Loan Ratios in Multifamily and Commercial Real Estate

Loan To Cost Ratio and Loan To Value In Commercial Real Estate Finance

When a lender is determining the amount it is willing to lend on an apartment building or other piece of commercial real estate, there are many factors that come into play such as property type, property class, location, sponsorship, DSCR (debt service coverage ratio), and more. However, one of the primary components used by commercial real estate underwriters to determine a loan amount is leverage. Leverage is summed up, and determined based on the LTC and the LTV.

LTC: Loan To Cost Ratio

LTC stands for loan-to-cost ratio. It is a ratio used in commercial mortgage finance and multifamily financing to determine the ratio of debt relative to the total cost of the project in question. LTC is most frequently used for value-add acquisitions such as substantial rehabilitation projects or ground up construction. The "C" refers to total project cost in that it is the total cost required to, in the case of an acquisition, purchase the property, then bring it to stabilization. So, in the case that you are building a 100 unit apartment complex, and you are looking to determine your cost, the total cost would be the cost to acquire the land + the cost to build your community + the cost to bring it to stabilization. So if your cost to buy the land is $3MM, and your cost to build the property is $6.5MM, and your cost to get it fully leased up and stabilized is $500k, your total cost would be $10MM. If you were looking for a 75% construction loan, your loan would be $7.5MM (75% of the total cost). It is important to remember that the value of the property has nothing to do with the LTC; the value of the property is a subject matter for LTV. Commercial mortgage lenders use LTC as a factor to determine risk in a deal, the lower the leverage, the lower the risk. Conversely, higher leverage offers higher risk. If you are buying a distressed property for $1MM, but its actual value is $2MM, and you are looking for a loan to purchase the property, lenders will traditionally look at the LTC (the cost, being 1MM) and not the LTV, or to be more specific, the lender will be looking at the lesser of the two. 

The formula for LTC (the loan to cost ratio) is:
LTC = Loan Amount / Total Cost 

LTV: Loan To Value Ratio

LTV stands for loan-to-value ratio. This ratio is used in commercial mortgage finance and multifamily property financing to determine the ratio of a particular debt (perhaps a first mortgage) relative to the value of the collateral (in this case a multifamily or other commercial property). If a borrower owns a property worth $10 million, and is looking to refinance a first mortgage for $7 million, the LTV is 70%. Lenders use this figure to determine their level of risk and borrower leverage in a transaction. The lower the LTV, the lower the risk. This formula is used in the case of standard purchases and refinances. In the cases of multifamily property rehabilitation, or ground-up construction, other factors like LTC become important factors. When LTV is used in a rehab, construction, or other value-add financing opportunity, it is used as a leverage constraint for the finished, or stabilized value of the property. So perhaps your cost to build a property is $10MM, and when it's complete and stabilized it's worth $20MM (good job by the way), and the lender has constrained you to the lesser of 75% LTC or 70% LTV, your loan would be the lesser of $7.5MM (75% LTC) and $14MM (70% LTV). Sorry, you've got no shot at a $14MM loan in this scenario because that would be 140% of total cost! There's not many lenders out there that are going to cut you a check for 100% of the project cost and another $4MM on top of that and hope that you take it from there! Leverage constraints keep borrowers committed to their deals and keep banks from having to get into the construction and real estate management business. 

The formula is for LTV (the loan to value ratio) is:
LTV = Loan Amount / Total Value

Mitigating Risk

After a loan is fully underwritten, the lender will traditionally offer financing constrained by the lesser of a pre-determined LTC, LTV, and normally, DSCR as well (lenders also frequently add debt yield as a requirement as well). The most common terms you will find for multifamily construction financing is structured like this:

$XXX MM (or maximum proceeds), subject to (a) maximum loan to cost ratio of 75%, a maximum loan to value ratio of 70%, and (c) a minimum debt service coverage ratio of 1.25x based on lender's underwriting.

So, don't get too excited if your loan amount based on your LTC or your LTV looks above and beyond what you expected, because you are going to get the lesser of the two, and quite often the lesser of three or four ratios. Lenders are experts in risk mitigation, and that means they know how to manage leverage and loan amounts.