Loan to value
Sector Deep DivesDebt divided by property value, the primary leverage measure in real estate and the one covenants are written against.
Also written: LTV
Loan to value expresses borrowings as a percentage of the value of the assets securing them. It is the real estate equivalent of a leverage ratio, and it is what lending covenants are typically written against.
Its danger is that the denominator is a valuation rather than an earnings figure, and valuations move with cap rates. A portfolio can breach an LTV covenant purely because yields widened, with every tenant still paying rent on time.
That is what makes real estate downturns self reinforcing. Falling values raise LTV, covenant pressure forces asset sales, and forced sales push values down further.
It is read alongside an interest coverage ratio, which is based on income rather than value and therefore does not move with sentiment. A borrower comfortable on coverage but tight on LTV has a valuation problem rather than a cash flow problem.
Worked example
A portfolio valued at 1,000 carries 550 of debt, so LTV is 55% against a 65% covenant.
Cap rates widen and the portfolio is revalued to 830. Debt is unchanged, but LTV is now 66% and the covenant is breached, with every tenant still paying rent on time.
Interest cover, which is based on income rather than value, would not have moved at all. That is why the two are read together: this is a valuation problem, not a cash flow problem.