Published by Forbes.com | October 9, 2024
When acquiring property, a key question buyers ask is, “How much financing can I get for this property?”
Finding the answer involves sizing up the deal, determining the type and amount of financing that can be achieved, and building out a capital stack. (You can learn more about the components of the capital stack in a previous article).
While the specifics will depend on the market, property type, and goals of the borrower, there are certain metrics that remain consistent in the process. In this article, we’ll define some of the terms that are used in this stage, including loan-to-value, loan-to-cost, debt service coverage ratio and debt yield, along with the impact that fluctuations in the market can have.
Loan-to-Value
Loan-to-value (LTV) refers to the loan amount to the appraised value of the property. Lenders use this ratio to assess the risk of a loan, as it determines how much of the property’s value is being financed. The higher the LTV, the more risk a lender is taking on. For example, if a lender agrees to an LTV of 70%, they will lend 70% of the property’s appraised value, while the borrower must come up with the remaining 30%.
In some cases, the property’s appraised value does not align with the borrower’s expectations or the purchase price. This disconnect is where a discussion of loan-to-value versus loan-to-cost becomes important.
Loan-to-Cost
Loan-to-cost (LTC) is simply the loan amount relative to the purchase price of the property. The higher the loan-to-cost is, the more risk a project carries for the institution providing the financing. It is usually expressed as a percentage.
Loan-to-Project Cost
This ratio looks at the amount of the loan and compares it to the total project cost of the deal, which would be the acquisition plus the financing that is needed to improve the property. This metric is especially useful in value-add or development projects where the purchase price or initial cost of acquiring the property is just one component of the overall project cost. In these cases, lenders consider the total project cost, including acquisition, construction, and any renovations, to determine how much financing they are willing to provide.
