Development Finance LVR vs LTC: Which Ratio Caps Your Loan

Key takeaways

• LVR in development finance is usually measured against gross realisation excluding GST; LTC is measured against total development cost, including finance costs.
• The lender calculates both and lends the lower amount, so the binding ratio depends on the project's profit margin.
• With illustrative caps of 65% LVR and 80% LTC, the LVR cap binds whenever profit on cost is below about 23%.
• In the worked examples, the same $10 million project needs $2.0 million of equity at a 30% margin and $2.525 million at 15%.
• Capitalised interest counts inside the facility limit, so the cash available for land and construction is less than the headline loan.
• Mezzanine finance can lift total debt above the senior cap, but its cost comes straight out of profit.

What do LVR and LTC mean in development finance?

On an ordinary property loan, LVR compares the loan with today's value. On a development loan, today's value is mostly land and a hole in the ground, so lenders measure against two things that describe the finished project instead.

Lenders define the inputs slightly differently. Some measure LVR against gross realisation including GST, some exclude selling costs, and some cap the land component separately against the land's current "as is" value. Ask each lender for its exact definitions before comparing offers. A lender quoting a higher LVR on a GST-inclusive basis may be offering less than one quoting a lower LVR on a GST-exclusive basis.

If the basics of how these facilities are drawn are new to you, start with construction and development finance; for ordinary LVR arithmetic, see LVR and equity: worked calculations.

Why does the lower answer set your loan?

Each ratio is a separate limit, and the lender must be inside both. Whichever produces the smaller loan is the binding constraint. For illustration, take a lender with caps of 65% LVR on gross realisation excluding GST and 80% LTC. These are examples, not any lender's policy; senior limits vary by lender, project and borrower (indicative).

The binding ratio depends on the margin. The LVR cap is 0.65 x realisation and the LTC cap is 0.80 x cost. They are equal when realisation is 0.80 / 0.65 = 1.231 times cost, that is, at a profit on cost of about 23.1%. Below that margin the LVR cap is smaller and binds; above it, the LTC cap binds.

That is a useful rule of thumb with your own lender's numbers: divide its LTC cap by its LVR cap to find the margin at which the two cross. It tells you, before you speak to anyone, which ratio your project will run into.

Worked example: when does the LTC cap bind?

For illustration, a project with total development cost of $10,000,000: land $3,000,000, construction and other costs $6,200,000, finance costs $800,000.

Here the cost cap binds. The lender would be comfortable with more debt against the end value, but not with the borrower having only $1.55 million of their own money in a $10 million project. A strong margin does not reduce the equity below 20% of cost with this lender.

Worked example: when does the LVR cap bind?

Same costs, but the finished product is worth less.

Now the value cap binds. The same costs need $525,000 more equity because the lender will not lend more than 65% of what the project will sell for. Note the double hit: project B has half the profit of project A and needs more of your cash. That is the lender's way of making a thin-margin project carry more of its own risk.

Valuations move this answer. If the lender's valuer puts realisation at $11,000,000 instead of $11,500,000, the LVR cap falls to $7,150,000 and the equity requirement rises to $2,850,000. This is why a late valuation can leave a deal short of money at the last minute.

How does capitalised interest affect the loan you can actually use?

Most development facilities capitalise interest: instead of you paying it monthly, it is added to the loan and repaid from sales. The lender therefore sets aside part of the limit as an interest allowance. In both examples the $800,000 of finance costs is inside the total cost, so in project A, $800,000 of the $8,000,000 limit is reserved for interest and fees, and $7,200,000 is available for land, construction and other costs.

Two consequences follow. First, if the program runs longer or rates rise, the interest allowance can run out, and the lender will usually ask you to top it up in cash before it funds further work. Second, the equity normally goes in first: in project A, your $2,000,000 pays the land deposit and early costs, and the lender's first draw comes only after your contribution is spent. Model the draws month by month with the development feasibility calculator so you can see when the facility reaches its peak.

Can land equity count towards your contribution?

Often, with limits. If you bought the site some time ago, or the development approval has lifted its value, the land may be worth more than you paid. Some lenders recognise part of that uplift as equity, measured by their valuer; others count the land only at cost, or cap how much of your contribution can be uplift rather than cash (indicative; it varies by lender).

