Loan to Cost and Loan to Value: How Lenders Size a Development Facility

When a developer asks how much a lender will advance against a project, the answer is rarely a single number. Development lenders size a facility by testing it against two different measures: what the project will cost to deliver, and what it will be worth once complete. These are loan to cost (LTC) and loan to value, which in Australia is usually expressed as a loan to value ratio (LVR).

This guide, prepared by Amar Alamar of Blended Ventures, explains what each ratio measures, how lenders calculate the inputs, why the lower result usually sets the limit and what a developer can do when the debt does not cover the full cost.

What loan to cost measures

Loan to cost compares the facility limit with the total development cost. Total development cost is broader than the land price plus the building contract. Lenders typically include:

The land acquisition cost, including stamp duty and acquisition fees.

The construction contract sum and any separately procured works.

Professional fees for architects, engineers, town planners, project managers and quantity surveyors.

Council and authority charges, infrastructure contributions and connection costs.

Marketing and sales costs incurred before completion.

A contingency allowance, often reviewed by the lender's quantity surveyor.

Finance costs, including establishment fees, line fees and interest capitalised over the program.

The quantity surveyor's report is central to this test. It confirms that the budget is complete and that the construction cost is reasonable for the design. Where the lender's quantity surveyor considers an item to be missing or underestimated, the cost base rises and the available leverage on cost falls with it.

What loan to value measures

Loan to value compares the facility with the expected value of the completed project. For residential development this is usually the gross realisation value, meaning the total of the individual values of all the dwellings or lots, typically assessed net of GST. Some lenders also look at an as is value of the site, particularly for the land component of the facility.

The value comes from an independent valuation commissioned by the lender, not from the developer's feasibility or the selling agent's price list. Valuers assess the completed product against sales evidence in the area, and their figure can sit below the developer's expectations. Where presales are in place, the valuer will usually take them into account, but contract prices that sit above the market evidence may not be fully reflected.

Why lenders apply the lower of the two

Each ratio protects the lender against a different risk. The cost test makes sure the developer has a meaningful amount of its own capital in the project. The value test makes sure the debt can be repaid from the sale of the completed product, with a margin for price movement and selling costs.

Most development lenders set a maximum for each ratio and lend to whichever produces the smaller facility. Which one binds depends on the project's margin. A hypothetical illustration, using ratios only, shows how this works. Suppose a lender's policy allowed up to 80 per cent of cost and up to 65 per cent of end value. On a project whose end value is 1.25 times its total cost, 65 per cent of value equals about 81 per cent of cost, so the cost limit of 80 per cent applies. On a project whose end value is 1.15 times its cost, 65 per cent of value equals about 75 per cent of cost, so the value limit applies and the facility is smaller. These percentages are illustrative only and do not represent any particular lender's policy or current market terms.

A project with a thin margin is therefore constrained twice: it has less room for error and it also attracts less debt. The guide How Private and Development Finance Works for Gold Coast and Queensland Projects explains how lenders assess feasibility more broadly.

How capitalised interest affects the ratios

Interest on a construction facility is commonly capitalised, meaning it is added to the loan balance rather than paid monthly. Lenders generally include that interest in total development cost and require the facility limit to be large enough to cover it through to the expected repayment date.

This has a direct effect on sizing. A longer construction program, a slower expected sales period or a higher interest rate all increase the interest allowance. That allowance occupies part of the facility limit, so less of the limit is available for land and construction. If the allowance proves too small and the project runs late, the facility can run out of capacity before completion. Construction Finance in Queensland explains how progress draws and interest allowances are managed during the build.

Peak debt and equity in first

Lenders usually test the ratios at peak debt, the point at which the facility is fully drawn, which is normally at or near practical completion. They also tend to require the developer's equity to be contributed before the first advance is made, so the lender's funds go in last.

Equity can take several forms. It can be cash, the unencumbered value of the land, or capital from a third party. Where a site has risen in value since purchase, some lenders will recognise part of that uplift as equity and others will only count the purchase cost. That one policy difference can materially change how much cash a developer needs to find, so it is worth confirming early.

Funding the gap between debt and cost

Where the senior facility leaves an equity gap, developers commonly consider mezzanine debt, preferred equity or a joint venture partner. Mezzanine and preferred equity rank behind the senior lender and are priced higher, usually under an agreement that sets out each party's rights. They raise the total leverage on the project and also its blended cost of capital, so the feasibility needs to absorb that cost.

Once the project is complete, the same ratios reappear in a different form. A residual stock facility is sized against the value of the unsold stock, as explained in Residual Stock Finance.

What to prepare before approaching a lender

A developer can usually get a clearer answer on leverage by preparing:

A full feasibility with every cost line, including contingency and finance costs.

A quantity surveyor's cost plan or the builder's contract and schedule of rates.

The planning approval, design drawings and any presale contracts.

The proposed program, including the construction period and expected selling period.

Details of the equity available and its form.

Running both ratios before going to market shows which one limits the project and where the conversation with lenders is likely to focus.

The role of Blended Ventures

Blended Ventures is a finance brokering consultancy founded by Amar Alamar, working with property owners, investors, developers and business owners from the Gold Coast and Brisbane. It connects clients with private credit funds, non-bank lenders, banks and capital partners, and focuses on business, commercial and investment purpose finance.

For a development facility, each engagement starts with the feasibility, the cost plan and the developer's equity position, so that the structure presented to lenders fits both the cost and the value tests. More information is available at blendedventures.com.au.

Important information

This article is general information only. It is not financial, credit, legal or tax advice and does not take into account any person's objectives, financial situation or needs. Blended Ventures is a finance broker, not a lender. Any finance is subject to the relevant lender's assessment, credit criteria, security valuation and approval. Readers should obtain independent professional advice before acting.