Loan-to-Value Ratio

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When the Commercial Project is Completed, How Much Protective Equity Will the Commercial Construction Lender Enjoy?

The commercial construction project has now been completed. The prop- erty has been leased up and occupied. Where does the commercial construction lender now stand? Does the developer have plenty of equity that he will want to protect, or will he be tempted to simply walk away from the project and hand over his keys to the commercial construction lender?

This is the purpose of the Loan-to-Value Ratio calculation. You divide the construction loan amount by the appraiser’s estimate of fair market value of the project upon completion and occupancy, and then multiply by 100%.

Suppose Jake and Beth Smith build a new office tower near Ground Zero in New York City. Suppose the construction loan is $90 million and the fair market value of the project after it is completed and occupied, according to the appraiser’s estimate, is $140 million. The loan-to-value ratio would be 64.2%, a wonderfully low LTV.

So what is a reasonable loan-to-value ratio for a proposed commercial con- struction project today?

Multifamily (apartment) projects should not exceed 75% to 80% LTV. Retail is hot as of this writing (7/5/04), so you might be able to obtain a construction loan up to 75% loan-to-value. Industrial and self-storage are semi-hot: 70% to 75% LTV is reasonable.

Commercial construction lenders are cool to office buildings in most cen- tral business district locations, and commercial construction lenders are cool to assisted living projects located anywhere today. Ideally these commercial construction projects should not exceed 70% in most markets, but there are plenty of exceptions.

Hotels are cold after 9/11 (although no longer ice cold), so it will be dif- ficult to get conventional commercial construction loan in excess of 65% loan-to-value. Sixty percent is more realistic. You will almost certainly need a mezzanine loan.

So what happens if your commercial construction project does not appraise out? The purpose of building is to to sell the project for more than it costs to build. If the project does not appraise for significantly more than it costs to build, it may simply be a poorly conceived project.

But if you are absolutely committed to the project, you may want to look into a mezzanine loan.

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