Loan-to-Cost Ratio (LTC) is a metric that compares the amount of financing a real estate construction project has to the cost it will take to build the project. In terms of HUD multifamily loans, LTC typically only affects HUD 221(d)(4) loans and HUD 232 loans, as these types of financing involve the new construction or substantial rehabilitation of multifamily and healthcare properties.

Loan to Cost is a ratio used in commercial mortgage financing and multifamily financing to determine the ratio of debt relative to the cost of acquiring the property. Commercial mortgage lenders use the LTC ratio as a factor to determine risk in a deal: the lower the leverage, the lower the risk while higher leverage offers higher risk. LTC can be calculated by dividing the loan amount by the cost of the loan.

In relation to the HUD 232 Loan Program, Loan-to-Cost ratio, or LTC, is a metric comparing the amount of a project’s financing to its construction costs. For HUD 232 construction loans, loan-to-cost ratio is one of the major measures of leverage. In contrast, HUD 232 acquisitions and refinance loans are more often assessed based on their loan-to-value ratio, or LTV.

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%

For example, if a borrower is buying a property for $1 million, and the property is worth $2 million, and the loan requested is $800,000, then the LTC ratio is 80%.

The Loan-to-Cost Ratio (LTC) is a valuable metric for lenders to assess the potential risk of a deal. Generally, the lower the leverage, the lower the risk. LTC is typically used for value-add acquisitions such as ground-up construction or the acquisition of properties that require substantial rehabilitation. Other factors that lenders take into consideration 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. Source, Source, Source.

The risks associated with Loan-to-Cost Ratio (LTC) are related to the amount of leverage used in a deal. The higher the leverage, the higher the risk. Commercial mortgage lenders use the LTC ratio as a factor to determine risk in a deal. For example, if a borrower is buying a property for $1 million, and the property is worth $2 million, and the loan requested is $800,000, then the LTC ratio is 80%. This high leverage ratio increases the risk of the loan.

In terms of HUD multifamily loans, LTC typically only affects HUD 221(d)(4) loans and HUD 232 loans, as these types of financing involve the new construction or substantial rehabilitation of multifamily and healthcare properties. For HUD 232 construction loans, loan-to-cost ratio is one of the major measures of leverage.

The alternatives to Loan-to-Cost Ratio (LTC) for commercial real estate financing include:

• Pro Forma Income and Expenses
• Asset Class
• Location
• Borrower Financial Strength

These factors are considered by lenders in order to determine the level of risk and the borrower’s leverage in a commercial real estate transaction.