Loan-to-cost (LTC) is the loan amount divided by the total cost of acquiring and building or renovating a property, expressed as a percentage. It is the leverage measure lenders apply to construction and value-add loans, where the value that loan-to-value would test does not yet exist, and its complement is the equity share the borrower must fund.
How is LTC calculated?
The formula divides the loan commitment by the project budget:
LTC = Loan Amount / Total Project Cost
The numerator is the full loan commitment, not the amount drawn to date. The denominator is the lender-approved budget for the whole project, from land through completion and lease-up.
What counts as total project cost?
The cost basis is defined in the loan agreement, and every line in it is subject to the lender’s review. Land enters at the purchase price or, when the borrower already owns it, at a basis the lender approves, commonly the lower of cost and appraised value. Hard costs are the construction contract, site work, materials and labor. Soft costs are architecture, engineering, permits, legal and title, insurance, the developer fee, financing fees and marketing. Contingency is a reserve against overruns in hard and soft costs. The interest reserve is the interest the loan will accrue during construction and lease-up, capitalized into the budget so the project pays its own carry until it produces income.
Lenders scrutinize the developer fee, which is a cost the sponsor pays itself, and the land basis, which is where a sponsor with an old purchase can inflate the denominator.
How does LTC differ from loan-to-value?
Loan-to-value measures the loan against what the finished property is worth, on an as-completed or as-stabilized appraisal. LTC measures it against what the project spends. The gap between the two is the developer’s profit: a project that costs less than it will be worth carries a lower LTV than LTC on the same loan amount.
LTC guarantees the sponsor has real equity in the project before the lender’s money goes in. LTV guarantees the finished collateral is worth more than the debt even if the profit disappears. Stabilized debt yield and DSCR on the projected income form a third constraint on the same loan.
How do lenders size a loan to the lower of LTC and LTV?
The maximum loan is the smaller of the amount the LTC limit allows and the amount the LTV limit allows, and whichever governs sets the equity the borrower must fund.
Illustrative example:
| Line item | Amount |
|---|---|
| Land | $5,000,000 |
| Hard costs | $20,000,000 |
| Soft costs | $3,000,000 |
| Contingency | $1,000,000 |
| Interest reserve | $1,000,000 |
| Total project cost | $30,000,000 |
| As-stabilized appraised value | $40,000,000 |
| Maximum loan at 70% LTC | $21,000,000 |
| Maximum loan at 60% LTV | $24,000,000 |
| Loan sized to the lower of the two | $21,000,000 (LTC governs) |
| Required equity | $9,000,000 |
With these inputs, the cost test governs and the borrower funds the difference between the budget and the loan. Had the appraisal come in lower, the value test would have governed and the required equity would have risen even though the budget was unchanged. Lenders commonly require the equity to be funded into the project before the first draw, so the borrower’s money goes in first and the loan funds the balance through the draw schedule.
Why does LTC matter after closing?
The loan is a fixed commitment, and the budget is not. When change orders and overruns push the cost above the approved budget, the loan agreement’s balancing requirement obliges the borrower to fund the shortfall, commonly before the lender releases the next draw, so the loan stays in balance with the remaining cost to complete. The contingency line absorbs the first overruns; once it is exhausted, every further dollar of cost is equity.
At completion, the construction loan is repaid by a construction-to-permanent loan or a separate take-out. The permanent lender sizes on loan-to-value, DSCR and debt yield against the stabilized property, not on cost, which is why a project that finishes on budget but stabilizes below its projected income can be undersized at conversion.
How LTC shows up in LoanBoss
LoanBoss enters construction draws on the day they are made and tracks proceeds remaining against the commitment, alongside the loan’s critical dates.
Frequently Asked Questions
What is a good LTC?
Lenders commonly cap LTC below their LTV cap so that the sponsor holds a meaningful equity share in the project. The loan agreement states the limit for each loan.
Does LTC include land the developer already owns?
Yes, at a basis the lender approves. Lenders commonly use the lower of the original cost and the appraised value rather than the current market value.
What is the difference between LTC and LTV?
LTC divides the loan by the total project cost; LTV divides it by the appraised value of the finished property. Construction and value-add lenders test both and size the loan to whichever produces the smaller amount.
What happens to LTC when costs run over budget?
LTC falls, because the loan amount is fixed and the denominator grows. The loan agreement’s balancing requirement obliges the borrower to fund the overrun, commonly before the next draw, so the loan remains in balance with the cost to complete.
Does the borrower’s equity go in first?
Commonly yes. Lenders require the required equity to be funded into the project before the first loan draw, so the borrower’s money is at risk before the lender’s.
Related Terms
- Loan-to-Value
- Construction Loan
- Construction-to-Permanent Loan
- Draw Schedule
- Debt Yield
- Construction Loan Draw Tracking for Real Estate Developers: The Borrower’s Side
Part of the LoanBoss CRE Debt Glossary. For hedging-specific terms, see Pensford’s resources.
Sources
- LoanBoss CRE Debt Glossary