Real estate lenders use a variety of criteria to evaluate a potential transaction. One key area they must consider is the level of risk involved in a loan. Issuing a loan for a higher percentage of a project or purchase price also means taking on a higher level of risk. This is why lenders will often specify their maximum LTC or LTV for a loan. Learn more about these metrics and how they’re used in real estate financing.
Loan-to-cost (LTC) is the ratio of a loan amount to the total cost of the project. A project cost may consist of an acquisition cost, construction cost, or both. In other words, LTC outlines how much of a project will be funded by a loan versus how much will be funded through equity.
LTC is represented as a percentage. For example, if the LTC is 75% on a $1 million project, that means the lender is providing a $750,000 loan to cover the majority of the project. The sponsor must cover the remaining 25% of the project on their own.
Loan-to-value (LTV) is the ratio of a loan amount to the property value. This value could be the total appraised value of an existing property or the expected market value after a project is complete.
As with LTC, loan-to-value ratio is represented as a percentage. For example, if the loan terms specify an LTV up to 80%, this means, on a property valued at $4 million, the lender would be willing to loan as much as $3.2 million.
Because LTV can differ depending on how the property value is determined, you’ll often see one of the following qualifiers added to LTV:
LTC and LTV are both used in commercial real estate lending to determine the level of risk the lender is willing to take on. In both cases, the higher the percentage, the higher the level of risk. Therefore, lenders will specify their maximum LTC and LTV percentages for different loan products.
While LTC and LTV function in similar ways, as we’ve seen, they are not exactly the same. The main difference between the two formulas is how they are used. For some projects, LTC may be a more relevant measure whereas, in other projects, LTV may be more pertinent.
Generally, LTC is more important when a borrower needs to fund a renovation or a lease-up, while LTV is more important for real estate that does not need any future funding. In many cases, lenders use both LTC and LTV along with other measures as they underwrite a loan to assess risk and determine the interest rate offered.
LTC and LTV are both important metrics to understand as you navigate the world of commercial real estate finance along with single-family rental portfolio lending. Verus Commercial Real Estate Finance (VCREF) offers a variety of loan programs to help you finance your rental properties.
Investors with a single-family rental (SFR) portfolio should take a moment to learn about the SFR portfolio loan products VCREF offers and the many terms, in addition to LTC and LTV, that often enter the SFR financing conversation.