Loan to cost
Also called LTC.
Loan to cost is the loan amount divided by total project cost. It is the leverage constraint used on construction and heavy value-add loans, where the property has no stabilised value to lend against and cost is the only verifiable basis.
How it works
A building that does not exist yet cannot be capitalised into a value, so a construction lender measures against what is being spent. Total project cost means everything in the sources and uses: land, hard costs, soft costs, the developer fee, loan fees and the interest carried during construction.
Construction lenders normally apply both a loan to cost cap and a loan to stabilised value cap, and take whichever produces less. Typical caps run 55 to 70 percent of cost, tightening for merchant-build product and speculative space and loosening where there is meaningful preleasing. The as-stabilised value test then catches the case where a project is expensive relative to what it will be worth.
Draw mechanics matter as much as the ratio. Most construction loans require the borrower's equity to be spent first, so the loan funds only after the full equity contribution is in the ground. That changes the timing of the equity outflow, which changes the IRR, even though the total dollars are unaffected.
Formula
Loan to cost = loan amount / total project cost- Total project cost includes land, hard costs, soft costs, developer fee, loan fees and interest carry
- Contingency is part of cost. Whether the lender will fund against it should be confirmed, not assumed
- Almost always tested alongside a loan to as-stabilised-value cap, with the lesser governing
Worked example
Illustrative development. Total cost $48,000,000, stabilised NOI $3,360,000, as-stabilised value at a 5.75 percent cap.
| Loan at 65% of cost | $31,200,000 |
|---|---|
| As-stabilised value | $58,434,783 |
| Loan at 60% of stabilised value | $35,060,870 |
| Governing constraint | loan to cost |
| Loan amount and equity required | $31,200,000 of debt, $16,800,000 of equity |
The cost test binds because the project creates value: it is worth more than it costs. On a project with a thinner development spread the value test binds instead, and that reversal is a useful early signal about how much margin a deal really has.
The common mistake
Excluding interest carry from cost and then borrowing against it
Interest accruing during construction is funded by the loan and is part of total project cost, which makes the calculation circular: the loan sizes off a cost that includes interest on the loan. Solving it by ignoring the carry understates cost, overstates loan to cost compliance, and produces a sources and uses that does not balance once the first interest payment accrues. Size it iteratively, and confirm which soft costs the lender will actually fund.
Related terms
- Loan to valueLoan to value is the loan amount divided by the property's value, expressed as a percentage. It is the most familiar leverage constraint and, on a purchase, is normally tested against the lesser of the appraised value and the purchase price.
- Yield on costYield on cost is stabilised net operating income divided by total project cost, including land, hard costs, soft costs, financing costs and carry. It is the development and value-add equivalent of a cap rate, and the spread between it and the market cap rate is where the profit comes from.
- Loan sizingLoan sizing is the process of determining the maximum loan proceeds a property supports. A lender runs three independent tests, a loan-to-value cap, a minimum debt service coverage ratio at a stressed rate, and a minimum debt yield, and lends the lowest of the three.
- Interest-only periodAn interest-only period is a stretch at the start of a loan during which the borrower pays interest and no principal. It raises early cash flow and coverage, and it ends with a step up in debt service that has to be modelled.
Keep reading
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