Loan-To-Value Ratio

By Robert Prouty and Darrell Roberts

Loan-to-Value (LTV) is a ratio to measure the amount of debt on a property in relation to its value. LTV, along with DSCR, is one of the loan constraints in any real estate transaction. It is calculated as:

LTV =   Debt Amount

     Value

LTV is often used when referring to the appraised value of a property. Market value can only be determined by an appraisal. Remember, just because you believe the property is worth more, lenders must lend based upon an unbiased, third party market appraisal.

Example 1: Suppose an investor refinanced their loan. The appraised value of the property was $6,000,000 and the owner received a loan for $4,500,000. The LTV would be:

$4,500,000   = 0.75% x 100 = 75%

$6,000,000

There are several other measures that can be found in real estate finance: loan-to-purchase price (LTPP) and loan-to-cost (LTC). Loan-to-purchase price is obviously the amount of debt in relation to the property’s purchase price.

LTPP = Debt Amount

Purchase Price

Loan-to-cost is another metric when acquiring the property. It the amount of debt in relation to the total costs necessary to close the acquisition. It can include a variety of items such as: purchase price, acquisition fees, lender fees, legal fees, third party reports, or deferred maintenance or immediate capital expenditures.

LTC =   Debt Amount

 Total Costs

Example 2: Assume a buyer has a property under contract for $7,500,000. The property has significant deferred maintenance and the budget is $300,000. The buyer also wants to upgrade the property amenities and interiors with another $750,000. Finally, the acquisition costs to acquire the property are $150,000 and the buyer has a loan commitment from a lender for $6,960,000. Then, the loan-to purchase price and loan-to-cost would be:

LTPP = $6,960,000 = .928% x 100 = 92.8%

             $7,500,000

The total costs of acquiring the property are:

Purchase Price:                $7,500,000

Deferred Maintenance:       $300,000

Upgrades:                         $750,000

Closing Costs:                  $150,000

Total Costs:                      $8,700,000

LTC = $6,960,000 = .80% x 100 = 80%

$8,700,000

In this example, the loan-to-purchase price is about 93%. However, since the buyer is improving the property, the lender is offering a loan that is 80% loan-to-cost. The loan to value will be calculated based upon the appraised value of the property. If the appraiser believes the buyer will improve the performance of the property thereby creating value, the appraisal may come in more than the total costs. If the appraised value is $9,000,000 then the LTV would be:

LTV = $6,960,000 = .773% x 100 = 77.3%

$9,000,000

In this example the buyer has created $300,000 of equity from the improvements based upon the appraised value of the property.

LTV requirements vary from lender to lender and from market to market. The higher the LTV less equity is needed to purchase a property. And the lower the LTV greater equity is needed to purchase a property. Some of items to consider:

Shortcoming #1: LTV is not the only loan constraint. Most loans have a maximum LTV and a minimum debt service coverage ratio (DSCR). Simply because a lender tells you they will loan up to 80% of the value (or whatever their parameter) of a property does not mean you will receive all of the loan proceeds.

Shortcoming #2: Do not get confused by LTV and LTPP and LTC. If you believe you are purchasing a property at a “discount” (such as a foreclosure) and the market value of the property is higher, the lender most likely will only lend an amount based upon the hard equity invested into the property. 

Shortcoming #3: Lenders vary LTV constraints to make loans less risky. While that may be debatable, the reason is that lenders believe if there is more equity in a transaction the safer their loan. Therefore, lenders may require more equity in an acquisition or restrict the amount of cash-out during a refinance.