For illustration, suppose project B's land cost $3,000,000 and is now valued at $3,400,000. A lender that recognises the uplift would treat $400,000 of the $2,525,000 equity as already contributed, leaving $2,125,000 of cash or other equity to find. A lender that counts land only at cost would not. The difference is worth asking about directly, because it can decide whether you need extra capital.

How does mezzanine debt sit above the senior loan?

When the senior cap leaves a gap you cannot fill with equity, mezzanine finance can sit between the senior loan and your equity. It ranks second: the senior lender is repaid first from sales, the mezzanine lender next, and you last. Because it is behind the senior debt, it costs much more, and the senior lender must agree to it, usually through an intercreditor or priority deed.

For illustration, in project B a mezzanine lender lends up to 85% of cost behind the senior loan:

At an illustrative 18% a year plus a 2% fee, fully drawn for 18 months, the mezzanine costs about $297,250 ($1,025,000 x 18% x 1.5 + $20,500). Profit falls from $1,500,000 to about $1,202,750, but your cash in falls by $1,025,000. That is leverage working in both directions: a smaller fall in prices now wipes out your equity. The trade-offs are covered in mezzanine and second mortgage finance, and the price of the alternatives in what private lending actually costs.

Much mezzanine money comes from private credit funds. Moneysmart's explainer on private credit notes that this lending includes construction and development finance, and many such funds operate as managed investment schemes regulated by ASIC under the Corporations Act.

How do lender types differ on LVR and LTC?

These patterns are general, and individual lenders vary widely. The RBA's Financial Stability Review examines the resilience of banks and non-bank financial institutions twice a year, which is worth reading if you rely on one type of lender to fund a long project. The ABS Lending Indicators release also reports new business lending for construction as its own purpose category.

What should you work out before you ask a lender?

1. Your total development cost, including finance costs and contingency.
2. Your gross realisation excluding GST, supported by comparable sales.
3. Your profit on cost, and from it, which ratio is likely to bind (divide the lender's LTC cap by its LVR cap).
4. The equity you need under each cap, and where it comes from: cash, land equity, or a second-ranking lender.
5. A downside case with the valuation 5% below your figure, to see how much extra equity a lower valuation would demand.

With those numbers ready, post one development finance request on ADS and 200+ verified lenders and brokers can ask about it.

Frequently asked questions

What is the difference between LVR and LTC in development finance?

LVR compares the loan with the project's end value, usually gross realisation excluding GST. LTC compares the loan with total development cost, including land, construction, fees, contingency and finance. Lenders apply both and lend the lower of the two results.

Which ratio usually limits a development loan?

It depends on the margin. Projects with strong profit margins tend to hit the LTC cap, because cost is low relative to value. Thin-margin projects tend to hit the LVR cap. With illustrative caps of 65% LVR and 80% LTC, LVR binds below about 23% profit on cost.

Does LTC include interest?

Usually yes. Lenders count interest, fees and other finance costs in total development cost, and capitalised interest sits inside the facility limit. That means part of the headline loan is reserved for interest and is not available for land or construction.

How much equity do I need for a development loan?

Total development cost less the loan the binding ratio allows. In the illustrative examples, a $10 million project needs $2 million of equity when an 80% LTC cap binds, and $2.525 million when a 65% LVR cap binds on a thinner margin. Some lenders count part of any land value uplift as equity.

Can mezzanine finance replace my equity?

Partly. A mezzanine lender can fund some of the gap above the senior loan, ranking second, but at a much higher cost and with the senior lender's consent. Most mezzanine lenders still expect you to contribute meaningful equity, and their cost reduces your profit.

Related reading

• Construction and Development Finance
• Mezzanine and Second Mortgage Finance
• LVR and Equity: Worked Calculations

Sources

• What is private credit — Moneysmart (ASIC)
• Managed funds and managed investment schemes — Australian Securities and Investments Commission
• Financial Stability Review — Reserve Bank of Australia
• Lending Indicators (business construction lending) — Australian Bureau of Statistics