LTV and DSCR

Lenders ask two questions about a loan. If things go wrong and we have to sell, will we get our money back? And can the property's income pay the loan in the meantime? LTV answers the first and DSCR the second.

Loan-to-value (LTV) = loan amount ÷ property value. A $6,000,000 loan on a $9,000,000 building is about 66.7% LTV. The rest, the owner's equity, is the cushion: values can fall a third before the loan is under water. Lenders set a maximum, often somewhere from 60% to 75% for commercial property depending on the type of property, the market and the lender.

Debt service coverage ratio (DSCR) = NOI ÷ annual debt service, where debt service is a year of loan payments, interest and principal. A DSCR of 1.25 (often written 1.25x) means the property earns $1.25 for every $1.00 it owes the bank each year. Below 1.00 the income doesn't cover the payments. Minimums of about 1.20x to 1.35x are common, higher for riskier property.

value, loan = 9_000_000, 6_000_000
noi = 560_000
annual_debt_service = 430_000
print(f"LTV {loan / value:.1%}")
print(f"DSCR {noi / annual_debt_service:.2f}x")

A loan must pass every test, so the largest loan is the smallest of the amounts each test allows. With a 70% LTV limit on a $9,000,000 building, LTV allows $6,300,000. With a 1.25x minimum and $560,000 of NOI, the payments can be at most $448,000 a year; at 6.5% interest with 30-year amortisation, that supports a loan of only about $5,900,000. The loan is $5,900,000: DSCR is the test that binds.

When rates are high, DSCR usually binds; when they're low, LTV usually does. That's why the same building can borrow much less when interest rates rise, even at the same value.