Equity Multiple
The equity multiple is a simple financial metric used to compare the income an investment has generated compared to the amount of capital input into it during a specific period of time, usually the length of time an investor plans to own an asset.
Equity multiple is a simple financial metric used to compare the income an investment has generated compared to the amount of capital injected into it over a specified period of time, most commonly the length of time an investor intends to own an asset.
The equity multiple metric is used to evaluate and compare different commercial real estate opportunities to see which offers a greater return, though it is best to use additional calculations — including cash-on-cash return or IRR calculations — to gain a more comprehensive view of an opportunity.
The higher the equity multiple is, the higher the return. If the multiple is greater than 1, it means the full investment has been recouped, and a multiple below 1 translates to an overall loss.
The Calculation
Before calculating the equity multiple, an investor should collect four data points:
Initial investment amount (purchase price), plus any capital expenditures
Divestment amount (sale price)
Income generated by the property per year
Length of investment holding period
The overall formula is simple, as seen below:
Equity Multiple = Total Cash Distributions ÷ Total Invested Capital
Your total cash distributions are, effectively, all income you realize from the investment. This would include your annual income from rents and other sources (multiplied by the number of years the asset will be held), plus the expected income from the sale of the property.
Your total invested capital, on the other hand, would include the acquisition price plus any (usually major) capital expenditures you are able to anticipate.
Simple Example
You plan to acquire a 50,000-square-foot self-storage asset for $3 million. You make your calculations, and anticipate that your rental income will be $100,000 per year. You plan to hold the asset for five years, selling it for $4 million.
In this case, your total cash distributions would be your annual rental income ($100,000 × 5 years, or $500,000) plus your expected sale price of $4 million. Thus, your total cash income would be $4.5 million.
Your total invested capital would simply be the price you paid on the investment, or $3 million.
$4.5 million ÷ $3 million = 1.5x Equity Multiple
If you then ran the same calculation on other potential investments, you could see at a glance which appears to offer a better return.
Realistically, however, equity multiple calculations take into account more factors than involved in the previous example. That $3 million acquisition? Let’s say that was a value-add purchase, and you invested $1.5 million to completely renovate the asset, plus you incurred additional maintenance costs of $100,000 per year.
This would increase your total invested capital to $5 million for that same five-year period. Of course, you would certainly charge higher rents for your newly renovated asset, and your sale price at the end of your holding period would also likely be significantly higher. These factors all generally would need to be included in your calculations.
Limitations
There are some notable limitations for using equity multiples in your investment calculations. For one thing, the length of time can often be misleading — imagine an equity multiple of 2x calculated on a 30-year term. Sure, the return is positive, but it ignores opportunity costs associated with such a long hold term, and it can be confusing if looking at investment opportunities with different hold times.
Also, due to the projected nature of many of the variables, a calculated equity multiple is by no means a guarantee that an investment will yield a solid return. Your expected sale price five years down the road may be completely unreasonable, or perhaps your property will have occupancy trouble. All of this can easily throw off your projected capital distributions.
Despite the potential for inaccuracy, this metric is still useful, but it usually should not be used on its own — other calculations can offer additional insights that an equity multiple does not encompass.
Other Calculations
Two useful metrics that should be considered alongside an equity multiple are internal rate of return, or IRR, and cash-on-cash return calculations.
An internal rate of return can be particularly useful in determining whether or not an investment opportunity is a strong one, as IRR calculations include the time value of money. Of course, a downside to this metric is that an investment with a higher IRR may have a lower equity multiple.
Cash-on-cash returns are essentially the same calculation as an equity multiple, but with two key differences: The result is expressed as a percentage, and it is calculated on an annual basis. This provides a much clearer picture of the annual returns on an investment, but it would not include the sale of the asset until the year it is sold.
Related Questions
What is an equity multiple?
An equity multiple describes how much money a commercial real estate investor can earn compared to her or his initial investment. It utilizes two figures: total equity invested and total cash distributions over a specified period of time. The Equity Multiple Formula is calculated by taking the total cash distributions divided by the total equity invested. For instance, if the amount of money invested in a property totaled $500,000, and the total cash distributions (after the sale of the property) equaled $1,000,000, the equity multiple would be ($1,000,000/$500,000 = 2). In general, equity multiples are based on the amount that’s derivative of the property sale.
How is equity multiple calculated?
Equity multiple is calculated by taking a property’s total cash distributions over a specific time period and dividing it by the total equity an investor has put into the property. It can be calculated by using the formula below:
Equity Multiple = Total Cash Distributions/Total Equity Invested
For instance, if the amount of money invested in a property totaled $500,000, and the total cash distributions (after the sale of the property) equaled $1,000,000, the equity multiple would be ($1,000,000/$500,000 = 2). In general, equity multiples are based on the amount that’s derivative of the property sale.
More information can be found at apartment.loans/posts/what-is-equity-multiple and www.multifamily.loans/equity-multiple.
What are the benefits of using equity multiple?
The main benefit of using equity multiple is that it provides an excellent determination of whether a property is likely to be a profitable investment or not. Equity multiple compares the amount of cash a property generates to the amount of equity invested, and when looked at alongside IRR (internal rate of return) and cash-on-cash returns, it can provide a comprehensive view of the profitability of a property. Equity multiple can also be used to compare similar properties in similar markets, allowing investors to get an idea of the general profitability of the market and how the property they want to purchase factors into it.
For more information, please see Equity Multiple and Equity Multiple Alternatives and Calculator.
What are the risks associated with equity multiple?
The risks associated with equity multiple depend on the time window of the investment and the potential risks of the investment. Investors should compare the equity multiple to other metrics, such as cash-on-cash returns and internal rate of return (IRR), to get a complete picture of the risks. For example, if the equity multiple is low compared to the other metrics, it could indicate a higher risk investment.
What are the different types of equity multiple?
The two main types of equity multiple are the short-term equity multiple and the long-term equity multiple. The short-term equity multiple is calculated by dividing the total cash distributions over a short period of time (usually one year) by the total equity invested. The long-term equity multiple is calculated by dividing the total cash distributions over a longer period of time (usually five years) by the total equity invested.
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How does equity multiple compare to other investment metrics?
Equity multiple is one of the most important metrics in commercial and multifamily real estate, and is used to compare the amount of cash a property generates to the amount of equity invested. When looked at alongside IRR (internal rate of return), and cash-on-cash returns, equity multiple can provide an excellent determination of whether a property is likely to be a profitable investment. While multifamily lenders may look at a property’s equity multiple, it is mainly used by investors. In comparison, lenders are more likely to look at other metrics, such as DSCR, LTV, or debt yield.