Whether a commercial real estate senior loan is issued for an acquisition or a development, if it is sized to the the lender’s maximum specified threshold (whether Loan To Value–“LTV”, or Loan To Cost–“LTC”), and the lender is exercising wise underwriting standards, the statement the lender is in essence making is: “in the instance of borrower default, should we need to foreclose on the property, we feel that after foreclosure and transaction costs, in a quick-sale scenario, we will be able to recoup all of our unreturned loan principal based on the then-market price we will be able to achieve from selling the property after the foreclosure is complete.”
This might demystify why senior loan thresholds are currently often capped at around 60% LTV (perhaps as high as 80% currently, depending on a variety of factors). As lenders are not primarily in the business of owning and operating real estate, in a foreclosure and subsequent quick-sale situation, the lender feels that whatever amount remains outstanding of their original 60% LTV exposure on the property would be recouped without issue from the liquidation net proceeds.
It seems reasonable for the lender to bet that they will be able to sell for at least 60% of the market value of the property, right? I think so.
If you agree, using this same logic, you would also likely think that placing a senior loan with an LTV significantly above 80% would be pretty risky. And by extension, a 90%+ LTV is likely a foolish bet.
When we think back to the 1980s in the U.S., and how lenders were routinely placing loans at or even above 100% LTV, we see just how dangerous this was for them. As we all know, property values do not necessarily go up forever, so it is just a matter of time before loans of this level of exposure run into problems that then ripple throughout the system.
We need to always remember that quick sale transactions, where on a relative basis price is not sticky, and the LTVs that the likely sale pricing would imply, should serve as a sanity check on senior lender exposures to any one particular property.