The Loan to Value (LTV) Ratio in Real Estate: How to Level Up by Levering Up

Loan to Value (LTV) Definition: In real estate, the “Loan to Value” (LTV) ratio indicates the percentage of Debt used to acquire a property or refinance an existing loan; this percentage is always based on the property’s estimated market value at the time.

In financial models, such as property valuation and the real estate pro-forma, the LTV is typically a key driver that determines the amount of Debt and Equity used to fund the initial purchase.

If this initial loan is refinanced during the holding period, the LTV also acts as a key driver and determines the net proceeds to the equity investors.

The LTV is crucial in these models because the Debt used determines the Equity used, which determines your potential returns in the deal.

The higher the LTV, the higher the Debt and the less the Equity balance, which means that your returns will be higher, assuming the deal performs well.

On the other hand, if the LTV is too high, the property might run into cash-flow problems, and if the deal performs poorly, you will lose MORE money than you would have with a lower LTV.

It’s like leverage in a leveraged buyout: It does not “increase returns” but amplifies returns.

The LTV is especially significant in real estate because properties often use far more leverage than normal companies (60%, 70%, or even 80%) – which is possible because of very long amortization terms, high margins and cash-flow yields, and stable/predictable rental income for many property types.

One Final Note: For real estate developments, you use the Loan to Cost (LTC) ratio instead of the LTV.

It’s a similar concept, but it is based on the ratio of the Construction Loan to the Total Development Costs rather than the property’s market value – since the property will not have a market value until construction has finished.

Files & Resources:

• Why High LTV Ratios “Work” in Real Estate – Simple Example (XL)
• Simple Pro-Forma Real Estate Model (XL)
• The Loan to Value (LTV) in Real Estate – Slides (PDF)

Video Table of Contents:

• 0:00: Introduction
• 0:31: The Short Version
• 4:19: Part 1: How to Find the Right LTV
• 5:17: Part 2: Acquisition Example
• 7:22: Part 3: Refinancing Example
• 9:09: Part 4: Why High LTVs “Work” in Real Estate
• 13:02: Part 5: LTV vs. Debt-to-Equity and Debt-to-Total Capital
• 14:18: Recap and Summary

Where Do You Find the Loan to Value (LTV) Assumption for a Real Estate Model?

Typically, you base the LTV on the leverage used in similar recent deals in your region.

For example, if you are analyzing multifamily (apartment building) property deals in Miami, you might base the interest rates and LTVs on this type of data from Select Commercial Funding:

If you use a higher LTV in the deal, the lenders will generally demand a higher interest rate because a higher LTV means greater risk for them.

If you use a lower LTV, you’ll likely pay a lower interest rate because a lower LTV means less risk for the lenders.

So, in this example, if you were acquiring a Miami apartment building and only wanted to use a 60% LTV for the deal, you would likely pay a lower interest rate than the ones shown here.

How the Loan to Value (LTV) Assumption Works in an Acquisition Model

Here’s an example from the simple real estate pro-forma model used in these free tutorial lessons:

In this case, we use a 50% LTV for the Senior Debt and a 10% LTV for the Mezzanine (a riskier and more expensive form of Debt with a higher interest rate and no principal amortization).

These assumptions, in turn, directly drive the Required Equity for this deal.

The property costs $25 million, so we use Debt for 60% of that price and Equity for the rest of the required funds, including the fees and Replacement Reserves:

When we calculate the returns in this deal, the LTV makes no impact if we consider the unleveraged or project-level IRR.

The unleveraged number assumes that the deal uses no Debt, so the upfront investment equals the property price plus the relevant fees, and there is no Debt to repay when we sell the property.

With the leveraged or equity-level IRR, however, the LTV makes a major impact:

Here’s what happens if we use a lower LTV, such as 40% for the Senior Loan and 0% for the Mezzanine:

How the Loan to Value (LTV) Assumption Works in a Refinancing

In a commercial real estate loan refinancing, the LTV works slightly differently because we use the new Debt to repay the old Debt, which might have been a Construction Loan or the initial Acquisition Loan.

The motivation is to increase the equity returns because the property’s value tends to increase over time:

• Once a new property is developed, it should be worth more once it starts operating and generating rental income.
• In an acquisition, an existing property’s Cap Rate does not necessarily fall over time – in fact, it usually rises, indicating a lower valuation – but its Net Operating Income does increase as rents go up. Therefore, since Property Value = NOI / Cap Rate, the property’s value can increase because of this rising NOI.

