LTV Explained for Commercial and Multifamily Financing
LTV, or loan-to-value ratio, is one of the most important metrics in commercial real estate. It is used to compare the amount of a loan to the current estimated market value of a commercial or multifamily property. LTV can be thought of as the amount of leverage in a transaction. The higher the leverage, the higher the risk for both the lender and the borrower (but particularly the lender). Borrowers typically aim for higher LTVs, as it means that they will need to bring less cash to the table and can maximize potential profits on their investment.
The formula for LTV is:
LTV = Total Loan Amount / Estimated Property Value
For example, a $750,000 loan on a property worth $1 million would be a 75% LTV.
LTV Amounts for Commercial and Multifamily Property Loans
LTV is perhaps the most important measure of risk that lenders use when determining how much funding they will provide for a specific property. LTV limits vary greatly between lenders. For example, banks and CMBS lenders are generally willing to offer maximum LTVs of 70-75%, while Fannie Mae and Freddie Mac multifamily loans typically offer LTVs up to 80% for well-qualified borrowers. Life insurance and hard money lenders sometimes max out at 65% LTV due to their lower risk appetites.
HUD multifamily financing offers the highest LTV on the market today, generally offering up to 83-85% LTV for market-rate properties, 87% for affordable properties, and up to 90% for LIHTC (low-income housing tax credit properties).
For non-multifamily property types, LTV can vary by asset class. Office, retail, and senior living properties are often thought of as higher risk than traditional multifamily properties, so lenders will often limit LTVs to 70% or lower. For instance, HUD multifamily loans for some types of senior living properties, such as memory-care properties, max out at 65% LTV. For exotic property types, such as parking lots or marinas, LTVs also often max out at 65%.
Borrowers looking to boost the leverage on their property may also turn to mezzanine finance or supplemental loans. These are issued “on top” of a borrower’s primary loan, meaning that these secondary lenders will be second in line to get repaid should the lender foreclose on the property. In many cases, the primary lender will need to agree to the secondary mezzanine loan via an inter-creditor agreement, a document that demonstrates the hierarchy of repayment in the case of a borrower default.
LTV vs. LTPP vs. LTC
LTV is not the only measure of leverage that lenders use to calculate risk. LTPP, or loan to purchase price, is another metric. Due to market conditions or extenuating circumstances, a borrower may pay more or less for a property than its market value, which is calculated via the LTTP formula. Sometimes LTPP includes closing costs, but sometimes it does not.
The formula for LTPP is:
LTP = Total Loan Amount / Total Purchase Price
LTC is another metric, typically used for construction or development projects. LTC compares the total loan amount to the total cost of the project, including construction and development costs.
The formula for LTC is:
LTC = Total Loan Amount / Total Project Cost
LTV is Only One Measure of Lender Risk
LTV is only one measure of risk that lenders use when evaluating a deal. They will also use DSCR (debt service coverage ratio), which compares the monthly loan payment a borrower will pay to the monthly NOI (net operating income) a property generates. Lower DSCRs demonstrate higher risk, while higher DSCRs demonstrate lower risk. Most lenders require properties to have a DSCR of at least 1.25x.
Debt yield is another measure some lenders use to calculate risk. This measures the annual income of the property compared to the outstanding loan amount in order to determine, in the case of foreclosure and repossession, how many years it would take for the lender to recoup their initial investment. Most lenders want a debt yield of 8 or below, though some will accept higher debt yields.
In addition to these metrics, lenders will use other factors, such as property condition and location, occupancy rate, the borrower or sponsor net worth, the borrower/sponsor credit score, and the experience of the borrower or property manager in order to determine whether they will approve a loan, and at what LTV they will approve it for.