The Loan-to-Cost Ratio
How Much of the Total Construction Cost is the Construction Lender Being Asked to Finance?
Remember - The Commercial Construction Lender Wants the Developer to Have Some Skin in the Game
The Loan-to-Cost Ratio is different than the Loan-to-Value Ratio. You are probably more familiar with the Loan-to-Value Ratio, where the underwriter uses the fair market value of the project after it is completed and occupied in the denominator.
The Loan-to-Cost Ratio only considers what it actually costs to build the project. For example, let’s suppose that Jake and Beth Smith own a piece of land near Ground Zero in New York City that would be an ideal site to build a new ofﬁce tower. The land alone is worth $10 million.
The Smith’s want to build a new ofﬁce tower to replace the one they were forced to demolish after 9/11. Including the $10 million value of their land, their contractor tells them that the total cost to build the proposed ofﬁce tower will be $100 million.
Since Mr. and Mrs. Smith own the land free and clear, they only need $90 million more to build the new ofﬁce tower. They could go to a commercial construction lender, most likely a bank, and ask for a $90 million commercial construction loan.
The commercial construction lender would then compute the Loan-to-Cost Ratio. The loan amount is $90 million and the total cost is $100 million, so the Loan-to-Cost Ratio is 90%.
Is 90% loan-to-cost too high? Traditionally commercial construction lend- ers will only lend up to 80% of cost. And if a property type is out of favor with investors, like assisted living, hotels, and ofﬁce buildings located in many over- built central business districts, some commercial construction lenders might only want to go 70% loan-to-cost.
But loan-to-cost ratios are frequently stretched. If the Smith family was worth $100 million, and they were willing to personally guarantee the loan, many New York banks would probably be willing to make the loan at 90% loan-to-cost.
And if the Smith clan had been building ofﬁce towers for three generations, in other words they had a ton of experience, an aggressive bank might even be willing to lend up them up to 95% loan-to-cost.
But what if a developer just can’t come up with 20% to 30% of the total cost of the project? In that case, he will probably need to either bring in a partner with more equity dollars or obtain a mezzanine loan.