What it is
Loan-to-cost compares the loan to what the project will cost to build or reposition, not to what it will be worth. It is the main leverage test for construction loans and is common on value-add bridge loans where renovation money is part of the loan.
The logic is simple. Before a building exists, there is no income to value. Cost is the most solid number available.
How it's calculated
Add up the full budget, then divide the loan by it.
| Budget line | Amount |
|---|---|
| Land | $4,000,000 |
| Hard costs | $12,500,000 |
| Soft costs | $2,500,000 |
| Financing costs and interest reserve | $1,000,000 |
| Total project cost | $20,000,000 |
| Loan amount | $13,000,000 |
| LTC | 65% |
The sponsor funds the remaining $7,000,000, usually before the lender's first draw.
What counts as cost
Lenders differ on details, so read the term sheet.
- Land is often counted at purchase price or appraised value, whichever is lower. Land bought years ago at a low basis can shrink the cost base, though some lenders give credit for appreciation.
- Hard costs cover construction itself, usually supported by a general contractor's bid or contract.
- Soft costs include architecture, engineering, permits, legal and insurance.
- Contingency is expected. A budget with none looks unrealistic.
- Interest reserve and financing fees are typically included in total cost.
How lenders use it
Construction lenders commonly set maximum LTC somewhere in the 50% to 75% range, varying by lender, asset class, sponsor strength and market. They usually check LTV on the completed value as well, often called loan-to-stabilized-value. A deal can pass one test and fail the other.
The loan funds in draws as work is completed, after the borrower's equity is in. Lenders track LTC through the project and may require more equity if costs run over.
Common mistakes
- Leaving costs out to make LTC look lower. An understated budget gets caught in the lender's cost review and damages credibility.
- Confusing LTC with LTV. A 65% LTC loan on a project worth more than cost may be 50% LTV. Show both.
- No contingency. It signals inexperience, and lenders will add one anyway.
In the package
Include the full budget, the contractor's bid, the schedule, and a sources and uses table showing how equity and debt fill the capital stack. See how to package a commercial real estate loan for the rest of the checklist.