A.CRE

Loan to Cost

In real estate, Loan to Cost (LTC) is the ratio of the outstanding loan balance to total project cost. The higher the loan-to-cost, the less cash equity the borrower has invested in the property (i.e. less skin in the game) and therefore the higher the risk that the borrower will default on the loan. Real estate lenders most often use this metric in assessing the risk of lending on a real estate development project, but LTC is also considered on acquisition loans to compare the proposed loan amount to the acquisition price.

Loan to Cost (LTC) = Loan Amount ÷ Total Project Cost

Putting “Loan to Cost” in Context

Case Study: James River Apartments

Old Dominion Realty Partners, a real estate private equity firm, recently acquired James River Apartments, a 200-unit market-rate multifamily community in Richmond, Virginia. The property was purchased for $30 million, with the firm securing a 70% loan-to-value (LTV) mortgage from a regional bank. However, to better understand the financing structure, the Loan to Cost (LTC) ratio was also analyzed.

Loan to Cost in This Context

The total project cost, which includes the purchase price of $30 million along with an additional $1 million in closing costs, legal fees, and initial capital improvements, amounted to $31 million. The loan amount was $21 million. Using the Loan to Cost formula:

  • Loan to Cost (LTC) = Loan Amount ÷ Total Project Cost
  • LTC = $21,000,000 ÷ $31,000,000
  • LTC = 67.7%

Key Insights

  • The LTC of 67.7% indicates that the lender is financing approximately 68% of the total project cost, while Old Dominion Realty Partners is contributing the remaining 32.3% as equity.
  • Compared to the Loan to Value (LTV) ratio of 70%, the LTC ratio provides a more comprehensive view of the financing structure because it considers additional project costs beyond just the acquisition price.
  • A lower LTC ratio, compared to the maximum threshold typically set by lenders (e.g., 75% for similar core investments), suggests that the lender perceives this deal as relatively lower risk due to the sponsor’s significant equity contribution.

Implications for Investment Strategy

By maintaining an LTC ratio below 70%, Old Dominion Realty Partners aligns with conservative financing practices, minimizing risk and ensuring better access to capital for future projects. Furthermore, this approach provides the lender with confidence in the sponsor’s commitment to the project, which is especially critical for building strong lender relationships.

Conclusion

This hypothetical scenario demonstrates the importance of analyzing Loan to Cost (LTC) as part of a real estate acquisition or development project. While Loan to Value (LTV) focuses on the property’s market valuation, LTC provides a more detailed picture by incorporating all project costs, ensuring the financing structure supports both the lender’s risk tolerance and the sponsor’s investment strategy.

Frequently Asked Questions about Loan to Cost (LTC) in Real Estate

Loan to Cost (LTC) is the ratio of the loan amount to the total project cost, which includes purchase price, closing costs, legal fees, and capital improvements. It shows how much of the total investment is financed through debt.

LTC = Loan Amount ÷ Total Project Cost. In the case of James River Apartments, the LTC was calculated as $21,000,000 ÷ $31,000,000 = 67.7%.

LTV compares the loan amount to the property’s appraised value, while LTC compares the loan to the total project cost. LTC provides a more comprehensive view of the financing structure by including all costs associated with the transaction.

Lenders use LTC to assess how much equity a borrower has in a project. A lower LTC suggests lower risk, as it means the borrower has invested more capital and thus has more at stake in the project’s success.

A 67.7% LTC means that the lender is financing 67.7% of the total cost of the project, while the borrower contributes the remaining 32.3%. In the James River Apartments example, this reflects a conservative capital structure aligned with prudent investment practices.

A lower LTC improves lender confidence and can reduce borrowing costs. It also leaves room for potential refinancing or securing additional capital later. For Old Dominion Realty Partners, a 67.7% LTC supported their conservative financing goals.

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