Here’s how two little acronyms can define your cash flow business.
Loan to Value or LTV
LTV tells note investors how much the buyer or payer owes against the property. It helps answer an important question based on the buyer’s equity:
“What is the likelihood the payer will continue to make payments?”
Calculating LTV is fairly simple. Just add up all the money owed against the property and divide by the property value.
Example: A buyer owes $160,000 and the property is worth $200,000.
- Step #1: Take 160,000 divided by 200,000, which equals .80
- Step #2: LTV is usually expressed as a percentage so move the decimal two points to the right for an 80% LTV
- Step #3: The flip side of what a buyer owes and the part they own is called equity. Just take 100% and subtract the LTV to determine the buyer has 20% equity.
Be sure to remember two important things. Mortgage note buyers will use the current value of the property rather than the sales price. That means if the property value goes down so does the equity position.
LTV should also take into consideration ALL the outstanding loans. So if the payer has a first and second lien, you add both those together then divide by the value of the property. This is sometimes called CLTV or Cumulative Loan to Value.
Investment to Value or ITV
ITV shows how much a note buyer has invested in the real estate note. It answers:
“What is the likelihood the investor will get their money back if the buyer stops making payments?”
Calculating ITV takes the invested amount divided by the property value.
Example: An investor offers to pay $150,000 for the $160,000 note with a property value of $200,000.
- Step #1: Take $150,000 divided by 200,000, which equals .75
- Step #2: ITV is also expressed as a percentage so move the decimal two points to the right for a 75% ITV
- Step #3: If an investor says they will only invest up to 75% ITV then just reverse the calculation. Take the $200,000 value and times it by .75 to get a maximum investment of $150,000 (subject to yield and minimum discount calculations).
This example is for a first position residential note. ITV should also take into consideration any senior debt that will survive closing. If the purchase is for a second lien then you add the balance of the first lien to the investment amount and then divide by the value of the property. Second lien buyers may have additional restrictions and calculations when it comes to ITV.
Putting LTV and ITV Together
LTV helps determine risk. The higher the LTV, the lower a buyer’s equity, which equates to greater risk.
ITV helps minimize the risk. The LTV on an existing real estate note was determined when the seller carried back financing. It can’t be changed. So the note buyer tries to reduce risk by reducing exposure. The higher the risk, the lower the ITV offered by a note investor.
Of course other things determine risk including property type, credit, terms, and seasoning – to name just a few. But in the end the note buyer will use risk to decide on what yield and ITV they will need to make the deal happen.
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