Loan to Cost
The loan-to-cost ratio, or LTC, represents the amount of debt in relation to a project’s total cost.
What Is a Loan-to-Cost Ratio?
The loan-to-cost ratio, known more commonly as LTC, is a metric used often in commercial real estate financing to determine the ratio of debt in relation to the total cost of a project. Unlike loan to value (LTV), which is typically used for acquisition and refinancing transactions, LTC is most frequently utilized for transactions concerning ground-up construction or the acquisition of properties that require substantial rehabilitation or conversion. The C in LTC refers to the total project cost — generally referring to the total cost required not only to purchase and develop or redevelop an asset, but also to bring it to stabilization. For instance, in the case of an investor developing a multifamily apartment complex, the total cost would include the the cost to acquire the land, the cost to develop the community, as well as the cost to bring it to stabilization.
To better illustrate how LTC works, imagine that the investor from the example above must pay $3 million for the land, $6 million to develop the property, and $1 million to get the asset fully leased up and stabilized —making a grand total of $10 million dollars. If that investor qualified for a 75% LTC construction loan, the loan sum would be $7.5 million, or 75% of the total cost.
Commercial mortgage lenders utilize LTC as a factor to determine the potential risk in a deal. The rule of thumb is the lower the loan to cost, the lower the risk for the lender. Conversely, a higher LTC equates to higher risk.
Calculating Loan-to-Cost Ratio
Understanding the loan-to-cost ratio can be quite helpful for investors to be able to determine what financing their project may be eligible for. Additionally, understanding the LTC limits of a loan product helps investors determine the amount of equity they will be required to provide towards the project. In order to find the LTC of a transaction, there a couple of metrics investors must know:
The total cost of the project, which should include —when applicable — land acquisition, construction costs, stabilization costs, and/or rehabilitation costs
The amount of financing
With those figures handy, the LTC can be determined using a simple formula.
The LTC Formula
LTC = Loan Amount ÷ Total Cost
Loan to Cost Ratio Calculator
Related Questions
What is Loan to Cost (LTC) in commercial real estate financing?
Loan to Cost (LTC) is a ratio used in commercial mortgage financing and multifamily financing to determine the ratio of debt relative to the cost of acquiring the property. Commercial mortgage lenders use the LTC ratio as a factor to determine risk in a deal: the lower the leverage, the lower the risk while higher leverage offers higher risk. LTC can be calculated by dividing the loan amount by the cost of the loan. For example, if a borrower is buying a property for $1 million, and the property is worth $2 million, and the loan requested is $800,000, then the LTC ratio is 80%.
The loan-to-cost ratio, or LTC, is used in commercial real estate to calculate the percentage that a construction or rehabilitation project's loan amount represents relative to the total project cost. Some examples of costs include purchase price, materials, labor, and insurance costs. Other costs, depending on the scope of the project could include soft costs (like architectural plans and impact fees) or even finance costs like interest and fees.
What are the benefits of Loan to Cost financing?
The main benefit of Loan to Cost (LTC) financing is that it allows for a high loan-to-value ratio, which reduces the risk for the lender. According to Apartment Loans, LTC can be calculated by dividing the loan amount by the cost of the loan. For example, if a borrower is buying a property for $1 million, and the property is worth $2 million, and the loan requested is $800,000, then the LTC ratio is 80%.
According to Commercial Real Estate Loans, HUD loans across the board are well known for allowing some of the highest loan-to-value ratios in the multifamily industry. This is especially true for HUD 221(d)(4) financing, which typically allows for a loan-to-cost ratio of up to 85%. If the property is a subsidized housing development, a HUD 221(d)(4) loan can have a maximum loan-to-cost ratio of up to 90%.
What are the risks associated with Loan to Cost financing?
The risks associated with Loan to Cost financing include the possibility that the projected net operating income could decrease substantially, leaving the owner liable to make principal and interest payments or even, at some point, pay back the entire loan prematurely. Additionally, the higher the leverage, the higher the risk. It is important to study the income taxes, risks, amount of money to be borrowed, and the various financing alternatives available before making a decision.
What are the typical Loan to Cost ratios for commercial real estate financing?
The most common terms you will find for multifamily construction financing are structured the following way: a maximum loan to cost ratio of 75%, a maximum loan to value ratio of 70%, and a minimum debt service coverage ratio of 1.25x based on the lender's underwriting.
The Loan to Cost (LTC) ratio is calculated by dividing the amount of the loan used to fund the project by the total project cost. For example, if the commercial property construction total cost is $4 million and the lender is willing to lend $3 million, the LTC ratio is 75%.
What are the different types of Loan to Cost financing?
Loan to Cost (LTC) financing is a type of loan that covers the cost of a construction or renovation project. It is typically offered by banks, credit unions, and other financial institutions. The loan amount is based on the total cost of the project, including materials, labor, and other associated costs. The loan amount is typically expressed as a percentage of the total cost, such as 80% LTC.
Fannie Mae and Freddie Mac loans are available for significant renovation work, and HUD’s 221(d)(4) financing offers some of the most competitive ground-up construction financing in the industry. Private debt funds are also a source of LTC financing, and can provide financing for lease-up financing for multifamily properties, or a loan to rehabilitate an office asset.
How does Loan to Cost financing affect the return on investment for a commercial real estate project?
Loan to Cost financing can increase the return on investment for a commercial real estate project by reducing the amount of cash that must be invested in the beginning of a project. This can increase equity multiples, IRRs, and cash on cash returns. The extent to which it will do this depends on factors including interest rates, loan fees, and other expenses. If the levered equity multiple also includes reversion (for example, the sale of the investment), the duration of the holding period is also important, as amortizing loans begin by contributing a greater amount of the payment to interest, slowly increasing the principal contribution over the life of the loan.
For more information, please see Cash On Cash Returns: Calculator, Risks Involved and Equity Multiple in Commercial Real Estate.