Debt Markets

Debt availability is generally expected to improve in 2025, however, lenders will remain selective and nuanced between asset classes, locations and borrowers. Credit spread dynamics will begin to normalize and loan underwriting will echo broader market trends with respect to rents and vacancy rates.

Trends to Watch

1. Overall debt availability is expected to be greater in 2025, but lenders will continue to be selective with nuanced approaches between asset classes, locations and borrowers.  
2. Credit spreads for top real estate assets are likely to remain at tightened levels while some modest compression is expected at the wider end.
3. Lenders are incorporating more conservative market trends with higher minimum hurdles into their underwriting, specifically with respect to vacancy and rents, that will impact loan economics accordingly.

Greater debt availability expected in 2025, but lenders will remain selective

For most of 2024, lenders were very selective in their dealmaking which led to many groups ending up well behind on their capital allocation budgets for the year. Lenders focused on financing for assets considered defensive, such as multifamily, industrial and grocery-anchored retail, which continued to see strong levels of competition among lenders. Meanwhile, assets facing headwinds or uncertain outlooks were more difficult and costly to finance.

In order to meet  2025 capital deployment allocations, lenders have already begun adjusting, exploring a wider range of assets and markets. Financing activity is beginning to increase and improve, including in such asset classes as enclosed retail and office. While this trend is expected to take hold in 2025 resulting in greater overall debt liquidity, lenders will still remain selective with specific and conservative underwriting approaches as well as cautious, but certainly increasing, appetite for quality risk-adjusted returns.

With real estate investment volumes also expected to rise next year, this will be another catalyst for increased debt activity and competition in 2025. Real estate debt markets traditionally follow the equity side and so will accordingly see a reciprocal increase in activity as buyer capital re-emerges and transaction momentum starts to build in Canada.

Credit spread dynamics to begin normalizing next year

Due to the highly selective nature of lenders this year, the delta of real estate credit spreads between the tightest and widest ranges for mainstream term lenders had surged to its greatest point in recent years. However, amid increasing debt capital availability and lending competition, these dynamics have begun to change, with the wide end of the range expected to start contracting towards more historic norms in 2025.

Credit spreads for top assets steadily tightened throughout the year, amid strong lending competition and a constant compression in corporate bond spreads. In the year-to-date, the spread of Canadian investment grade corporate bond yields to the Government of Canada 10-year yield has steadily fallen to the 100 bps range and now matches levels last consistently seen in late-2018. Credit spreads for top real estate assets converged and, in some best-in-class cases, financing was achieved very near this effective “risk free” level. As a result, credit spreads for this tranche of real estate will likely remain at current levels into 2025, as further tightening is unlikely without a parallel movement in corporate spreads.

Meanwhile, for real estate loans that have encountered widened credit spreads, these are expected to begin modestly compressing in 2025 as lenders generally become more active and open, following a similar trend in real estate equity markets. However, there will remain some exceptions as lenders more clearly define the specific range of asset classes they are willing to compete in.

In terms of gross financing costs, real estate base rates for fixed mortgage loans are most closely tied to the Government of Canada bond or Canada Mortgage Bond yields instead of the policy interest rate. So despite 100 - 125 bps of cuts expected from the Bank of Canada over 2025, declines in bond yields are largely already priced in and are projected to fall more modestly.

Lenders incorporating more conservative market trends into their underwriting

With rising vacancy rates across most of the major asset classes, lenders have adapted and made some adjustments to their underwriting process. Most notably, lenders are now factoring larger vacancy provisions in line with current market rates.

As underwriting incorporates expectations for the market over the length of the term, this shift is reflective of lenders’ more conservative outlooks for the next few years. Until there is a more pronounced shift in market fundamentals, lenders are likely to continue applying these growing market vacancy rates and softening rents in their underwriting. This will generally lead to more cautious net operating income projections and property valuations that will impact loan economics such as the total loan amount available or debt service coverage covenants.