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What's an LTC and LTV Ratio?
Both the LTC (loan-to-cost) and LTV (loan-to-value) ratio are key factors in any commercial real estate construction project. Find both outlined below, but if you'd like direct advice, don't hesitate to reach out to us at SBA7a.loans .
Both the LTC (loan-to-cost) and LTV (loan-to-value) ratio are key factors in any commercial real estate construction project. Find both outlined below, but if you'd like direct advice, don't hesitate to reach out to us at SBA7a.loans.
What’s a Loan to Cost Ratio?
The loan to cost ratio is a commercial real estate construction term. It describes the relationship between the construction loan (“loan”) and the actual cost of construction (“cost”). It’s the loan amount divided by the construction cost, which yields a percentage -- the loan to cost ratio.
To get a clearer picture, let’s look at loan to cost ratio in action. Imagine a construction project that costs $500,000. The developer needs a loan to get this project started, so the lender offers a $400,000 loan with the expectation that the developer will shell out for the remaining $100,000.
So, the LTC ratio would look like this:
$400,000/500,000 = 80%
The LTC ratio for this project would be 80%. If you play around with it, you’ll see that a high loan to cost ratio would mean the lender is taking on more risk; whereas a lower loan to cost ratio means that the borrower would have more equity invested in the project.
What is the Loan to Value (LTV) Ratio?
Loan to value ratio, like loan to cost, is another term used in commercial real estate construction. It compares the amount of the loan (“loan”) to the estimated value of the building post-construction (“value”). Like the LTC ratio, for the LTV ratio we use the actual loan amount for the “loan” portion of the ratio, but value is subjective -- which is why it’s determined by a property appraiser.
So, what does a commercial appraiser look for when they’re determining the future value of a construction project? They’ll look at the value of similar properties in that particular area. They’ll also consider the income that’ll be generated from the commercial building -- if it’s an apartment building, this would be the amount of rent paid by tenants. Using our same example above, let’s look at LTV in action:
Loan amount: $400,000
Estimated future value of the property: $800,000
What is an LTC ratio in commercial real estate financing?
LTC stands for Loan to Cost Ratio and is a measure of the amount of the loan used to fund a project compared to the total project cost. The formula to calculate LTC is LTC = Loan Amount / Cost. For example, if the total cost of a commercial property construction project is $4 million and the lender is willing to lend $3 million, the LTC ratio is 75%.
What is an LTV ratio in commercial real estate financing?
The loan-to-value ratio (LTV) is a measure of the relationship between the loan amount and the value of the commercial real estate (collateral). It is used to measure, or determine risk when financing commercial property or making a commercial mortgage. A lower LTV results in more competitive commercial loan terms and rates, whereas a high LTV results in higher risk, and therefore less advantageous loan terms for the borrower.
For example, suppose that a building is worth $10 million and the existing loan is $6 million. That means the LTV is 60%. This would be a lower risk and more competitively priced loan than perhaps an $8 million loan (80% LTV) on the same property.
Leverage constraints vary by property (type and tenancy), underwriting factors (such as DSCR, debt yield, loan terms, market, etc), sponsorship and recourse.
How does an LTC ratio affect commercial real estate financing?
The Loan-to-Cost (LTC) ratio is an important factor in determining the qualification for a commercial real estate loan. A higher LTC results in higher risk for the lender than would a lower LTC. Since lending is risk-based, higher leverage loans call for more conservative pricing and terms. In contrast, commercial property loans with a lower LTC command more competitive structures (i.e. lower rates and more favorable loan terms).
Other factors lenders pay close attention to include but are not limited to: location, borrower financial strength, pro forma income and expenses, and asset class.
The formula to calculate LTC is as follows:
LTC = Loan Amount / Cost
For example, suppose that the commercial property construction total cost is $4 million. Moreover, assume that the lender is willing to lend $3 million. By dividing the amount of the loan by the cost of the project, the LTC ratio is 75%.
How does an LTV ratio affect commercial real estate financing?
The loan-to-value ratio (LTV) is a measure of the relationship between the loan amount and the value of the commercial real estate (collateral). A lower LTV results in more competitive commercial loan terms and rates, whereas a high LTV results in higher risk, and therefore less advantageous loan terms for the borrower. For example, if a building is worth $10 million and the existing loan is $6 million, that means the LTV is 60%. This would be a lower risk and more competitively priced loan than perhaps an $8 million loan (80% LTV) on the same property.
Leverage constraints vary by property (type and tenancy), underwriting factors (such as DSCR, debt yield, loan terms, market, etc), sponsorship and recourse.
What are the differences between an LTC and LTV ratio in commercial real estate financing?
The Loan to Cost (LTC) ratio is the ratio of the loan amount to the total cost of the project. It is used to determine the amount of leverage a borrower can get in terms of funding for a project. The Loan to Value (LTV) ratio is the ratio of the loan amount to the appraised value of the property. It is used to determine the risk of the loan for the lender.
For SBA 7(a) loans and other commercial real estate mortgages, the LTV and LTC ratios are used to determine how much the lender is willing to loan for the project. A higher LTC results in higher risk for the lender than would a lower LTC, so higher leverage loans call for more conservative pricing and terms. In contrast, commercial property loans with a lower LTC command more competitive structures (i.e. lower rates and more favorable loan terms).
The LTV ratio, then, would be 50%. As a rule of thumb, the higher the LTV ratio, the more of a risk the project is for the lender. The lower the LTV ratio, the lower the risk to the lender.
How Do LTV and LTC Apply to SBA Loans?
If you’re hoping to use an SBA 7(a) loan or other commercial real estate mortgage to finance new construction, your lender will use the LTV and LTC ratios to determine how much they’re willing to loan you for your project. If the commercial real estate appraiser estimates a much lower future value than you expected, it’s not a bad idea to ask your bank to get a second opinion from another appraiser. After all, these ratios will be the sole determinants of how much “leverage” you can get in terms of funding for your project -- so it’s important that they’re as close to correct as possible!