What Is a Loan-to-Cost Ratio?

The loan-to-cost ratio, or LTC, is a metric used in commercial real estate which represents the ratio of a construction or rehabilitation project's loan amount relative to the total project cost. While these costs vary with every project, some common examples of cost types include:

• land or property acquisition

• materials

• labor

• insurance

Depending on the scope of a project, expenses may also include soft costs such as architectural plans, impact fees, or even finance costs like interest and fees. Lenders consider the loan-to-cost ratio of a project in order to determine the level of risk and the borrower’s leverage in a commercial real estate transaction.

LTC Calculator

Calculating the Loan-to-Cost Ratio

LTC is calculated by dividing the amount of the project loan by the total project cost. The formula for calculating an LTC ratio is:

LTC = Loan Amount ÷ Total Project Cost

To illustrate, consider a commercial property rehabilitation project that has a total cost of $4 million and a lender willing to finance $3 million. Simply divide the amount of the loan by the cost of the project, and the LTC ratio comes to 75%

LTC = $3,000,000 ÷ 4,000,000 = 75%

Usage and Application of the Loan-to-Cost Ratio

An LTC ratio is a commonly used metric in commercial lending for value-add acquisitions such as ground-up construction or the acquisition of properties that require substantial rehabilitation. Lenders analyze the LTC ratio of a deal to understand the borrower’s debt in relation to the cost of a project. Unlike with the similar loan-to-value ratio metric, the value of a property has no effect on the LTC. Even so, similar to how LTV is used, the LTC is a valuable factor in the determination of the potential risk in a deal. The general rule of thumb is the lower the leverage, the lower the risk.

Although many lenders view the LTC ratio as essential for qualifying construction or rehabilitation financing, there are many other factors taken into consideration. These include the location, the financial strength of the borrower, pro forma income and expenses, and the asset class of the collateral property. Additionally, lenders will also review other key metrics in a deal, such as the debt service coverage ratio, the debt yield, and the loan-to-value ratio (of the property’s future stabilized value) before making a financing decision.