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Have you considered using premium steel for your business construction project? Whether you are planning to build a coffee shop, manufacturing plant, or car dealership, it is essential to understand how commercial lenders function to ensure that your project is viable.
Before a reputable commercial lender invests in any project, he will plug several criteria into specific profit formulas that consider such factors as:
Is the project plan written, detailed and well-thought out?
What is the income potential?
Is the potential profit margin large enough?
What is the LTV (Loan-to-Value) Ratio?
What is the LTC (Loan-to-Cost) Ratio?
What is the Net Worth-to-Loan Size Ratio?
What is the Debt Service Ratio?
In this article, we’ll focus on the definition and calculation of the financial ratios. Then we’ll briefly discuss some financing options.
LTV Ratio
Generally speaking, a higher LTV Ratio lowers the risk of an investment. LTV is computed as follows: (Construction Loan Amount / Estimated Fair Market Value) x 100 = LTV%
Example: Loan Amount = $300,000, Est. Fair Market Value = $500,000
(300,000 / 500,000) * 100 = 60%
Popular American business investments such as self-storage units, retail properties, and industrial steel manufacturers may offer LTV Ratios as high as 70% to 80%.
LTC Ratio
LTC Ratio is computed with a similar formula as the LTV, substituting the estimated cost of building construction for the estimated fair market value:
Example: Loan Amount = $300,000, Est. Cost of Building Construction = $400,000
(300,000 / 400,000) * 100 = 75%
In general, the LTC Ratio should be higher than the LTV Ratio. In other words, the definition of a viable construction project implies that the whole business (land value, inventory, building, furnishings, etc.) should be worth more than the construction cost of the building that houses it.
Net Worth-to-Loan Size Ratio
Lenders prefer businesses that have a Net Worth (assets minus liabilities) that is at least equal to the loan amount. Net Worth divided by Loan Amount should equal approximately one. Once again, higher is better.
Debt Service Coverage Ratio is calculated by dividing annual operating income by the mortgage payment. Lenders favor a minimum Debt Service Coverage Ratio of 1.25, while a result of 1.0 is considered break even.
Loan Options
If your ratios are not optimal, you may choose to seek out an equity partner to reduce the necessary loan amount. Once you have acquired sufficient investment capital to convince the lender that your project is worthwhile, you’ll work with the lender to select the right financing for your situation.
Permanent Loans (Takeout Loans)
Construction loans are commonly satisfied through permanent loans, also called takeout loans. Once your building loan is approved, construction can begin. Generally, repayment begins when the project is completed.
Alternatively, you may negotiate a forward takeout commitment, which is a promise to repay the takeout loan after the site is rented at the goal rental rate.
Mezzanine Loans
A mezzanine loan loosely correlates to a second mortgage, but it is guaranteed by the stock of the company that controls the land, as opposed to the value of the landholding. Mezzanine loans are usually very large–a minimum of $2 million–and at least $10 million collateral is required. To analyze the viability of a mezzanine loan, the financier particularly scrutinizes the Loan-to-Cost Ratio, expected to be at least 70-80%.
The Bottom Line
Pre-fabricated premium steel buildings are usually more economical than comparable conventionally built structures; even so, they likely require a substantial investment. Like you, commercial lenders are in business to make money. Your building project must be financially beneficial to the lender, to you and, perhaps most of all, to the success of your business. The better you understand the financial implications, the better able you will be to determine which, if any, loan is right for you.
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