What is Loan to Value Ratio (LVR) and Total Development Cost (TDC)?

December 16 2024 by Mark Wei

Property development finance is a crucial aspect of the real estate industry, enabling developers to fund their projects and bring their visions to life. Two key finance concepts in this space are the Loan to Value Ratio (LVR) and Total Development Cost (TDC). Understanding these terms is essential for anyone involved in property development, as they play a significant role in securing financing and managing project costs.

Loan to Value Ratio (LVR)

The Loan to Value Ratio (LVR) is a financial term used by lenders to assess the risk of a loan. It is the ratio of a loan to the value of an asset purchased. In the context of property development, the LVR is calculated by dividing the loan amount by the appraised value of the property.

\begin{align}\text{LVR} = \left( \frac{\text{Loan Amount}}{\text{Appraised Value of Property}} \right) \times 100\end{align}

For example, if a developer seeks a loan of \$800,000 to purchase a property valued at \$1,000,000, the LVR would be:

\begin{align}\text{LVR} = \left( \frac{800,000}{1,000,000} \right) \times 100 = 80\%\end{align}

Lenders use the LVR to determine the risk associated with the loan. A higher LVR indicates a higher risk, as the borrower has less equity in the property. In Australia, lenders typically prefer an LVR of 80% or lower for residential properties. For commercial properties or development projects, the acceptable LVR may vary depending on the lender's policies and the specifics of the project.

Importance of LVR in Property Development

• Risk Assessment: Lenders use the LVR to assess the risk of lending. A lower LVR means the borrower has more equity in the property, reducing the lender's risk.

• Interest Rates: The LVR can influence the interest rate offered by the lender. Higher LVRs often attract higher interest rates due to the increased risk.

• Loan Approval: A high LVR may result in the loan application being declined or approved with stricter conditions, such as requiring mortgage insurance.

Total Development Cost (TDC)

Total Development Cost (TDC) refers to the complete cost of a property development project. It includes all expenses incurred from the initial planning stages to the completion of the project. Understanding TDC is vital for developers to ensure they have adequate financing and to manage their budgets effectively.

Components of TDC

• Land Acquisition: The cost of purchasing the land on which the development will take place.

• Construction Costs: Expenses related to building the property, including materials, labour and equipment.

• Professional Fees: Fees paid to architects, engineers, surveyors and other professionals involved in the project.

• Permits and Approvals: Costs associated with obtaining necessary permits and approvals from local authorities.

• Financing Costs: Interest on loans, lender fees and other financing-related expenses.

• Marketing and Sales: Costs related to marketing the property and sales commissions.

• Contingency: A reserve fund to cover unexpected expenses or cost overruns.

Calculating TDC

To calculate the TDC, developers need to sum all the individual costs associated with the project. For example, if a project includes the following costs:

Land Acquisition: \$500,000

Construction Costs: \$2,000,000

Professional Fees: \$200,000

Permits and Approvals: \$50,000

Financing Costs: \$150,000

Marketing and Sales: \$100,000

Contingency: \$100,000

The TDC would be:

\begin{align}\text{TDC} = 500,000 + 2,000,000 + 200,000 + 50,000 + 150,000 + 100,000 + 100,000 = 3,100,000\end{align}

Importance of TDC in Property Development

• Budgeting: Understanding the TDC helps developers create accurate budgets and avoid financial shortfalls.

• Financing: Lenders often require a detailed breakdown of the TDC to assess the viability of the project and determine the loan amount.

• Profitability: By comparing the TDC with the projected revenue from the sale or rental of the property, developers can assess the potential profitability of the project.

Relationship Between LVR and TDC

The LVR and TDC are interconnected in property development finance. Lenders use the LVR to determine the maximum loan amount they are willing to provide, which in turn affects the developer's ability to cover the TDC. For instance, if a lender offers a loan with an 80% LVR on a property valued at \$1,000,000, the maximum loan amount would be \$800,000. If the TDC for the project is \$3,100,000, the developer would need to secure additional financing or equity to cover the remaining costs.

Conclusion

In conclusion, understanding the Loan to Value Ratio and Total Development Cost is essential for successful property development. These financial metrics help developers secure financing, manage budgets and assess the profitability of their projects. By carefully considering the LVR and TDC, developers can make informed decisions and navigate the complexities of property development finance with confidence.