Providence Lending Group | Development Finance
6 min read
KEY POINTS
- Development loan ratios generally test two different points in the project.
- The loan-to-cost ratio caps how much of the total project budget — land, construction, fees and contingency — a lender will fund.
- The loan-to-value ratio, based on the as-if-complete valuation, becomes the more relevant test as the project approaches completion and sale.
- A thin contingency or an optimistic completion valuation can make a loan-to-cost ratio look more favourable than the project’s real risk position supports.
- This article explains the mechanics only. How these ratios apply to a specific project depends on individual circumstances, and we’re always happy to work through it with you and your lender.
Developers comparing finance offers often focus on a single headline percentage, when a development loan is actually tested against two distinct ratios that measure different things at different points in the project. Confusing the two — or assuming a strong result on one automatically means a strong result on the other — is a common source of surprises later in the approval process.
Development loan ratios to know: Loan-to-cost vs Loan-to-Value
The loan-to-cost ratio measures the loan against what the project actually costs to build — land, construction, professional fees, finance costs and contingency combined. The loan-to-value ratio measures the loan against what the finished project is expected to be worth once complete, based on an independent valuer’s assessment rather than the developer’s own feasibility numbers. Both ratios matter, but they matter at different moments: loan-to-cost tends to dominate the funding decision at the outset, while loan-to-value becomes the more relevant test as completion and sale approach.
What sits inside the loan-to-cost ratio calculation
The loan-to-cost ratio is only as meaningful as the total development cost it’s measured against, and that figure needs to be genuinely complete. Land value, construction costs verified by a quantity surveyor, professional and consultant fees, statutory charges, capitalised interest over the construction period, and a realistic contingency all belong in the denominator. A total development cost that understates any of these — commonly capitalised interest or contingency — makes the loan-to-cost ratio look more conservative than the project’s actual risk position supports.
A loan-to-cost ratio is only as trustworthy as the cost figure sitting underneath it — and cost figures are where feasibility studies most often flatter a project.
Where the loan-to-value ratio comes in
The loan-to-value ratio is calculated against an independent valuer’s assessment of the completed project’s market value — not the developer’s projected gross realisation value, and not the sum of individual off-the-plan contract prices. This distinction matters because valuers tend to apply their own discounting to account for the risk of selling multiple similar units into one market at the same time, which can produce a lower figure than the presale contracts alone would suggest. It’s also an area APRA’s guidance on credit risk management flags directly, noting that ADIs are expected to consider portfolio limits for higher-risk exposures such as speculative development and high loan-to-valuation lending.
As a project moves toward completion, lenders increasingly rely on the loan-to-value position to judge how much equity buffer exists between the debt and the asset’s worth — which is also why an optimistic completion valuation assumed early in a feasibility study can create a gap that only becomes visible once an independent valuation is actually obtained.
Why contingency size affects both ratios more than it looks
Contingency sits inside the total development cost figure, which means it directly affects the loan-to-cost ratio, but it also functions as the project’s buffer against cost overruns that would otherwise erode the margin the loan-to-value calculation is implicitly relying on. A thin contingency can make a project look more efficiently funded on a loan-to-cost basis while quietly increasing the risk that cost overruns push the project toward — or past — the loan-to-value threshold a lender is comfortable with.
How the two Development loan ratios interact with presales
Presale cover and these two ratios aren’t separate conversations — they influence each other directly. A stronger presale position can sometimes support a higher loan-to-cost ratio than would otherwise be approved, because the presales provide independent evidence supporting the eventual loan-to-value outcome. Conversely, a project with a lean contingency and an aggressive loan-to-cost ratio typically needs stronger presale cover to offset the additional risk a lender is being asked to carry.
The considerations that deserve weight
A few points are worth keeping in mind when weighing up loan-to-cost against loan-to-value for a specific project:
- Total development cost needs to genuinely capture every cost, including capitalised interest and a realistic contingency, or the loan-to-cost ratio understates the project’s real risk.
- Loan-to-value is based on an independent valuer’s opinion, which can differ meaningfully from the developer’s own gross realisation figure.
- A thin contingency improves the loan-to-cost ratio on paper while increasing exposure on the loan-to-value side if costs overrun.
- Presale cover and these two ratios move together — a weaker position on one is often compensated for by strength in another.
Understanding your position
For a developer preparing a funding application, the useful exercise is stress-testing both ratios rather than just the more favourable one — running the loan-to-cost calculation against a genuinely complete cost figure, and sense-checking the loan-to-value assumption against comparable sales rather than the feasibility’s own gross realisation figure.
How these two ratios apply to a specific project, and which lender’s approach to contingency and valuation is the best fit, are questions we’re glad to work through with you before your feasibility study is finalised, not after.
Find out more about Development loans here.