Real estate can be a very attractive investment for investors looking to diversify their holdings, reduce portfolio volatility, or generate consistent returns. However, to choose the best real estate investment, investors must first learn how to compare the various available opportunities. The equity multiple is one of the most effective methods used to assess the attractiveness of specific real estate investment opportunities or compare them to their peers.
In this article, we’ll briefly discuss what you need to know about the equity multiple, give examples of how to use it, and present the pros and cons you should be aware of.
What is equity multiple?
Generally, “equity” refers to the money you place in a specific investment, and “multiple” refers to the multiplication concept. So, by putting it together, we get the definition of equity multiple. It is simply how many times your invested money (initial investment) might be multiplied if you choose to invest in a particular investment. For instance, an equity multiple that is less than 1 implies that you will get less than what you initially invested once you terminate your investment, while a multiple above 1 means that you are getting back more than you invested. Numerically, an equity multiple of 3.0x means that for every €1 invested, you’ll get back €3 in total.
Using equity multiple in real estate
The equity multiple is used in real estate to indicate the return on investment. It is a quick way to show investors how many times their money will grow if they invest in a specific real estate project. That’s why many real estate agents display the expected equity multiple next to their listing in order to facilitate the selling process.
The equity multiple formula
The below formula illustrates how to calculate the equity multiple:
Equity Multiple = Total Distributions / Total Equity Invested
Total cash distributions is the sum of all money received from a real estate investment
Total equity invested is the initial amount of money invested in return for owning part of the real estate
You can follow the below steps to calculate the equity multiple for a certain project:
- Step 1: Determine the amount of the initial investment
- Step 2: Project the amounts expected to be received over throughout the investment
- Step 3: Estimate the final value of the property once you want to exit the investment
- Step 4: Add the sum of distributions received and the final value of the property to get the total cash distributions
- Step 5: Divide the total cash distributions by the initial amount invested.
Example 1: A simple buy and hold
An investor purchased a plot of land two years ago for €100,000. We need to calculate the equity multiple assuming he did not rent it or generate any income during this period and is willing to sell it for €250,000 now.
Total invest capital = €100,000
Total Distributions = €250,000
Equity Multiple = Total Distributions / Total Equity Invested = 250,000/100,000 = 2.5x
So, by the end of this investment, the investor could increase his initial investment value by 2.5 times.
Example 2: Adding rental income
An investor purchased an apartment for €250,000, and the below schedule represents the expected cash flow to be received as rental income over the coming five years:
We need to calculate the equity multiple, assuming he will sell the apartment at the end of the fifth year at €300,000.
Equity invested = €250,000
The sum of the expected distributions over 5 years = €125,000
The final value of the property = €300,000
The sum of all distributions = €425,000
Equity Multiple = Total Distributions / Total Equity Invested = 425,000/250,000 = 1.7x
So, if the investor decides to invest in this real estate project, his initial investment value will increase by 1.7 times.
Example 3: Debt effect on equity multiple
Everyone can take out a loan and invest the amount in some project, so let’s illustrate how the debt affects the equity multiple.
Using the same assumptions as in the last example, and assuming that the investor takes a loan for €100,000 and that the annual interest amount to be paid on this loan is flat at €5,000 (total of €25,000), we need to calculate the new equity multiple.
Since the investor took out a loan to finance his investment, the initial equity is now lower at €250,000 – €100,000 = €150,000
The sum of the expected distributions over 5 years needs to account for the interest payments. So, the amount now is €125,000 – €25,000 = €100,000.
The final value of the property = €300,000
The sum of all distributions = €400,000
Equity Multiple = Total Distributions / Total Equity Invested = 400,000/150,000 = 2.7x
As shown in this last example, the equity multiple increased to 2.7x due to the inclusion of debt. Keep in mind that including leverage also increases your investment risk since if the project does not generate enough return to cover the loan payments or the property’s value deteriorates, you’ll still need to pay the debt.
Advantages and disadvantages of using equity multiple
- Simple and easy to compute
- It can be compared across different projects
- It takes all income and expenses into account
- It does not take time into account: an amount received/paid in year 1 is different than one received in year 5
- It isn’t easy to efficiently compare two projects with different time horizons: a 1.97x over two years cannot be compared to a 3.5x over five years.
The equity multiple is invaluable for real estate agents and investors. It is used to calculate the total return on investment very fast. However, using the equity multiple has some limitations since the time factor is not accounted for in the calculation. This metric can be used with other metrics, such as the Internal Rate of Return (IRR), when evaluating a potential real estate investment.
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