Loans come in all shapes and sizes, with terms and conditions that are unique to each property and are based on factors like the experience of the borrower, the investment strategy, and the profitability of property. When a lender is assessing the amount it is willing to lend on a piece of commercial real estate or an apartment building, there are several factors that are analyzed such as property type & class, location, debt service coverage ratio and more. Commercial real estate underwriters primarily use leverage when they are determining a loan amount.
Leverage is determined based on the loan to cost ratio (LTC) and loan to value ratio (LTV).
Continue reading to learn more about multifamily and commercial real estate loan ratios.
Loan to Cost Ratio (LTC): What is it and How Does it Work?
LTC is a ratio used in commercial real estate financing to determine how much of a development project will be financed by debt versus equity. Simply put, LTC is defined as the value of the loan divided by the cost of the project.
The formula for LTC (the loan to cost ratio) is:
LTC = Loan Amount / Total Cost
Essentially lenders use LTC as a high-level metric to set a basic standard of the risk they’re willing to accept for a construction or renovation loan. The higher the loan to cost ratio, the more risk the lender is taking on if the project struggles. Loan to cost values are dictated by the market, and typically tend to get higher during bull markets.
Keep in mind the value of the property is not related to the LTC; the value of the property matters for LTV. Commercial lenders use LTC as a factor to assess risk in a deal: the lower the leverage the lower the risk.
A commercial real estate loan is conventionally taken with an LTC percentage anywhere from 50% to 75%. For example, if the total cost of construction is $1,000,000, a lender may offer a loan amount of $750,000, which would correlate to an LTC of 75%.
Loan to Value Ratio (LTV): What is it and How Does it Work?
This ratio is similar, but not the same, as LTC. Basically, LTV is the ratio of the value of a loan to the market value of the property, as opposed to the cost of construction for a project. In other words, LTV is the mortgage amount divided by the appraised value of the property. When LTVs are concerned, there is usually an appraiser involved
The formula is for LTV (the loan to value ratio) is:
LTV = Loan Amount / Total Value
It is obviously more difficult to predict the value for commercial real estate (CRE) that has yet to be built. The most common scenarios in commercial real estate development involve originating a LTC loan during the construction period, which will be refinanced with a LTV loan once the construction is completed. Once there is a finished product (or at least a partially-constructed asset), it is much easier to determine the value of the asset, which makes a LTV loan more viable at that point.
RCN Capital | Multifamily and Commercial Real Estate Loans
RCN Capital offers short-term bridge financing, fix and flip financing, & long-term rental financing for 5+ unit apartments & mixed-use properties.
As a direct, private lender, RCN Capital takes a common-sense approach to underwriting, with all approvals made in-house. We are dedicated to providing quick responses to time-sensitive loans, often times with the ability to close in as few as 10 business days. At RCN Capital, we value referrals and our brokers are protected. We are committed to the highest level of customer service, because our success lies in building relationships.