Applying for a commercial real estate loan is dependent on three factors: how much money you need, how much money you can put down, and how much the property is worth. Conventional commercial lenders will consider these three numbers — along with the property type, class, location, sponsorship and other determiners — to decide whether they will get anything out of making a deal with you. But numbers that don’t line up in a way that is beneficial for them can hurt your chances of getting the loan you need to buy the property you want.
Whether you’re buying a multifamily housing complex, an industrial yard or a mixed-use office tower, convincing a lender to invest in the property depends on your loan-to-value ratio. This ratio is the percentage point that tells them what they’re getting into before agreeing to get into business with you. Knowing what an LTV ratio is — and how to make it look good for an investor — will help you close the deal.
The loan-to-value ratio is the percentage that indicates the borrower’s debt relative to the value of their collateral. It’s calculated by comparing the amount of financing you need on a property to the actual value of the real estate and is written as a number that tells lenders how much of a risk they will take in providing you with a loan.
Loan-to-value is also the number that determines your leverage as a borrower. The lower the LTV ratio, the lower the risk for the lender, and the higher chance you have of getting the funds you need for your new investment — not to mention competitive offers. If you have a high LTV, the higher your interest rate is likely to be, as the loan terms will favor the lender due to your need for funding.
LTV is another form of borrower appraisal. It determines the leverage — along with property type, loan terms and market — of both the lender and the borrower in the agreement. It’s a number that shows both the qualifications of the borrower and the terms they propose for the acquisition of funds. By measuring the relationship between a loan amount and the value of the property asset, conventional commercial mortgage lenders can determine if your commercial real estate goals are worth the investment. Whether a private lender or a bank, a commercial real estate financier will first want to know how high the chance is of your loan going into default. And if the property were to foreclose because the borrower can’t repay the loan, the lender might have trouble selling the property again because of how little equity had been built up.
This makes LTV ratios another form of credit checking. Just as a low credit score of under 550 can hurt your chance of acquiring funds for your commercial property investment, so does a high LTV. And if your credit score sits near the 700 mark, your chances of loan approval are higher — just like a low LTV.
Remember, conventional commercial mortgage lenders don’t guarantee some sort of funding like some government-regulated banks, credit unions and insurance companies do. Private lenders and banks can deny borrowers based on many factors and set their own preference of acceptable LTV terms.
It’s important to know the difference in use and definition of LTV and LTC. LTC, or loan-to-cost, is a ratio used to determine debt in relation to the total cost of a commercial or multifamily project, not to the asset’s total value. This makes LTC more common in value-add acquisitions like in renovations and rehabilitation projects (e.g. adaptive reuse of historic buildings or REO properties), but it isn’t relevant in traditional commercial real estate acquisitions.
Your loan-to-value ratio is determined by the amount of money you need to purchase the asset and how much it is worth. Lenders compare the two price points by dividing the amount of the loan by the property’s appraised value (or, if lesser, its purchase price). This comes out to a simple formula:
Loan Amount / Total Value = LTV %
The higher the percentage out of 100%, the higher the risk, and the less likely a conventional lender will be willing to negotiate a loan.
The best way to understand LTV is to see it in practice.
Take, for example, a borrower looking for a financier for a downtown office property in a top-market city worth $10 million. The borrower has $3 million available as a down payment and needs another $7 million in loans to acquire the entire asset. These figures make their loan-to-value ratio 70% when approaching potential commercial lenders.
7,000,000 = Desired loan
10,000,000 = Property value
7,000,000 / 10,000,000 = 70% LTV
Most conventional commercial lenders will consider a 70% LTV for an office tower. If, however, the borrower can’t put more than $1.5 million on a down payment for the same property, their LTV will be higher.
8,500,000 = Desired loan
10,000,000 = Property value
8,500,000/10,000,000 = 85% LTV
A higher loan-to-value ratio like this can be considered a higher risk acquisition and may put the borrower into a position of taking an offer with a higher interest rate and other unfavorable terms.
The loan-to-value ratio for a commercial property depends on loan, asset and lender types. In general, commercial loan LTV ratios fall between 65% and 80%. Multifamily housing is offered at an average of 73% LTV and is often maxed out by conventional lenders at 80%. Offices, industrial properties and self-storage come in around 68% LTV. Bridge loans on average come in at 80% LTV, while construction financing is lent for around 75% LTV.
Loan-to-value ratios differ when it comes to commercial vs residential real estate spaces. However, borrowers with a lower LTV will generally qualify for better financing rates and repayment options. This is because the borrower would have more equity in the property — meaning the lender takes on less risk.
If you’ve purchased a residential property using an FHA loan or a VA loan, you may have been able to make a down payment under 20% on the condition that you purchase private mortgage insurance (PMI). Mortgage insurance protects the lender in case the borrower defaults. Unfortunately, PMI does not apply to commercial real estate. In CRE, the lender takes on all of the risk, which is why they often require a down payment of at least 20%, even on a refinance.
When looking for investors in your potential new commercial asset, your loan-to-value ratio is what determines whether or not a lender will want to invest in your property. It doesn’t matter how much a property is worth on its own. What commercial lenders really care about is how much your money compares to that property’s total value. A borrower will never be able to find a lender if they can not put any money down in the first place. For lenders, a property is only worth how much a buyer is willing to pay for it.