Loan to Cost Ratio (LTC)
A ratio used in commercial real estate construction to compare the amount of the loan used to finance a project to the cost to build the project. If the project costs $1 million to complete and the borrower borrows $700,000, the loan-to-cost (LTC) ratio would be 70%. The costs included in the $1 million cost figure would be land, construction materials, construction labor, professional fees, and permits.
Loan to cost is a primary measure of leverage used to describe the proportionate use of debt in the financing of a real estate investment or development. All else being equal, the higher the measure of leverage, the riskier the loan or investment is considered to be. Investors or lenders may also consider LTV (loan to value) or DSCR (debt service coverage ratio) closely alongside loan to cost.
Whether to Use LTC or LTV?
Loan to cost expresses debt versus the total cost of a project, whereas loan-to-value (LTV) measures debt against the appraised, fair-market value of a property. In either case, a higher value indicates greater risk, all else being equal, because the borrower has proportionally less equity in the investment. In short, loan to cost is a better measure when evaluating a construction-heavy project – ground-up development or value-add investments with a higher degree of necessary capital expenditure. LTV is a more apt metric to consider when evaluating a stabilized asset or core investing strategy.
For more on the use of debt and leverage in commercial real estate investing, please review this article from our Learning Series.
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