In other terms: An equity multiple is a ratio that compares all of the cash distributions from an investment – including recurring cash flows as well as the return of the initial money invested – to the total equity invested in the venture. The equity multiple of a project is defined as the ratio of investment returns to the amount of capital invested in the project.
The equity multiple of an investment is analogous to the cash-on-cash return on a real estate investment. Unlike cash-on-cash return, which is typically given as a percentage on an annual basis, equity multiple is a ratio that is disclosed over the course of a company’s multi-year holding period of an investment.
Calculation of Equity Multiples
The equity multiple calculation considers both the overall cash flow distributions during the course of the project as well as the returns on the asset when it is sold. Let’s return to the deal with the 2x equity multiple as an example. Let’s imagine you’re willing to put $100,000 into this venture. You want to know how much money you could make compared to the amount of money you put in (equity).
Let’s say this investment has an expected annual return of 8%. That means you’d collect around $8,000 per year for the next five years. In other words, over the course of five years, you would get around $40,000 in cash flow distributions. When the asset is sold, you will receive your original $100,000 plus an additional $60,000 profit. Take the $40,000 from the cash flow distributions and add it to the $60,000 from the sale for a total return of $100,000. So, you began with $100,000 and ended up with $200,000?
The following is how you should calculate equity multiples:
Equity Multiple = Total Cash Distribution / Total Equity Invested
Similarly, if we use the investment returns from the previous example, it looks like this:
100,000 / (40,000 + 60,000) = 2
That’s what having a 2x equity multiple means. Your initial investment has grown by a factor of two. To put it another way, you’ve more than doubled your money.
When evaluating private investments, you shouldn’t rely solely on the equity multiple.
The equity multiple compares total returns over the whole holding period to the capital you invested, with no consideration for time value or annual returns. This could indicate that your annual returns will fluctuate or that you will have to wait a long time for the investment’s absolute return potential to be realized.
Do you recall how I mentioned the Internal Rate of Return earlier? If you desire steady cash distributions over time and want to account for the time value of money in your calculations, you should look into IRR in addition to the equity multiple as part of your due diligence. In addition to an equity multiple more than 1.5x, you’ll want to carefully examine the tax benefits, illiquid time, potential for cash calls, and other risks vs return aspects, particularly on your initial investment.
In preparation for your first investment in a commercial real estate syndication:
Having learned about equity multiples and what they represent for you as a passive real estate investor, how do you know how they fit in with the rest of the forecasts you see in the investment description for a potential real estate syndication deal?
Check out the Anatomy of an Investment Summary article for a step-by-step walkthrough of a mock investment transaction. In this section, you will get a realistic look at a hypothetical investment and all of the specifics surrounding it, such as the equity multiple against internal rate of return and other essential information you should be aware of before making your first real estate syndication investment.
Following your lesson on the equity multiple, why it is important to your investments, and how equity multiples are computed, what do you plan to do with your knowledge? You can contact us to guide you through to the next step.
