Real Estate Investing Explained - Loan to Value vs. Loan to Cost | GowerCrowd
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Welcome to "Real Estate Investing Explained", a brand new series presented by Dr. Adam Gower of GowerCrowd for beginners looking for information about investing in real estate! In this series, Dr. Adam Gower will go about explaining many important aspects of real estate investing that beginners need to know.
In today's video, we're going to be talking about loan to value vs. loan to cost.
When a sponsor goes out and buys a piece of real estate, they will be financing it with two key components of capital. One is going to be debt that they get from the bank, and the other is going to be equity which they'll be getting from you.
The debt placed on the property is never going to be 100% of what the sponsor needs. If it were, they wouldn't need your equity. The way that the banks determine how much they're going to lend to a sponsor is by using one of two ratios: loan to cost and loan to value.
Loan to cost is the amount that a lender will lend to a sponsor, that is a proportion of the total cost of the project. The total cost of the project is going to include the purchase of the land and any improvements that the sponsor may be putting on the project. This could include fees and soft costs.
Loan to value is a different ratio than loan to cost. What the bank is saying when it comes to loan to value is, what is the ultimate value of this property? How much should we lend against that? In theory, the value of the property is going to be higher than the cost. Due to this, you might expect that the loan to value ratio will be higher than the loan to cost.
The more debt that you have on a project, the higher the risk that the project will fail. Why? Well, if the borrower fails to pay the lender what is agreed in the lending documents, the lender will retain the right to foreclose on the borrower.
Overall, you want to be looking for projects that have a lower relative loan to value ratios and loan to cost ratios.
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