Calculating Loan to Cost Ratios for Commercial Real Estate Loans
Loan to cost (LTC) compares the financing amount of a commercial real estate project to its cost. LTC is calculated as the loan amount divided by the construction cost.
Some examples of costs include purchase price, materials, labor, and insurance costs.
Other costs, depending on the scope of the project could include soft costs, like architectural plans and impact fees or even finance costs like interest and fees.
The formula to calculate LTC is as follows:
LTC = Loan Amount / Cost
A higher LTC result in higher risk for the lender than would a lower LTC. Since lending is risk based, higher leverage loans call for more conservative pricing and terms.
Commercial property loans with a lower LTC command more competitive structure with lower rates and more favorable loan terms.
The loan to cost ratio is essential in determining the qualification for a loan, other factors lenders pay close attention to include location, borrower financial strength, pro forma income and expenses, and asset class.
Winston Rowe and Associates prepared this article. They are a national consulting firm specializing in the due diligence and preparation of commercial loan proposals to submit to their network of capital sources.
They also have a free book “Commercial Real Estate Finance” available on their website.