LTC and LTV in Commercial Real Estate
Note: this learning series on Modern Commercial Real Estate Investing first appeared on the EquityMultiple blog. Please check in there for updates and additions to this series.
LTC, LTV, and Commercial Real Estate Loans
Even a quick glance at one of our offerings will reveal a number of acronyms, describing various aspects of a commercial real estate property and project. Let’s take a moment to break down a couple of key concepts in commercial real estate lending (and, by extension, in CRE debt investing).
LTC — Loan to Cost Ratio
Loan-to-cost (LTC) ratio is the dollar amount of a commercial real estate loan divided by the cost of the project, inclusive of acquisition cost (where applicable), construction expenditures, and various fees (e.g. attorney’s fees, appraisal, etc.). The LTC ratio is most often specific to construction loans, and allows commercial real estate lenders to determine the risk of offering a construction loan.
LTV — Loan to Value Ratio
Loan-to-value (LTV) is a close relative of LTC, but they are not interchangeable. LTV is simply the ratio of the loan amount to as-is fair-market value of the property. This value is a straightforward calculation in the case of an existing asset; while an appraiser may be involved, as-is fair-market value of an asset can be estimated by dividing Net Operating Income (NOI) by a selected cap rate. This is called the Direct Capitalization method. The situation is more difficult in the case of an asset that is yet to be built. By definition, such an appraisal would have to involve an estimate of future market conditions in order to value the asset post-completion, and appraisers take into account market data, sales and rent comparables of similar properties, and the pattern and duration of the property’s anticipated net income stream, discounting to present value.
How LTC and LTV Are Used in Commercial Real Estate Lending
Lenders combine loan-to-cost, loan-to-value, and debt service coverage ratio (DSCR) assess the risk of the borrower and the borrower’s project. The higher the LTV and LTC, the higher the proportion of the project cost that is being financed by the loan, and thus the riskier the loan. The higher the DSCR, the more comfortably the borrower can service the loan, and thus the less risky the loan. Lenders typically operate with a minimum threshold DSCR, and max LTV and LTC they are willing to lend at, and these ratios are typically instrumental in determining the interest rate offered.
When evaluating potential debt syndication offerings for our platform, the EQUITYMULTIPLE real estate team pays careful attention to these ratios. Considered alongside the net rate of return, LTC and LTV help us hone in on syndicated debt investment opportunities that offer attractive risk-adjusted return to our investors.
