When analyzing potential real estate deals to invest in, you’ll come across the term “equity multiple.”The equity multiple is a commonly used performance metric in commercial real estate, but despite that, it’s not widely understood, especially among novice real estate investors.In this article, we’ll show you what equity multiple is, how it can be used to evaluate a real estate deal and share an example.
What is Equity Multiple?
Equity multiple is a key metric used in real estate investing to measure the total return on an investment relative to the initial equity invested. In this way, the equity multiple is similar to the ROI of the investment. The key difference between them is that the equity multiple is shown as a ratio whereas the ROI is shown as a percentage. Equity multiple is calculated by dividing the total cash distributions received from an investment, plus the final equity value, by the total equity invested. As a result, the equity multiple both the cash flow generated by the property and the appreciation in the property's value over the holding period into account. In this way, equity multiple provides a comprehensive view of the overall return on investment, making it a crucial metric for real estate investors to evaluate potential deals and compare investment opportunities.Equity multiple is particularly useful for value-add or opportunistic investments, where investors aim to enhance the property's value through improvements or repositioning.
Equity Multiple vs IRR
Another common metric you’ll see when evaluating potential multifamily investment opportunities is IRR. Equity multiple and Internal Rate of Return (IRR) are both important metrics in real estate investing, but they measure different aspects of an investment's performance.IRR is a time-sensitive metric that measures the annualized return on an investment, taking into account the timing of cash flows. It represents the discount rate at which the net present value of all cash flows (both inflows and outflows) equals zero.Equity multiple, on the other hand, is a simpler metric that measures the total return on investment relative to the initial equity invested, without considering the time value of money.While IRR is useful for comparing investments with different holding periods or cash flow patterns, equity multiple provides a straightforward measure of the total return achieved. As an investor, you should consider both equity multiple and IRR when evaluating real estate investment opportunities for a comprehensive understanding of the potential returns.
How to Calculate Equity Multiple
Equity multiple is fairly simple to calculate (especially compared to more complex figures like IRR). There are a few steps that you need to follow to determine the equity multiple of an investment though:
- Determine the total equity invested: Start by adding up the equity invested including any initial capital contributions and additional equity injections over the holding period.
- Calculate the cash distributions: Then add up the total cash distributions received from the investment, such as rental income, refinancing proceeds, and sale proceeds.
- Estimate the final value of the investment: This is the net proceeds from the sale of the property or the estimated market value at the end of the holding period.
- Add up and divide: Divide the total return (cash distributions + final value) by the total equity invested (Step 1) to arrive at the equity multiple.
The formula for equity multiple is:Equity Multiple = (Total Cash Distributions + Final Equity Value) / Total Equity Invested
An Example of Equity Multiple Calculation
You have the formula, but let’s break down an example equity multiple calculation for a multifamily real estate syndication deal to make this clear. Suppose an investor puts $250,000 into a multifamily real estate syndication. Over the 5 year holding period, the investor receives:
- $50,000 in cumulative cash flow distributions
- $425,000 in net proceeds at the sale of the property
This investor received a total of $475,000 in cash distributions on their $250,000 equity investment. The equity multiple is $475,000 / $250,000 = 1.9x. In five years, the investor nearly doubled their money - this shows the power of investing in real estate!
How to Interpret Equity Multiple
Equity multiple is a fairly straightforward metric. Like ROI, it shows the return on your investment - but what is a good equity multiple? And how can you compare deals by their equity multiples?
- An equity multiple less than 1.0x means the investor lost money. They received back less than their initial investment.
- An equity multiple equal to 1.0x means the investment broke even.
- An equity multiple greater than 1.0x means the investor made a profit. The higher above 1.0x, the more money the investor made.
The definition of a "good" equity multiple can vary depending on the investor's risk tolerance, investment strategy, and market conditions. However, here are some general guidelines:In general, an equity multiple between 1.5x to 2.0x is considered a good return for a low-risk, stable investment over a 5-7 year holding period. For value-add or opportunistic investments with higher risk profiles, investors may target equity multiples of 2.0x to 3.0x or higher over a shorter holding period (e.g., 3-5 years).It's important to note that higher equity multiples often come with increased risk, and investors should carefully evaluate the risk-return trade-off when considering investment opportunities.In general, investors look for opportunities with higher equity multiples, as it means they will make more money on their investment. However, equity multiple has to be balanced against other factors like time horizon, risk, and IRR.
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