Loan-to-value is set on day one and tested on the last day. A good LTV is the highest one that still refinances when the loan matures at a higher rate.
A good loan-to-value is the highest one the loan can still be refinanced at when it matures. On an illustrative 40,000,000 property at a 6.00 per cent cap rate, a refinancing lender at 7.00 per cent and 1.30x cover will lend 24,032,765 in five years, so the highest LTV that refinances cleanly today is 60.1 per cent. At 65 per cent the borrower faces a 1,967,235 gap at maturity; at 70 per cent, 3,967,235.
Worked in full in Real Estate Finance by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A fictional stabilised property financed with a five-year interest-only loan. A second lender refinances it at maturity on its own terms. All figures are illustrative, not market levels.
| Input | Value |
|---|---|
| Value today | 40,000,000 |
| NOI today (6.00% cap rate) | 2,400,000 |
| Loan rate, interest-only, term | 6.00%, 5 years |
| NOI growth a year | 2.0% |
| Cap rate at maturity | 6.50% |
| Refinancing: rate, amortisation | 7.00%, 25 years |
| Refinancing: max LTV, min DSCR, min debt yield | 65%, 1.30x, 9.0% |
At origination every LTV in the usual range looks comfortable. Two of the lender's measures follow directly from the LTV and the cap rate:
Debt yield = NOI / loan = cap rate / LTV. At 60%: 6.00% / 0.60 = 10.00%
DSCR, interest-only = NOI / (loan × rate). At 60%: 2,400,000 / (24,000,000 × 6.00%) = 1.67x
The debt yield is also the cap rate at which the loan equals the value: at 60% the cap rate can widen 400 basis points before the lender is under water.
NOI at maturity (year 6) = 2,400,000 × 1.025 = 2,649,794
Value at maturity = 2,649,794 / 6.50% = 40,766,060 (growth just outruns the wider cap rate)
Loan constant, 7.00% over 25 years, monthly = 8.48%. Excel: =PMT(7%/12, 300, -1)*12
By LTV: 65% × 40,766,060 = 26,497,939
By DSCR: 2,649,794 / 1.30 / 8.48% = 24,032,765
By debt yield: 2,649,794 / 9.0% = 29,442,155
Maximum new loan = the lowest = 24,032,765, or 60.1% of today's value
The binding test is cover, not LTV. The new lender charges more and amortises, so each unit of debt costs 8.48 per cent a year in debt service against 6.00 per cent of interest today. That is what caps the refinancing, and therefore what caps a prudent LTV at origination.
| LTV today | Loan | Debt yield | DSCR | LTV at maturity | Refinancing gap |
|---|---|---|---|---|---|
| 50% | 20,000,000 | 12.00% | 2.00x | 49.1% | 0 |
| 55% | 22,000,000 | 10.91% | 1.82x | 54.0% | 0 |
| 60% | 24,000,000 | 10.00% | 1.67x | 58.9% | 0 |
| 65% | 26,000,000 | 9.23% | 1.54x | 63.8% | 1,967,235 |
| 70% | 28,000,000 | 8.57% | 1.43x | 68.7% | 3,967,235 |
| 75% | 30,000,000 | 8.00% | 1.33x | 73.6% | 5,967,235 |
Read the 65 per cent row. The loan passes a 65 per cent LTV test at maturity, at 63.8 per cent, with the value up 1.9 per cent. Cover today is a healthy 1.54x. Yet the borrower must find 1,967,235, 7.6 per cent of the loan, or sell. At 70 per cent the gap is 14.2 per cent of the loan; at 75, 19.9 per cent. Nothing has gone wrong with the building: rates are a point higher and the new loan amortises.
| Refinancing rate | NOI growth 0.0% | 2.0% | 3.0% |
|---|---|---|---|
| 6.00% | 59.7% | 65.9% | 69.2% |
| 7.00% | 54.4% | 60.1% | 63.1% |
| 8.00% | 49.8% | 55.0% | 57.8% |
Each point on the refinancing rate takes about five points off the safe LTV; each point of annual growth adds about three. With no growth and an 8.00 per cent refinancing rate, a loan above 49.8 per cent of value today does not refinance in full. That is why a good LTV cannot be read from a table of market norms: it is a forecast of the rate and the income at maturity, expressed as a percentage of today's value.
A lender reading the same grid sees its exit, not the borrower's. A 70 per cent loan that cannot refinance becomes an extension or a workout, which is why credit committees size on the downside row and treat the base case LTV as an output. The full ranking of the three sizing tests, and the income fall that breaks each, is in which covenant breaches first.
Judging LTV by the cushion against a fall in value. A 65 per cent loan does have 35 per cent of equity below it, and in this case value never falls at all. The loan still fails to refinance, because the next lender sizes on income and debt service, not on value. The second mistake is comparing interest-only cover today with amortising cover tomorrow: 1.54x at 6.00 per cent interest-only becomes 1.20x on the same 26,000,000 at an 8.48 per cent constant, even with NOI grown to 2,649,794, below the 1.30x the refinancing lender requires.
The book's sizing chapter puts LTV, cover and debt yield on one sheet and names the binding test; it is live in the free workbook for this case.
It depends on the lender, the asset and the cycle, so treat any range as illustrative: senior lenders on stabilised property often work around 55 to 65 per cent, with higher advances for bridge or mezzanine money at a higher price. The binding constraint is often not the LTV cap but cover: in the worked case a 1.30x DSCR at 7.00 per cent limits the loan to 60.1 per cent of today's value.
The equity cushion is one minus LTV, so a 60 per cent loan survives a 40.0 per cent fall. In cap rate terms the loan is fully covered until the cap rate reaches NOI over loan, the debt yield: 10.00 per cent at 60 per cent LTV on a 6.00 per cent cap, a widening of 400 basis points, and 9.23 per cent at 65 per cent.
Because the refinancing lender sizes the new loan on debt service cover. In the illustrative case, with 2.0 per cent growth, the highest LTV that refinances falls from 65.9 per cent at a 6.00 per cent refinancing rate to 60.1 per cent at 7.00 and 55.0 per cent at 8.00. Rate risk at maturity is LTV risk today.
This article is one calculation from Real Estate Finance. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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