LTV: How Lenders Decide What You're Worth

The lending community uses lots of jargon. One of the most common terms is "LTV," or "loan to value." LTV is almost always expressed as a percentage, which is calculated by dividing the proposed new loan by the estimated value of your property. Most lenders limit their lending to no more than 75 percent of that value. In addition, many tie their pricing to LTV, with lower LTV properties getting more favorable rates than those with higher LTVs.

The issue of LTV often causes a problem because borrowers and lenders view a property's value from different perspectives. When most co-op residents think of their building's value, they typically multiply the most recent apartment sales price by the number of units in their building. For your co-op, you might use an average sales price of $325,000 per apartment times the nine units in your building to arrive at a "value" of $2,925,000. So the new loan of $1,400,000 that you've been seeking – which would give you an LTV of 48 percent – seems perfectly reasonable.

Lenders, on the other hand, calculate value a little differently. A lender's biggest fear is that a borrower will not make his or her monthly payment, forcing the property into foreclosure. Lenders don't want to own properties, so for them, a property's value is the price it will bring in a quick foreclosure sale. And that value is a little more difficult to determine.

When a co-op building defaults on its underlying mortgage, the lender will probably move to foreclose. If completed, the foreclosure will dissolve the apartment cooperation and convert the property to a rental. Whether any lender actually could accomplish such a conversion in today's legal and political environment is fodder for another article. Nonetheless, that's what goes through a lender's head when considering value.

Let's look at your building through a lender's eyes. First, let's pretend your building is a rental and ascribe a fictitious rent to each apartment. If we assume that all nine of your units would rent for an average of $3,000 a month, the maximum gross income for your building would be $324,000 per year. Most lenders will expect that some of your apartments will be vacant at least some of the time, and adjust the total possible rent by some amount (say, five percent) to account for tenant moves, market slumps and so on. After allowing for these factors, we have an adjusted gross of $307,800.

Bring on the NOIse

Your current operating expenses run roughly $170,000. Most lenders will increase various line items (like real estate taxes and heating oil) to allow for inflation and rising rates of costs (let's assume an average increase of six percent). They most likely will increase your insurance coverage. They also will add a full-service management fee (about five percent of adjusted gross income) and an amount for maintenance, repairs, and replacements ($1,000 per unit per year or more). After making these adjustments, your total operating expenses come to $204,590. If we deduct that amount from the adjusted gross, we are left with a net operating income (or "NOI" in lenderspeak) of only $103,210.

This NOI represents the annual cash flow that an investor would receive if the investor bought your building paying all cash. The amount an investor would be willing to pay depends on the rate of return he or she expects. If an investor wanted an annual return of seven percent, we could estimate the value of your building by dividing the NOI of $103,210 by seven percent to get $1,474,429.

Lenders refer to this calculation as "capitalizing the net operating income", and they call the seven percent return a "cap rate." If we then apply the common maximum LTV of 75 percent, we get a maximum new loan of $1,105,821…let's round that to $1,100,000. It's pretty clear that a new loan of $1,400,000 would be considered excessive by most lenders.

Knowing why lenders are rejecting your loan request may be of little comfort. However, it might help you find a solution. For example, you might assemble data on apartment rentals in your neighborhood. If you can document higher rents than those the lender assumed, you might get your loan amount increased. You also should take a hard look at each line item in your operating budget to capture any cost savings. Finally, you can borrow less and either scale back your capital plans or supplement a smaller new loan with shareholder assessments.

Patrick B. Niland is a professional mortgage broker.

Adapted from Habitat January 2008. For the complete article and more, join our Archive >>