How lenders size a loan: LTV, DSCR and ICR
Your model says the deal works. Your lender says it does not. Both are right: you sized the debt wrong.
By the CRE Modelling team
Most people size a loan to LTV, stop there, and call it done. 60 percent of a £20m purchase is £12m of debt. Simple. The lender is not looking at LTV alone. They are looking at whether the building can service the loan.
The three constraints
- LTV says how much they lend against value.
- DSCR says how much the cash flow can carry.
- ICR says the same thing before amortisation.
Whichever is tightest is the one that sets your debt quantum. Not the one you prefer.
Why deals die at credit committee
In a low yield market at high rates, DSCR binds long before LTV does. You can be at 45 percent LTV and still be unfundable. Here is the sum, on a £20.0m purchase at a 4.2 percent net yield, with a loan at a 6 percent coupon amortising over 25 years (a debt constant of about 7.8 percent) and the lender asking for 1.35x cover:
| Line | Amount | |
|---|---|---|
| 1 | Purchase price | £20.00m |
| 2 | NOI at a 4.2% net yield | £0.84m |
| 3 | Loan at 45% LTV | £9.00m |
| 4 | Annual debt service at a 7.8% debt constant | £0.70m |
| 5 | DSCR (NOI ÷ debt service) | 1.19x |
| 6 | Cover the lender requires | 1.35x |
| 7 | Debt service the NOI can carry at 1.35x | £0.62m |
| 8 | Loan that debt service supports (÷ 7.8%) | £7.97m, about 40% LTV |
At 45 percent LTV the building covers the loan 1.19 times. The lender wants 1.35. The most it will lend is about £8.0m, 40 percent, whatever your LTV box says. This is why deals die at credit committee after the sponsor has already agreed a price.
So build both. Take the minimum. Let the model tell you which constraint is actually running your capital stack.
If your model only has an LTV input box, it is not a debt model. It is a wish.