What Is Loan-to-Cost Ratio (LTC)?

Real estate inestorsuse a ariety of metrics to measure the riskiness ofcommERCial real estate inestments. The loan-to-cost ratio, or LTC, is a common one used primari for real estate construction projects like ground-up deelopment or alue-add redeelopment. The loan-to-cost ratio measures the de used to finance a project compared to the total cost of construction. Thus, the higher the LTC ratio, the more leerage a deeloper has taken on to complete a project, which increases its risk profile.

What is an LTC ratio, and how is it used in CRE?

The loan-to-cost ratio measures the leerage of a commERCial real estate (CRE) project. It compares the amount of de used as a pERCentage of the total costs to complete a construction project, whETHer that be a ground-up deelopment or a alue-add redeelopment. The higher the rate, the more de a deeloper is using to finance construction, making the project riskier.

The LTC ratio is an important metric for inestors in commERCial real estate projects with a alue-add or ground-up construction component. For example, manyreal estate crowdfunding platformsoffer the opportunity to inest in real estate loans proided to deelopers as well as equity inestments in deelopment and redeelopment projects. One way inestors can gauge the risk profile of these opportunities is to calculate the LTC of the project. The closer that pERCentage is to 80%, the riskier it is since there’s less equity cushion proided by the deeloper.

How do you calculate LTC?

The LTC ratio calculates the pERCentage of a loan or the amount of funding a lender is willing to proide compared to the total construction cost of a real estate project. Inestors calculate it by diiding the loan amount by the total cost of the project, including the construction cost.

For example, a deeloper estimates that it will cost $1 million to complete a multifami project, which includes land acquisition, closing costs, permitting and other fees, and the construction cost. Ahard money lenderhas agreed to proide a $750,000 construction loan for this project, imping that the deeloper needs to inest $250,000 of equity. Thus, the LTC for this project would be 75%.

What’s the difference between LTC and LTV?

Another important metric used by commERCial real estate inestors isloan-to-alue, or LTV. This metric measures the amount of de compared to the appraised or fair market alue of a property. Like LTC, LTV helps commERCial real estate inestors gauge the riskiness of a project, with a higher pERCentage indicating greater risk.

CommERCial real estate inestors primari use LTV for measuring leerage on a stabilized property. For example, if lenders will proide $800,000 of senior de financing on a ful leased office building that’s on the market for $1 million, the property has an LTV of 80%.

Howeer, inestors can also use LTV to measure leerage where the deelopment or redeelopment inestment will increase the property’s alue aboe the initial cost. For example, a crowdfunding real estate platform offers the opportunity to inest in a alue-add multifami property. The initial purchase price is $1 million, and the sponsor expects to spend $250,000 on improements to renoate the units. A lender is willing to proide an $800,000 morage loan on the property.

Upon completion of the renoation projects, the borrower anticipates the renoation will allow for increased rents, which would boost the property’s net operating income(NOI). In the sponsor’s estimation, it could potential sell the property for $1.35 million. Here’s a look at the LTC and LTV ratios on this example:

With both pERCentages well below the 80% danger leel, this would be a less risky inestment.

Another way to measure risk

CommERCial real estate inestors need to do theirdue diligencebefore putting capital into a deal, especial a riskier one like a deelopment project. One of the ways to gauge the risk profile of an opportunity is to look at the pERCentage of de used to finance the project ia the LTC ratio. The further below 80%, the more cushion an inestor has should somETHing go wrong.

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