Are you an investor looking to purchase a multifamily rental property? Most investors borrow money to help fund the proceeds to purchase a property. Banks use the loan to value ratio (LTV) to consider how much money they are willing to lend.
The higher the LTV ratio the more the lender is willing to lend as a percentage of the purchase price and therefore the borrower has to place less equity in the property.
For investors, the loan to value ratio is important because it impacts how much money they need to bring to the table when purchasing an investment property. Factors other than a loan to value ratio that affects your loan terms is borrower creditworthiness, and debt coverage ratio.
What is the loan-to-value ratio, how is it calculated, and what is an excellent loan-to-value ratio will be covered in this article.
The loan to value ratio is one of the metrics lenders use to assess their lending risk before approving a loan. The formula, expressed as a percentage, is obtained by dividing the loan amount by the property’s purchase price. Some important considerations are:
As the mortgage principal is paid back, assuming property value does not decrease, the loan-to-value ratio decreases.
Generally the higher your loan to value ratio the higher your interest rate because the lender deems the loan to be riskier
Here is how you calculate loan to value ratio:
The loan amount is divided by the property’s value to determine the loan-to-value ratio. For instance, if you were taking out a loan to buy an apartment property worth $10,000,000 and the loan amount is $8,000,000 the loan to value is 80% ($8,000,000/$10,000,000).
One possibility is as you pay down your loan principle and if your property value stays the same or rises your loan to value ratio goes down.
Alternatively, you can lower your LTV ratio by putting down more money and obtaining a smaller loan.You can make improvements to your property to increase its value thus indirectly lowering your LTV ratio.
You have a property that is worth $10,000,000 with a $7,000,000 loan thus a 70% loan to value ratio. You spend $500,000 renovating which increases rents so much that the value shoots up to $12,000,000.
Further, you inherit $1,000,000 which you decide to utilize to pay the loan down to $6,000,000. You now have a property with a 50% loan to value ratio ($6,000,000/$12,000,000 = 50%).
Typically, a really good loan-to-value ratio when purchasing an apartment investment is about 80%. It indicates that you would have to contribute a down payment equal to 20% of the purchase price. In the current market capitalization rates have fallen so low it is not out of the ordinary for loan to value ratios for apartment investments to be no higher than 50%.
With the onset of significant inflation and the federal reserve’s response of raising overnight lending interest rates from .75% to 4.75% in less than a year. We can expect cap rates to rise and loan to value ratios to increase.
As real estate investors, your Loan to Value ratio has a significant impact on your multifamily investment prospects. Property investors need to pay close attention to day-to-day operations because the only way to sustain or increase income property value is to grow net operating income in a rising interest rate environment. Who you hire to manage your property matters.
The right property management partner can help you reduce significantly. Contact Summerfield Management to learn more if you own a 75+ unit apartment rental property.
Q: Is a 75% loan to value ratio good?
A: The short answer for rental apartment investment in today’s market is YES!
Q: What is better: higher or lower LTV?
A: It depends on the specific investment and deal structure but assuming you have positive leverage your rate of return on equity invested is always better the higher your loan to value ratio.
Q: What is the average loan to value ratio for apartment investments in today’s market?
A: The average loan to value ratio for apartment investments in today’s market is 60% + or –
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