What is Loan to Cost?
The loan to cost ratio (LTC) is a key metric that helps bankers and lenders determine the size of a requested loan. The loan amount is dependent on the risk level of the investment. For instance, if someone requests a loan for raw, open land, lenders may only offer 50% of the property’s value. In contrast, if someone applies for a loan for a retail center, the LTC may increase to 80%. The contrast arises due to the nature of risk between the two different investment. Raw land naturally carries a higher percentage of risk, while a retail center is more likely to generate income to pay off the loan amount.
How to Calculate Loan to Cost Ratio
The LTC also considers the type of property an investor is purchasing, whether it is a ground up development or an existing property.
To calculate the LTC of an existing property it would be the loan amount divided by the purchase price. For example, if the purchase price is $1,000,000 and the loan amount is $700,000, then the LTC would be 70%.
What does Loan to Cost Tell Lenders and Borrowers
Ultimately, the LTC tells a lender the amount of risk being involved. If the LTC is high, the more likely a lender is willing to lend. Typically, high LTCs are reserved for the safest property types and borrowers. When the LTC is low, this indicates that the property is risky, resulting in lenders to lend less. Typically, hotel, restaurants and new ground-up developments are classified as the riskiest types of investments.
What is Loan to Value Ratio
Loan to value ratio (LTV) is another common ratio lenders use to determine real estate loan amounts. An example is if the property value is $1,000,000 and the maximum loan value is 70%, the maximum loan amount is $700,000.
LTC vs. LTV in Commercial Real Estate Financing
One major difference between LTC and LTV is that cost and value aren’t always identical. The cost refers to the purchase price of a property. While a third-party appraisal determines the value. Lenders consider both the LTC and LTV when reviewing and considering loan requests, usually lending based on the investment with lower risk.
Why Should CRE Investors Know About the LTC Ratio?</h2
The LTC helps to determine how much financing is needed for a project. LTC varies between different lenders, reflecting their interest of specific loan types. LTC can also determine loan terms lenders may require. For instance, a lower LTC could suggest the increase in interest rates or closing costs may not be included in the total loan amounts.
