As a multifamily investor, understanding the concept of loan to value (LTV) is crucial for making informed investment decisions. In this article, we’ll explore what LTV is, how it’s calculated, and why it’s important for multifamily investors like you.
What is Loan to Value (LTV)?
At its most basic level, LTV is the ratio of a property’s loan amount to its appraised value. For example, if a property is worth $1 million and the loan used to purchase it is $750,000, the LTV would be 75%.
Why is LTV important for Multifamily Investors?
LTV is an important metric for multifamily investors because it affects the amount of money you can borrow for a property. The higher the LTV, the more you’ll be able to borrow, but the riskier the investment becomes. On the other hand, a lower LTV means less borrowing power, but also less risk.
To calculate LTV, you simply divide the loan amount by the appraised value of the property and multiply by 100 to get a percentage. For example, if a property is appraised at $1 million and the loan amount is $800,000, the LTV would be calculated at 80%.
LTV Ratios for Multifamily Properties
In the recent market, as of March 2023, lenders are offering lower LTVs capping at 50% on a fixed rate loan. Over the last 3 years lenders were bullish on giving high LTV Bridge Debt with floating interest rates, which allowed us to borrow more money with interest only payments for up to 5 years.
However, since February of 2022 that all changed and the floating rate loans went from 3.75% up to 6% in a few months. This could make or break a business plan on a poorly run property.
The Risks of High LTV Ratios and floating rate loans.
While a high LTV ratio may give you more borrowing power, it also increases the risk of default. If the property’s value decreases, or if rental income is not sufficient to cover the loan payments, you may end up owing more than the property is worth. Also it is not a great time in the market to consider bridge debt with floating rates.
This is why it’s important to carefully consider the LTV ratio and fixed rate debt, when investing in multifamily properties. A lower LTV ratio may limit your borrowing power, but it also provides a greater margin of safety in case of unforeseen circumstances.
Fixed rate agency debt refers to debt securities issued by government-sponsored entities such as Fannie Mae or Freddie Mac. These securities are backed by the full faith and credit of the US government and offer a fixed interest rate to investors. Fixed rate agency debt is considered a low-risk investment because of the implicit government guarantee, and it is typically used by investors seeking a stable, predictable income stream.
Floating rate bridge debt, on the other hand, is a short-term debt instrument typically used to finance the acquisition of real estate. It is called “bridge” debt because it is meant to bridge the gap between the time when the borrower needs the funds and the time when they can secure longer-term financing. The interest rate on floating rate bridge debt is variable and typically tied to a benchmark rate such as LIBOR. This means that the interest rate on the debt will fluctuate over time, depending on market conditions.
The main difference between fixed rate agency debt and floating rate bridge debt is the level of risk involved. While fixed rate agency debt is considered low-risk due to the government guarantee, floating rate bridge debt is considered higher-risk due to its short-term nature and variable interest rate. Additionally, fixed rate agency debt is typically used by investors seeking a stable, predictable income stream, while floating rate bridge debt is used by borrowers seeking short-term financing to bridge the gap between the time when they need funds and the time when they can secure longer-term financing.
Loan to value (LTV) is a critical concept for multifamily investors to understand. By calculating the LTV ratio, you can determine the amount of money you can borrow for a property and assess the risk of the investment. It’s important to carefully evaluate the LTV for each investment opportunity and consider other factors such as fixed or floating rate debt, cash flow potential, location, and property condition before making a decision. With careful analysis and due diligence, you can find investment opportunities that meet your financial goals and provide a strong return on investment.