In every commercial real estate development project, the LTC (loan-to-cost) and LTV (loan-to-value) ratios are critical. Both are described here, but if you need more information, please contact us at SBA7a.loans.
What Does a Loan-to-Cost Ratio Mean?
The loan-to-cost ratio is a construction phrase used in commercial real estate. It expresses the connection between a building loan (“loan”) and the actual construction cost (“cost”). The loan to cost ratio is calculated by dividing the loan amount by the building cost, yielding a percentage.
Let’s take a look at the loan to cost ratio in action to get a better understanding. Consider a building project with a budget of $500,000. To get this project off the ground, the developer needs a loan, so the lender provides a $400,000 loan with the assumption that the developer would cover the remaining $100,000.
As a result, the LTC ratio would be as follows:
$400,000 divided by $500,000 equals 80%.
This project’s LTC ratio would be 80 percent. If you experiment with it, you’ll see that a high loan to cost ratio indicates that the lender is taking on more risk, while a lower loan to cost ratio indicates that the borrower has more equity in the project.
What is the LTV (Loan-to-Value) Ratio?
Another phrase used in commercial real estate development is loan to value ratio, which is similar to loan to cost. It compares the loan amount (“loan”) to the projected post-construction worth of the building (“value”). We utilize the actual loan amount for the “loan” part of the LTV ratio, much like the LTC ratio, but value is subjective, which is why it’s evaluated by a property appraiser.
So, while evaluating the future worth of a building project, what does a commercial appraiser look for? They’ll assess the worth of comparable homes in the region. They’ll also take into account the revenue produced by the business property, which in the case of an apartment building would be the amount of rent paid by tenants. Let’s look at LTV in action using the same example as before:
Amount of loan: $400,000
The property’s estimated future worth is $800,000.
As a result, the LTV ratio would be 50%. As a general rule, the greater the LTV ratio, the bigger the risk the project poses to the lender. The lender’s risk decreases as the LTV ratio decreases.
What Is the Difference Between LTV and LTC When It Comes to SBA Loans?
If you want to finance new construction with an SBA 7(a) loan or another commercial real estate mortgage, your lender will utilize the LTV and LTC ratios to decide how much they’re willing to loan you. It’s not a terrible idea to ask your bank for a second opinion from another assessor if the commercial real estate appraiser predicts a significantly lower future value than you anticipated. After all, these ratios will be the primary drivers of how much “leverage” you can obtain in terms of project financing, therefore it’s critical that they’re as accurate as possible!