A quick summary
For real estate investors, finding the best deal is of paramount importance. Similarly, for lenders, the better the deal, the more likely they are to fund it. Enter the Loan-To-Cost (LTC) ratio, which is one of the most useful numbers for lenders and investors to determine the amount of risk associated with a project. Here’s how to calculate Loan-To-Cost ratio and use it in your next real estate project.
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Loan-To-Cost Calculator
To make life easier for you and save you some time, here’s a useful LTC calculator to help you work out what the LTC ratio of your project is, so that you can determine how much you’ll be responsible for and how risky the project is.
Real estate investing is all about finding good deals and making sure that your projects are successful and profitable. Making this all happen involves working out various numbers and ratios to determine whether a deal is worthwhile, and to get your ducks in row for financing. One such ratio is the Loan-To-Cost or LTC ratio.
The Loan-To-Cost ratio is an important number in the world of real estate investing because it’s a crucial part of measuring how risky a project is. It’s particularly useful for construction projects like ground-up developments or value-adding redevelopments. Let’s break down exactly what the LTC ratio is and how to calculate it.
What does LTC mean in real estate?
In real estate, LTC measures the debt used to fund a project and/or property purchase compared to the total cost of the project and/or property. This will give investors a good idea of how risky a project is. So, the higher the LTC, the more debt is being used to finance the project and the riskier the project is.
The value of the property has no impact on the LTC, and once the project is complete, it will take on a new value. The LTC ratio is not to be confused with the Loan-To-Value (LTV) ratio. What’s the difference between the Loan-To-Cost vs the Loan-To-Value ratio? The LTV ratio relates to the amount of debt being used compared to the assessed market value of a property.
The LTC is usually one of the numbers that lenders use to decide if they’re going to provide financing for a project, and they will typically only finance a portion of these projects (usually up to 80%). Real estate investors will be responsible for finding the funds for the rest of the project. Along with the LTC ratio, lenders will take into account the property’s location, the after-repair value of the property, and so on.
The LTC ratio is important for 3 types of investors:
- Fix and flip: These borrowers are doing repairs and renovations to properties that they purchase and then sell for more, and therefore need finance and the LTC for the entire project including the property purchase.
- New construction: These borrowers are doing ground-up construction projects and will therefore need to know the LTC of the build itself.
- Rehab to rent: These borrowers are purchasing a property to renovate and then rent out, so they will need a loan for all of this, and therefore the LTC ratio for the entire project will be necessary.
What is the Loan-To-Cost ratio formula?
The LTC ratio shows the percentage of a project that is being funded by the lender. The higher the number, the riskier it is for a lender, so this should be kept as low as possible. To work out the Loan-To-Cost ratio, investors can add up the total cost of the project and divide the loan amount by this number.
Loan-To-Cost ratio example
Let’s say a developer buys an apartment building with the idea of upgrading it to its full potential. The developer has estimated that it will cost a total of $1 million to do a major renovation to the apartment building. If the investor is applying for a ground-up construction hard money loan of $800,000, the LTC ratio is 80%. This means that the developer will need to finance the rest of the project, which amounts to $200,000.
Lenders often have a maximum LTC ratio that they will accept, and if this is the case, borrowers can work out what the maximum is that they can borrow, and what they’ll need to contribute at minimum to the project.
For example, if a lender sets a maximum LTC value of 75%, and the borrower’s project is going to cost $200,000, the maximum amount that the borrower will get from the lender is $150,000.
What costs are included in Loan-To-Cost?
The LTC ratio requires borrowers to work out the total cost of the project, which includes a variety of costs. Some of the total project costs included in the LTC are:
- The purchase of the property
- Any construction, demolition and renovation costs – the materials and labor associated with each of these are included
- Design and engineering costs involved with construction or renovations that require the likes of architectural services
- Permits needed for the project
- Insurance for the property and other purposes
- Interest
- Fees
Depending on the project there may be more costs than this, or less, however this is a good idea of the type of costs that you should include in the calculation to work out your LTC ratio as accurately as possible.
What is a good LTC in real estate?
There are no hard and fast rules around this, but it’s usually a good idea to aim for an LTC of 80% or lower. The main reason it that many lenders won’t lend more than 80% of the total, towards a project. The further below 80% the LTC goes, the more cushion a borrower has if something were to go wrong with the project, and the more likely they are to get loan approval for it.
Closing thoughts
The LTC ratio is a good indicator for lenders on how viable a deal is and whether they should provide funding for it, however it can be just as valuable for a borrower who may discover that their project is riskier than they initially realized. Either way, the LTC ratio is an important factor to consider when applying for funding for a real estate project, and it’s also useful to make sure that borrowers have their ducks in a row, because they’ll need to know all their costs, to work out the LTC ratio.
Lastly, this article also goes into more detail about the difference between loan to cost vs loan to value. It is important to understand the difference between LTC and LTV if you are an aspiring real estate investor.
