The Combined Loan to Value (CLTV) differs from the Loan to Value (LTV) by including all the loans on the property instead of just one primary loan. As discussed in the last post, the LTV is calculated by dividing the loan balance of one loan by the value of the property. The CLTV will add the amounts of all loans on the property and then divide the total by the value of the property.

For example, a property has a value of $800,000 and has two loans on it. The first loan is in the amount of $600,000 and the second loan is for $80,000. The LTV on this property is 75% (600,000 / 800,000) and the CLTV is 85% (680,000 / 800,000).

The lender for the prior example would be concerned with the CLTV on the property even though their money is more secure with the lower LTV of 75%.  They become more hesitant as that CLTV approaches 100%.  Lenders like to see owners with some “skin in the game.”

What is Loan-to-Value (LTV) Ratio?

The Loan-to-Value Ratio is calculated by dividing the amount of the loan by the value of the property. For example, if the property has a value of $800,000 and the loan amount is $600,000 then the LTV is 75% (600,000 / 800,000).

If the LTV is over 100%, as we often see in today’s market, then the property is considered to be “upside down.” Some will use the term “negative equity” to describe this situation. There is no equity in the property if the LTV is over 100%.

Lenders use the LTV Ratio when underwriting their loans. Generally, the LTV must be 80% or lower for conventional financing, 96.5% for FHA loans, and may be as high as 100% for VA loans. If the LTV on the loan is over 80%, then there is likely to be Private Mortage Insurance (PMI) added to the monthly payment.

Many investors use Hard Money Loans when purchasing or refinancing properties and these usually have stricter LTV requirements around 40-60%.

If there are multiple loans on the property, then an additional ratio is used called the Combined Loan To Value (CLTV).

Debt Service Coverage Ratio (DSCR) is calculated by dividing the mortgage payments by the net operating income. This number is used by banks when deciding whether or not to lend on a property. A DSCR of 1.0 means the net operating income is exactly enough to cover the mortgage payments. Banks generally like to see a DSCR of 1.1 or higher. Some lenders like it to be as high as 1.25.

To increase the DSCR, you could increase the net operating income of the investment. This can be done by increasing the gross rental income or decreasing the operating expenses. A decrease in the interest rate on the mortgage loan will also improve your DSCR.

Let’s use the example from last week. The Net Operating Income (NOI) was $69,000. The mortgage loan payment on the property was $60,000. Thus, the Debt Service Coverage Ratio (DSCR) is 1.15 (69,000 / 60,000). A small decrease in the utilities expenses of only $3,000 would actually increase the DSCR to 1.20 (72,000 / 60,000).

What Is Net Operating Income?

Net Operating Income is a measure of the business’s profitability from operations. It is the Income after deducting operating expenses but before deducting depreciation, amortization, interest and income taxes. It is also known as Earnings Before Interest and Taxes (EBIT).

As an example, let’s look at an apartment building with the following income and expense figures:

  • Gross Rental Income: $160,000
  • Laundry Income: $3,000
  • Management expense: $16,000
  • Utilities expense: $25,000
  • Maintenance expense: $35,000
  • Property Tax expense: $12,000
  • Insurance expense: $6,000
  • Depreciation expense: $45,000
  • Mortgage Interest expense: $60,000

The Net Operating Income would be $69,000 (160,000 +3,000 – 16,000 – 25,000 – 35,000 – 12,000 – 6,000)

Net Operating Income is part of the calculation of the cap rate which we covered last week. It is also used to calculate the debt service coverage ratio (DSCR) which we’ll cover next week.

Capitalization Rate (or “cap rate”) is a ratio used to calculate the value of an investment by looking at the annual net operating income as a percentage of the property’s cost. Cap rate is calculated as Net Income divided by Current Market Value.

For Example: If a building is worth $1,000,000 and has a net operating income of $100,000, then the cap rate is 10% (100,000 divided by 1,000,000.)

You can also use this formula to calculate the value of a property.

Since Cap rate = Net Income / Market Value,
then Market Value = Net Income / Cap Rate.

Thus, if an investor wants a cap rate of 11% on a building that’s generating $80,000 in net operating income, we would value it at $727,272 ($80,000 divided by 0.11)


Welcome to Rui Investments, the home page of Rui Azevedo.  In the following weeks we will begin posting articles and advice on real estate investing.  For further information, please contact us directly via the contact page.