Loan to value
Also called LTV.
Loan 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.
How it works
LTV measures the equity cushion protecting the lender. At 65 percent leverage, value has to fall by 35 percent before the loan is underwater, which is a straightforward statement about how much price decline the loan can absorb.
Its weakness is that value is an opinion. LTV depends on an appraisal, and appraisals move with the same market sentiment that moves cap rates, so leverage measured this way loosens exactly when markets are frothy and tightens when they are not. That procyclicality is why lenders stopped relying on LTV alone and added debt yield, which contains no valuation at all.
On a purchase the constraint is usually stated as the lesser of a percentage of purchase price and a percentage of appraised value. If the appraisal comes in below the contract price, the loan shrinks and the equity requirement grows, and that risk sits with the buyer between signing and closing. Refinances have the opposite exposure: proceeds depend entirely on an appraisal that has not happened yet.
Formula
LTV = loan amount / value- On a purchase, value is normally the lesser of appraised value and purchase price
- Loan to cost is the parallel measure for development and heavy value-add, using total project cost as the denominator
- Combined LTV, or CLTV, includes mezzanine debt and any preferred equity treated as debt
Worked example
Purchase price $55,900,000, lender cap 65 percent of the lesser of price and appraised value.
| Loan at 65% of purchase price | $36,335,000 |
|---|---|
| Equity required | $19,565,000 |
| Appraisal comes in at $54,000,000 | |
| Loan at 65% of appraised value | $35,100,000 |
| Additional equity needed | $1,235,000 |
A 3.4 percent appraisal shortfall costs $1.235 million of additional equity, a 6.3 percent increase in the cheque, with no change to the property or the price.
The common mistake
Assuming LTV is what actually sizes the loan
LTV is one of three tests and it is frequently not the binding one. A lender sizes to the LESSER of the LTV cap, the proceeds that satisfy the minimum DSCR at a stressed rate, and the proceeds that satisfy the debt yield floor. In a low cap rate market the value is high relative to the income, so the income-based tests bind long before the LTV cap does, and a model built on a 65 percent LTV assumption comes up short at term sheet. Run all three tests every time and take the minimum.
Related terms
- 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.
- Debt yieldDebt yield is net operating income divided by the loan amount, expressed as a percentage. It measures the return a lender would earn on its loan if it took the property back and operated it, and unlike DSCR it is unaffected by interest rate, amortisation schedule or loan term.
- Debt service coverage ratioThe debt service coverage ratio is net operating income divided by annual debt service. A 1.25x means the property produces $1.25 of income for every $1.00 of principal and interest owed, so net operating income could fall by 20 percent before coverage reaches 1.00x and the loan stops being covered.
- Loan to costLoan 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.
- Cap rateA cap rate is a property's net operating income divided by its value or price, expressed as a percentage. It is the unlevered first-year yield on the purchase price and the standard shorthand for what a market is paying for a stream of property income.
Every figure, traced to its source
Altyst computes these in exact decimal arithmetic, not with a language model, and clicking any number shows the formula behind it.