Loan to Value, a key metric while assessing property development projects
In a nutshell
In this series we'll be looking at understanding LTV (Loan to Value), how it changes throughout a development project, how it is different from the LTGDV (Loan to Gross Development Value), and how LTV changes during the investment.
In order to make effective property investment decisions, it's important to have a thorough understanding of what LTV is and how it is used.
The LTV is the ratio between the value of the loan you take out and the value of the property used as security, then expressed as a percentage.
How to calculate LTV
Usually, Crowdlords will raise a proportion of what a property is worth and that property will be secured under a first or second charge. This relationship between what a property is worth and the amount lent is what the LTV ratio is.
In its simplist form, if you're starting a property development which will cost £200,000 and you currently have £50,000, you'll need to borrow £150,000. Therefore, the LTV will be: £200,000 minus £50,000 = £150,000 divided by £200,000 x 100 = 75%.
But, if you only have £10,000 to begin with, the LTV will be £200,000 minus £10,000 = £190,000 divided by £200,000 x 100 = 95%.
The higher the LTV, the higher the risk, so lenders must be aware that if property prices fall, borrowers with a high LTV loan could actually owe more than the value of the property they are developing. This is known as "negative equity".
How does the LTV change during the project?
Over the course of the development, the LTV changes for two reasons - more is borrowed as the Development Finance is drawn down; and as more is spent on the site, the value increases.
It's worth noting that during the build, it's usual for the LTV to increase as there is a point where the work done and the money spent do not result in any "added value". If a site is taken over at this point and sold to recover debt then it would be unusual to sell it at "book value".
How LTV differs from LTGDV
CrowdLords tend to quote two LTV figures – LTV and Loan to Gross Development Value (LTGDV). The LTV is the ratio at the time the investment is made, and the LTGDV is the projected ratio at the point of exit.
Whether or not the LTV is higher than the LTGDV will depend on a combination of factors including the proportion of total costs that go towards buying the property and the amount of equity put in by the developer at the beginning.
Both ratios are important. The LTV on day one is critical at that time because if for some reason the development does not go ahead and we need to recover our funds, then it shows how much below market value is enough to ensure there is no capital lost.
On the other hand, LTGDV is only relevant at the end of the build and is a rough guide to the sales risk.
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