By Victor Alarsa
If you are looking to get into Real Estate financier or just being more familiarised with its vocabulary, here you will find a few metrics commonly used by loan underwriters.
The daily life of a developer is not easy. They need lenders to help them to finance their developments, but lenders do not lend money without a thorough due diligence on the investment, starting with the covenants. Covenants imposes a limit on the amount of money a financier can lend to a development. In this article and the next, we are going to run through the most common covenant metrics used by loan underwriters.
The loan-to-value (LTV) ratio is a financial metric used by lenders to assess the risk of real estate deals. The higher the LTV ratio, the riskier the loan is for the lender. For instance, LTV, which is often used for Property Bridging Loan or Refinance Loan, is calculated based on the current market value of the property.
Gross Loan (net loan amount + fees + interest) / Property Value
Loan-to-GDV (Gross Development Value) is similar to LTV, but instead of using the current property value, it’s an estimated value of the future development (GDV) after project completion (PC). For instance, a development loan, beginning at construction kick-off to PC and sometimes even further (lease-up period), uses GDV as a denominator for the LTGDV formula.
Gross Loan (net loan amount + fees + interest) / GDV
Loan to Cost (LTC) is a metric used to compare the amount of loan offered as a percentage of the total development cost (GDC). Together with LTGDV, LTC is commonly considered on Development Loans and Mezzanines. Usually, the highest figure between LTC and LTGDV is taken into account as the limit value of the facility.
Gross Loan (net loan amount + fees + interest) / GDC
Day-1 Loan (Net Loan Amount)
One common mistake done by lenders and developers is mixing up net loan (day-1 position or the cash to be released upfront to the project) and gross loan (all costs, including interest rate and financial fees).
Let’s see an example.
A lender is loaning at an LTC of 80%, but they forgot to consider the interest rate into the gross loan:
The total developing cost is £1,000, the project lasts 5 years and there is a roll-up interest rate of 10%. So, not considering the interest rate as a cost on the loan amount, the cash flow looks as follows:
Looking at the table above, notice that with the total interest summed by the development cost is £1,128. The lender is actually lending to the borrower £928, £128 more than the £800 expected. The LTC is not 80%, but 82.3%.
Now, let’s see the same scenario but correctly calculated, which considers the interest amount in the LTC calculation:
As you may have noticed, for a max LTC of 80%, the Day-1 Loan (total drawdown debt) is lower than the previous one (Day-1 = £776). The reason for that is because the interest rate is considered in the gross amount and in the GDC, that reduced the day-1 amount. Also, notice that the equity investor needs to top-up an extra £24 to cover the loan shortfall.
That’s the correct figure and lenders should acknowledge how to properly calculate the LTC/LTV/LTGDV, therefore, preventing mistakes like the one shown above from happening.
Continues next month…