How to Calculate Loan to Cost Ratio (LTC)
From the perspective of lenders underwriting a loan, the loan to cost (LTC) measures the riskiness of a requested loan by comparing the total loan amount to the total cost of the project.
Total Loan → The total size of the loan provided by the lender to financing the real estate project.
Total Project Cost → The cost component depends on the context of the project. For instance, the cost in a development project is likely to be the construction costs, or the purchase price in acquisition projects.
The loan to cost (LTC) is often used in conjunction with the loan to value ratio (LTV) and the debt service coverage (DSCR) ratio to determine the risk profile of a potential borrower.
The real estate lender’s decision on the loan request, the sizing of the loan, and the financing terms, such as interest rate pricing, are predicated on the borrower’s credit risk.
Each ratio is a measure of risk to gauge the likelihood of the borrower defaulting on the loan.
But unique to the loan to cost ratio (LTC), the metric is perceived as more conservative, which appeals to real estate lenders that prioritize capital preservation over yield.
The LTC ratio is a tool for lenders to gauge the risk posed by a requested loan to fund a project, whereas real estate investors use the ratio to determine their required equity contribution to complete the project.
Loan to Cost Ratio Formula (LTC)
The loan to cost ratio (LTC) formula divides the total loan amount by the total development cost of the real estate project.
Since the LTC ratio is expressed as a percentage, the resulting figure must then be multiplied by 100.
The “Total Development Cost” includes the following cost categories:
Hard Costs → Construction Materials and Labor Costs, Site Work Activities, Utilities Set-Up (HVAC), Landscaping, Parking Lot and Paving Costs
Soft Costs → Architectural Design, Engineering Planning, Inspection and Permit Fees, Professional Services (Legal, Accounting Fees), Maintenance and Insurance Costs
Property Acquisition Costs → Land Acquisition, Property Purchase Price
Operating Expenses → General and Administrative (G&A), Security Fees, Property Management Fees, Payroll, Marketing, Advertising
In comparison, the loan to value ratio (LTV) divides the total loan amount by the property’s fair value. The property value is based on an appraisal of its current fair market value (FMV).