In a refinancing following an acquisition, you need to estimate the property’s value and the LTV when the refinancing takes place.

The property value is normally based on its projected, stabilized NOI in the next year divided by the market Cap Rate. Here’s an example for a hotel in Darwin, Australia:

We use a 75% LTV for the refinancing, which is lower than the 85% we used in the initial acquisition!

This is important to note because we do not necessarily need a higher LTV for a refinancing to “work.”

If the property’s value increases by a significant percentage, the refinancing can boost the returns even if the LTV falls:

The net effect is that the equity investors here get a cash inflow from this refinancing in the year before the official exit, which boosts their returns:

Without this refinancing, the equity IRR would be ~18% rather than ~19%.

It’s not a huge difference here, but it would be more significant if it happened earlier in the holding period or the LTV increased.

How Can Properties Use Such High Loan to Value (LTV) Ratios?

Reading everything above, you might have one final question: How can properties support 60%, 70%, or 80% leverage when most real companies, even in leveraged buyouts, cannot use close to that much Debt?

The answer comes down to 3 main factors:

1. Properties’ Financials – Most properties tend to have high NOI margins – often 50% or greater – which are like EBITDA margins for normal companies. They also have relatively high yields, such as 5 – 10%, which means they can support significant Debt.
2. Long Amortization Periods – Even if a real estate loan remains outstanding for ~10 years, it may amortize over 20 or 30 years, which means the annual payments are lower than normal.
3. Special Terms – Finally, many real estate loans have interest-only periods that reduce the annual payments in the first few years. This allows properties to support even more Debt, especially when their NOI and cash flow numbers are lower in the earlier years.

Here’s a simple example to illustrate the math:

• Property Purchase Price: $10 million.
• Cap Rate: 7%, so the property generates $700K / year in Net Operating Income.
• Debt Used: $7 million (70% LTV) with a 5% fixed interest rate, 10-year maturity, and 30-year amortization.
• Cash Flow Available to Service Debt: $600K / year due to Capital Expenditures and other capital costs below the Net Operating Income line.
• Annual Interest Expense: $7 million * 5% = $350K.
• Annual Amortization: $7 million / 30 = $233K.

So, the Debt Service in Year 1 is $350K + $233K = $583K, while the Year 1 Cash Flow Available to Service Debt is $600K.

We’re cutting it close, but it is still possible to use 70% leverage to fund this deal, especially if the NOI increases over time:

By contrast, consider an amortization period of 10 years rather than 30 years.

The annual amortization would be $7 million / 10 = $700K, and the Interest expense would still be $350K, so the total Year 1 Debt Service would be $1.05 million.

But we only have $600K in Cash Flow, so we would lose money on the property in Year 1 and the next few years after that.

We’d have to contribute additional Equity to fund the property in the early years, which would reduce the returns (and lenders would never agree to a deal with a Debt Service Coverage Ratio well below 1.0x):

The Loan to Value (LTV) Ratio vs. the Debt-to-Equity Ratio

In some ways, the Loan to Value ratio in real estate is like the Debt-to-Equity ratio used in the valuation and credit analysis of normal companies, but there are some differences.

First, they use different formulas and measure different things.

If we assume that a company uses only Debt and Equity, then:

• Debt-to-Equity Ratio = Debt / Equity
• Loan-to-Value Ratio = Debt / (Debt + Equity)

The LTV will always be lower because the denominator is bigger. For normal companies, the LTV is normally labeled “Debt to Total Capital.”

Second, the Debt-to-Equity Ratio may be based on the Book Value of Equity (from the Balance Sheet or Statement of Owners’ Equity) or the Market Value of Equity.

We often use the Book Value for credit analysis but the Market Value in valuations, such as when calculating the Cost of Equity and WACC.

In real estate, though, the “Book Value of Equity” is irrelevant – only the Market Value of the property matters, and the LTV is always linked to this market value.

Third, with normal companies, the Debt-to-Equity Ratio is more of an “informational metric” or analysis output rather than a key driver.

For example, we might run a “stress test” for a company and evaluate how this ratio changes when the company’s growth rates or margins fall.

But we would not assume that the company’s Debt balance is based on this Debt-to-Equity Ratio.

Debt is normally based on a multiple of EBITDA, EBIT, Free Cash Flow, or another income-based metric.

But in real estate, Loan to Value (LTV) is the key driver that determines the Debt used in transactions.