In any commercial real estate construction project, the LTC (loan-to-cost) and LTV (loan-to-value) ratios are crucial considerations when considering applying for a construction loan.

You will find both of them described here, but if you'd prefer specific guidance, don't be afraid to contact an experienced commercial loan advisor.

Loan to Cost Ratio (LTC) Defined

A word used in commercial real estate construction is loan to cost ratio, or LTC. It explains the connection between the building loan's terms and the construction's actual price tag (“cost”). The loan to cost ratio is calculated by dividing the loan amount by the building cost.

Let's look at the loan to cost ratio in action to gain a clearer perspective. Consider a $5 million construction job. The lender offers a $4 million loan with the understanding that the developer will pay the remaining $1 million in order to start the project. The developer requires a loan to do this.

Thus, the LTC ratio would be as follows:

$4,000,000/$5,000,000 = 80%

For this project, the LTC ratio would be 80%. If you fiddle with it, you'll discover that a high loan-to-cost ratio indicates that the lender is accepting more risk, whereas a lower loan-to-cost ratio indicates that the borrower has more equity invested in the project.

Loan to Value (LTV) Defined

Another phrase used in commercial construction real estate is loan to value ratio, or LTV, which is similar to loan to cost. It contrasts the loan amount with the estimated post-construction value of the structure. Similar to the LTC ratio, the LTV ratio uses the actual loan amount for the loan element of the ratio. However, value is arbitrary, thus a property appraiser determines it.

So what factors does a business appraiser use when estimating the project's future value? They'll have a look at the prices of nearby properties that are similar to yours. They'll also take into account the revenue that will be created by the constructed building or facility; if it's an apartment complex, this would be the sum of rent collected from tenants. Let's examine LTV in action using the identical example from above:

Amount borrowed: $4,000,000

The property's anticipated future worth is $8,000,000.

In that case, the LTV ratio would be 50%. The riskier the project is for the lender, on average, the higher the LTV ratio. The lender is at less risk the lower the LTV ratio.

What Impact Do LTC and LTV Have on SBA Loans?

Your lender will use the LTC and LTV ratios to evaluate how much they're willing to loan you for your project if you're expecting to use an SBA 7(a) loan or SBA 504 loan or another commercial real estate mortgage to finance new development. 

Asking your bank to consult with another assessor for a second appraisal is a good idea if the commercial real estate appraiser predicts a significantly lower future value than you anticipated. Since these ratios will be the only ones used to determine how much “leverage” you can obtain in terms of funding for your project, it is crucial that they are as accurate as possible.

Remember, if you have any questions about SBA construction loans, LTV, or LTC, reach out to an experienced commercial loan advisor.