk and How It Can Be Reduced
Many commercial mortgage holders consequently seek ways through which they could minimize interest rate risk because of the uncertainty of interest rates.
Rate mortgages are those that are most vulnerable because of the fact that even slight increases in interest rates can have considerable impacts on the level of monthly payments and the overall amount of debt.
Any business can reduce this risk in a number of ways: Firstly, it can attain stability by locking in fixed mortgage rates for a longer time, especially in erratic markets.
Secondly, you can avoid a sudden spike in interest costs by spreading the maturities over different terms and diversifying your debt obligations.
Lastly, financial protection against unexpected rate increases can be obtained through the use of interest rate hedging products like interest rate swaps or caps.
Fairly, mortgage debt costs have surged considerably due to the continuous tightening cycle of the BoC, and borrowers should be cautious.
High rates call for debt to be kept reasonably small to avoid financial trouble later on.
The Role of the Bank of Canada and Prime Rates in Setting the Mortgage Landscape
The Bank of Canada has been one of the major determinants for rates in Canada.
In this way, the Bank of Canada, through changes in the overnight rate or simply called policy interest rate, determines directly the prime rate set by the various financial institutions of Canada.
Every time the BoC goes up with its target rate, the cost of borrowing by consumers and companies rises accordingly, which makes it more expensive.
The BoC has been in a policy tightening and rate hike mode for most of 2023 and the early part of 2024 as it grapples with a sky-high inflation rate to stabilize economic growth.
This, in turn, has pushed up Canadian prime rates and, consequently, commercial mortgages.
However, it is possible that if inflation keeps falling, or economic growth is considerably slower, the BoC may change course and begin cutting rates-a scenario which would lower the prime and give some relief to borrowers.
Over the next couple of years, another important reference will be the BoC’s neutral rate range, which is estimated to be between 2% and 3%.
Once the BoC is fairly confident that inflation has been tamed in its efforts to keep overheating or constraining too much, rates are likely to be kept within this neutral range.
Population Growth, Housing Market Trends, and Slowing Economy
This partly led to a strong housing market, contributing to growth in the population, and its prices went upwards, as did mortgage debt levels.
Increased immigration and urbanization trends have resulted in stronger demand for real estate financing, hence pushing rates higher.
Commercial Real Estate
Aside from that, the commercial real estate may suffer an economic slump. The owners of the commercial property may experience financial burden because of the swelling debt and interest rate.
This means businesses owning high levels of debt will encounter some hitches in paying their loans back, presuming that the interest rates would stay high for a sustained period.
However, with enough evidence that the economy is likely to slow down, most financial institutions are already preparing for the upturn of the rate cycle.
With inflation softening and growth moderating, accommodative monetary policy-which would lighten the interest rate burden on businesses-may be considered by the BoC.
The Global Influence: U.S. Federal Reserve and Financial Markets
Whereas the Bank of Canada bears the major responsibility domestically for monetary policy, global influences such as decisions made by the US Federal Reserve also ripple across borders.
The interest rates and bond yields in the US immediately have an influence on financial markets in Canada because of the integration between the economies of these two countries.
But with continued increases in the Federal Reserve’s rate-hiking cycle, there is spillover into the Canadian market that’s driving up borrowing costs in Canada.
Conversely, when the Reserve indicates an end to its tightening and starts cutting rates, Canada’s institutions would likely follow suit, and mortgage interest rates could go down.
Conclusion
The outlook for commercial rates in Canada offers both caution and optimism.
While high interest rate cut the rates are bound to continue in the near future, the forecasts indicate that through the coming five years, the rates may decline further, provided the inflation keeps on showing falling signs, and the pace of growth becomes moderate.
For now, companies must carefully consider their mortgage options, weighing the security against the potential cost savings of mortgage rate.
While hedging interest rates and diversification of debt obligations will be important strategies to help the company get through this period, for the time being, the solution is not straightforward.
The Bank of Canada will remain at the heart of setting borrowing rates, while the global economy will add further complexity.
Businesses seeking to manage their commercial mortgage requirements effectively will have to keep their finger on the pulse of both financial market trends and central bank policies.
Frequently Asked Questions (FAQs)
1. What are the projected mortgage rates in Canada for the next five years?
Over the next five years, rates in Canada are expected to stabilize but remain relatively high compared to pre-pandemic levels. The Bank of Canada may implement gradual rate cuts as inflation eases and economic growth moderates, potentially leading to lower mortgage rates by the mid-2020s.
2. How do fixed-rate mortgages compare to variable-rate mortgages?
Fixed-rate offer stability, with consistent interest rates over the term of the loan, protecting borrowers from market fluctuations. They are tied to the prime rate and fluctuate based on changes in interest rates, which can either increase or decrease over time, offering potential savings if rates fall.
3. What is interest rate risk, and how can I reduce it?
Interest rate risk refers to the uncertainty of future interest rate changes, which can increase borrowing costs, especially for variable-rate mortgages. To reduce this risk, borrowers can opt for fixed-rate, spread debt across different terms, or use financial instruments like interest rate swaps to hedge against rising rates.
4. How does the Bank of Canada influence commercial mortgage rates?
The Bank of Canada sets the policy interest rate, which influences the prime rate set by financial institutions. Changes in the BoC’s target rate directly impact both fixed and variable mortgage rates, with rate hikes leading to higher borrowing costs and rate cuts potentially lowering them.
5. How do global financial markets affect mortgage rates in Canada?
Global factors, particularly the actions of the U.S. Reserve, impact Canada’s bond market and financial institutions. As the Reserve raises or lowers interest rates, it influences Canadian borrowing costs, affecting both fixed and variable mortgage rates in the Canadian market.
