It’s important that you understand your options when you are looking to invest money. You may be familiar with the term ”equity multiplier” when it comes to real estate investing. What is equity multiple and how can you maximize your return?
This blog post will explain how equity multiple calculations can help you with your investment strategy.
What is Equity Multiple in Real Estate?
The equity multiple is the ratio between the total cash profit and the initial investment in commercial real estate or other possible investments.
The equity multiple is often used to measure the performance of an investment . It helps real estate investors determine if they are receiving a good return for their money invested.
Divide the total cash distributions (or returns), by the initial investment amount to calculate equity multiple. Equity multiples are calculated differently depending on the type and size of real estate deal.
A higher return on an investor’s initial capital is indicated by a higher multiple , while a lower multiple means that the total profit relative to their cash invested is less.
Investments with higher equity multipliers tend to be attractive and desirable for the investor’s goal . This is because they maximize their dollar invested. As explained below, don’t just rely on the equity multiple when evaluating a potential investment.
Equity Multiple Formula with Examples
The equity multiple can be used to calculate the return on cash over the holding period.
Divide the total net profit and current investment value divided by the original invested amount to calculate the equity multiple.
Leveraged equity multiple is useful for assessing investments that need a long-term hold period but it does not take into account other variables such as tax benefits or risks. Therefore, to improve accuracy, the levered multiplier should be used in conjunction with other qualitative factors.
- Example 1: Equity Multiple when Investment Produces No Rental Income
Robert bought his house 10 years ago at a cost of $200,000.
-> current value/purchase price
Calculated equity multiple: $500,000/$200,000 = 2,5 Robert’s investment has more than doubled over the course of his entire holding period.
A equity multiplier greater than 1.0x indicates that the investment has or will grow.
- Example 2: Equity Multiple in Commercial Real Estate or Similar Investments
James invested $200,000 a decade earlier in office space. The investment is worth $500,000 in addition to his $25,000 a year rental income.
Divide the equity by (current value + rental)
[$500,000 + (25,000 x 10 Years )]/$200,000= 3.75. James’ commercial real estate investment has almost quadrupled over the same period of time.
- Example 3: Equity Multiple with Crowdfunding
John concentrated on the exclusive investment opportunities provided by equityMultiple, and invested $200,000.00 in commercial real estate with significant upside potential. Over the past 10 years, this investment has generated an average annual return of 8%. This earned him $240,000 in cash flow.
(total distributions in cash + initial investment)/initial investments
($240,000 + $200,000)/$200,000 = 2.2. This equity multiplier measures John’s return of over $2 per dollar invested.
What is a good equity multiple?
A higher equity multiple than 1 means that the investor will get more money (returns). Anything below that suggests that an investor earns less cash than invested.
Another measure of a good equity multiple is the ability to generate cash flow that exceeds operating costs and covers all expenses.
What does a 2x equity multiple mean?
The 2x equity multiplier describes an investor who earns twice the amount of cash as their total equity invested.
Investors will be happy to see this outcome, since it means that their investment is producing significant returns during the holding period. A return of more than 2 equity multiple is considered a strong return. This depends on how long you hold the investment.
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Does the Return on Investment (ROI) mean the same as the Equity Multiple?
The equity multiple is a ratio, not a percentage. This is in contrast to the ROI (return on investment), which uses a similar method.
The calculation of equity multiples and ROI are similar. However, the return on investment takes only into consideration your additional money, leaving out all equity invested.
Looking back at
Cash on Cash Return vs Equity Multiple
Investors use the cash-on-cash-return metric to measure their investment success.
The cash-on cash return rate evaluates the business plan of a property, and its possible cash distributions throughout its life. This gives investors and entrepreneurs valuable data that will help them make informed decisions.
The Equity Multiple Formula: Final Thoughts
The equity multiple is a quick way to understand the return on investment for a project.
Divide your total return over time by the amount of equity you invested to calculate equity multiple.
Commercial real estate, unlike stocks and funds is a private asset that doesn’t provide as much insight into qualitative factors. This information can also be used to add context to an IRR when analyzing a series of cash flows. It will help you quickly assess the absolute return potential.
The equity multiple can be a useful metric but it is important that you do not rely on it exclusively when evaluating private investment.
Investors that understand the relationship between the two metrics can make better decisions and select the best investments with the best outcomes.