Loan-to-Value Ratio (LTV)

Loan-to-value ratio is the loan amount divided by the property's value, expressed as a percent. A $375,000 loan on a $500,000 property is 75% LTV. In cap rate analysis it is the weight that blends debt and equity returns in the band-of-investment method, and it decides how much leverage amplifies or drags the return.

In the band of investment, the cap rate equals LTV times the mortgage constant plus (1 minus LTV) times the equity investor's required cash return. With 75% LTV, an 8.2% constant and a 6% equity requirement, the implied cap rate is about 7.6%. Change any input and the cap rate buyers can pay moves.

For an investor, LTV sets how far the cap rate versus mortgage constant comparison reaches. When the cap rate is below the constant, higher LTV means a lower return on cash and a thinner DSCR. When it is above, higher LTV magnifies the gain. Most investment loans cap at 75 to 80% LTV on purchases and 70 to 75% on cash-out refinances.

Further reading: Loan-to-Value Ratio (LTV) on Wikipedia.