The Loan to Value (LTV) Ratio is one of the most crucial figures in commercial real estate.
LTV is used to evaluate the loan amount to the property’s current market worth. With this, LTV can be used as a measure of leverage.
In this article, you’ll learn what LTV is and how to calculate it:
What is the Loan to Value (LTV) Ratio?
The Loan to Value (LTV) Ratio compares the loan amount against the property’s market value. By evaluating at the loan amount and the property’s market value, LTV allows investors and lenders to measure how much leverage is used in a deal.
The LTV ratio is largely used as an indicator of lending risk. Low LTV loan assessments are typically seen as lower-risk loans, whereas high LTV loan assessments are typically seen as higher-risk loans.
How to Calculate the Loan to Value Ratio for Commercial Property
To calculate the Loan to Value (LTV), simply use the following loan to value formula:
LTV = Loan Amount / Appraised Property Value
The loan amount is simply the amount of money the investor(s) borrowed from the lender. That number is then divided by the appraised value of the property which will give you a number that is represented as a percentage to determine the LTV ratio.
Calculating Loan to Value Explained
As an example, if investors provide a down payment of $200,000 and purchase a property for its appraised value of $1,000,000, the investors will borrow $800,000 from the lender. To calculate the LTV in this deal, you need to divide $800,000 by $1,000,000 which gives you 0.8 or 80%.
$800,000 / $1,000,000 = 80% LTV
As another example, if investors provide a down payment of $400,000 and purchase a property for its appraised value of $1,350,000, the investors will borrow $950,000. To calculate the LTV in this deal, you need to divide $950,000 by $1,350,000 which gives you 0.7 or 70%.
$950,000 / $1,350,000 = 70% LTV
Why the LTV Ratio is Important
As mentioned above, the LTV ratio is used to measure leverage and risk.
Every deal is different, and different lenders may have different LTV requirements for the same property depending on how well they know the area, what they think about the property, how well they know the investors, and other factors.
Assuming a quality property is being presented with an experienced team of investors/operators, having a higher LTV ratio (85% and above) will make it the most challenging to convince lenders to provide a loan for the property. An LTV ratio of 70% to 80% will make it easier to convince lenders to provide a loan, and anything below 70% will make it much easier to get a loan.
Additionally, the lower the LTV, the better the financing terms may be because the investment is seen as less risky by the lender.
What Is a Good LTV?
As with many things in commercial real estate investing, the term “good” is subjective and dependent on the unique situation, property, and goals of the investor(s).
Generally speaking, a good LTV is 70% to 75%. At this ratio, investors are generally able to accomplish two things:
- The lender is likely to feel like the investors have enough “skin in the game” to make it a less-risky investment. Therefore, the lender is more likely to approve the loan and provide respectable financing terms.
- The investor is still able to implement substantial leverage to the deal without over- or under-leveraging themselves.
Summary
The Loan to Value ratio is one of the most common and heavily utilized real estate calculations. It helps investors and lenders alike quickly assess the amount of leverage and risk associated with any particular deal. Given its importance and frequency of use, every commercial real estate investor should understand how to calculate the LTV ratio and interpret it within the context of their deal.
