Commercial real estate financing involves several different kinds of loans. In order for real estate investors to be able to borrow the money they need to finance their project, both the investor and their project must be assessed for risks. The more risk identified with the borrower or the project, the stricter terms lenders will offer. That’s where LTC and LTV come into play. Below we define what the two terms mean, how they work, and what their roles are in CRE financing.
LTC—What is it and how does it work?
LTC stands for loan-to-cost. LTC is a ratio used in commercial real estate financing to determine how much of a development project will be financed by debt versus equity. LTC is defined as the value of the loan divided by the cost of the project.
Lenders use LTC as a high-level metric to set a basic standard of the risk they’re willing to accept for a construction loan for a new project. The higher the loan to cost, the more risk the lender is taking on if the development struggles. Loan to cost values are set by market rates, and tend to get higher during bull markets.
A commercial real estate loan is conventionally taken with an LTC percentage anywhere from 50% to 80%. For example, if the total cost of construction is $1,000,000, a lender may offer a loan amount of $800,000, which would correlate to an LTC of 80%.
LTV—What is it and how does it work?
LTV is an acronym standing for “Loan To Value. It is similar, but not the same, as LTC. LTV is the ratio of the value of a loan to the market value of the property, as opposed to the cost of construction for a project. In other words, LTV is the mortgage amount divided by the appraised value of the property. When LTVs are concerned, there is generally an appraiser involved.
It is obviously more difficult to predict the value for CRE that has yet to be built, which is where pro forma financial modeling comes in. The most common scenarios in CRE development involve originating a LTC loan during the construction period, which will be refinanced with a LTV loan once the construction is completed. Once there is a finished product (or at least a partially-constructed asset), it is much easier to determine the value of the asset, which makes a LTV loan more viable.
LTC, LTV, & CRE Financing
Both LTC and LTV are vital components when it comes to commercial real estate financing. They are tools to help lenders determine the risk level they’re willing to accept for a certain asset. This in turn determines the size of the loan a lender is willing to provide. Projects that are deemed to be higher risk will have lower LTC or LTV ratios, as determined by market rates.