The loan-to-value ratio (LVR) is one of the most common and widely used metrics in the world of property finance. For financiers, it is broadly used to manage and mitigate credit risk when creating a loan facility. For property developers and investors, understanding LVRs and their application in credit analysis will provide insight as to the likely challenges you will face when seeking a loan, as well as assist in identifying the best finance partner for your project.
It is important to remember that the simple loan-to-value ratio is only one metric used by lenders to assess credit risk. Other considerations extend to: the capacity of the client, past performance, the team of people appointed to the project (and their relevant experience), the form of pertinent contracts, relevant consents and a projects feasibility. Such considerations are generally summarised within the 5Cs of credit.
We’ve created this article to explain LVR’s and their implementation in development finance – enabling you to head into the lending process with your eyes wide open.
The Loan-to-Value Ratio
The loan-to-value ratio is a percentage that indicates how much of a property’s value is funded by debt vs. borrower’s equity (cash or otherwise). For example, if a property is worth $1,000,000 and the borrower has current borrowings of $800,000 the LVR would be 80%. A higher LVR is typically associated with greater credit risk, as there is less margin of safety for the lender between the funds lent and the property’s value.
LVRs and property type
Each class of property (residential, investment, commercial, industrial, bare land etc.) has its own unique set of characteristics which influence the risk profile of the property class. In response, and to take the variable risk profile of each asset class into consideration, lenders look to adjust their LVR’s.
For example, most lenders adopt a lower maximum LVR when lending against vacant residential land (50–65%) than they do when lending against a residential dwelling (up to 90%). This is because bare land usually has no holding income, requires improvement to be enjoyed, and has a shallow buyer pool when compared to standard residential property, making it more susceptible to price corrections.
Development loans – As-is & complete values
When putting a development loan facility in place, a lender will assess LVR positions both at the start and at the end of the development. A lender will ask:
- what is the initial exposure? (being the initial advance vs. as-is value), and
- what is the end exposure once the project is complete? (development facility limit vs. the projects completed value)
A development facility can split into an upfront initial advance, and a progress payment facility (used to fund the build). The initial advance is secured against the value of the property on an as-is basis (this tends to be land only). In instances where there is an existing dwelling on site, it is often removed during the early stages of the development to enable civil works; therefore, no value is attributed to it.
A skilled lender will ensure the initial advance LVR falls within an acceptable range for lending against bare land. This is an important metric as it will dictate what funds you will be able to obtain to purchase a property or refinance an existing property before the development commences. At ASAP Finance, this threshold tends to sit between 60-75%.
The second test applied ensures that end (as-if complete) position meets LVR requirements. This is simply the full development facility measured against the ‘As If Complete’ valuation which assumes that the proposed development work is already complete. This is done by obtaining a valuation or assessing the value from plans and specifications against comparable sale data and listing. At ASAP Finance, we lend up to 75% of the completed project value for standard residential developments. Noting that the completed value can be inclusive or exclusive of GST depending on the nature of the project and the client’s intentions.
Consider your GST position
When calculating LVR’s for a property development you must consider your GST position. If you are in the business (or intend to be in the business) of buying, selling, developing, or building residential properties, then you will likely need to register for GST. This means that all the figures within your project feasibility should be on a GST exclusive basis (including the purchase price and end values of your property).
To calculate the GST exclusive value of a property, simply divide the end value by 1.15. For example, if you are building 8 townhouses worth $1,150,000 each, the assumed end value would be: (1,150,000 x 8 units)/ 1.15 = 8,000,000. As you can see, forgetting to take GST into consideration can have a catastrophic effect on your LVR position.
Choosing a Non-Bank Lender for Your High-LVR Loan
Maximum LVR thresholds differ significantly between main bank and non-bank lenders. Deposit taking institutions who operate in a heightened regulatory environment (RBNZ) have restrictive funding conditions that result in lower LVR thresholds. In contrast, non-bank lenders (especially those who have access to private funding) have greater flexibility as to the implementation of LVR’s, enabling them to finance projects that would otherwise not get off the ground.
Why choose ASAP Finance?
Our independence enables us to work with our clients to customise their loan terms to suit the development they are undertaking. By choosing ASAP Finance, you gain a partner in the development process. We avoid enforcing onerous conditions that are restrictive to funding enabling you to focus on what matters most.
We specialise in development finance – with over 50 years in cumulative development experience across the ASAP team, we offer valuable insight into the viability of a project that other lenders don’t have. All of our lending managers possess real world development experience. We are able to walk alongside you during the development, offering advice and guidance at times when they are needed most.
Fund your next project with the market leading non-bank lender in New Zealand.
We partner with investors, developers, and home builders, walking alongside them from application all the way to the completion of the loan. From short-term bridging loans to development financing, our bespoke lending packages are made to get your development off the ground.
Reach out to one of our highly experienced lending managers today to discuss your application ASAP.