Equity Multiple Alternatives and Calculator
What is Equity Multiple?
One of the most important metrics in multifamily and commercial real estate is Equity multiple, which, when looked at in conjunction with IRR (internal rate of return), and cash-on-cash returns, provides an excellent determination of whether a property is likely to be a profitable investment or not. Equity multiple specifically compares the amount of cash a property generates to the amount of equity invested. It is important to remember that equity multiple is tied to a period of time. Whether an equity multiple metric can be considered good or not depends on the time length involved. For example, an equity multiple of 2 over a 2-year period would mean that a property is extremely profitable, but if it was over a 10-20 year period, it would indicate that the property is more of a poor investment.
Equity multiple can also be used to compare similar properties in similar markets. Investors can scrutinize the average equity multiple in any given market and compare that figure to the equity multiple of a prospective acquisition. In this case they can get an idea of the general profitability of the market, and how the property they want to purchase factors into it.
Equity Multiple Calculator
The Equity Multiple Formula
The equity multiple of a property 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. To put it simply, equity multiple is calculated by taking the total cash distributions divided by the total equity invested.
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.
Equity Multiple and IRR
Internal Rate of Return, or IRR, is another metric that attempts to determine the profitability and effectiveness of a real estate investment. Because of this, IRR is often confused with equity multiple. But while equity multiple focuses on the cash that a property generates over a specific time period, IRR looks at the overall return for each dollar invested into a property. Additionally, IRR uses time value of money (TVM), whereas equity multiple does not.
The IRR formula*
*T = TIME, C = CASH FLOW, R = INTERNAL RATE OF RETURN, AND NPV = NET PRESENT VALUE.
Equity Multiple and Cash-on-Cash Returns
Equity multiple can be more accurately compared to cash-on-cash returns, as this metric also compares the amount of cash a property has generated over a specific period of time. Unlike equity multiple, however, the cash-on-cash return metric is reported as an annual percentage, while equity multiple is reported as a number, typically calculated over a period of several years.
The cash-on-cash return formula
Net Operating Income (NOI)/Total Cash Investment
Related Questions
What are the different types of equity multiple financing?
The different types of equity multiple financing include:
- Equity Multiple Loans - These are loans that are secured by the equity in a property. The loan amount is typically based on the equity in the property, and the loan terms are usually based on the borrower's creditworthiness.
- Mezzanine Financing - This type of financing is a hybrid of debt and equity financing. It is typically used to finance the purchase of a property, and the loan amount is based on the value of the property.
- Preferred Equity - This type of financing is similar to mezzanine financing, but the loan amount is based on the equity in the property. The loan terms are usually based on the borrower's creditworthiness.
It's important to speak with a multifamily financing expert to determine which type of loan is best suited for your specific needs. In the end, the most important thing is to be well informed and make the best decision for your investment and financial situation.
What are the advantages of equity multiple financing?
The advantages of equity multiple financing include increased leverage, which can lead to higher equity multiples, IRRs, and cash on cash returns. Financing can also reduce the amount of cash that must be invested in the beginning of a project. Additionally, if the levered equity multiple includes reversion (for example, the sale of the investment), the duration of the holding period is also important, as amortizing loans begin by contributing a greater amount of the payment to interest, slowly increasing the principal contribution over the life of the loan.
Sources:
What are the disadvantages of equity multiple financing?
The disadvantages of equity multiple financing include call protection (expensive prepayment penalties) and limited ability to recapitalize (with sale or refinance). Additionally, financing greatly increases leverage, which can reduce the cash that must be invested in the beginning of a project, but the extent to which it will do this depends on factors including interest rates, loan fees, and other expenses. If the levered equity multiple also includes reversion (for example, the sale of the investment), the duration of the holding period is also important, as amortizing loans begin by contributing a greater amount of the payment to interest, slowly increasing the principal contribution over the life of the loan.
How does an equity multiple calculator work?
An equity multiple calculator works 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. The formula for calculating the equity multiple is:
Equity Multiple = Total Cash Distributions/Total Equity Invested
For example, 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). Equity multiples are usually used to compare similar properties in similar markets. Whether a certain equity multiple is a good also depends on the time length involved.
You can use our equity multiple calculator to quickly and easily calculate the equity multiple for a property.
What are the most common equity multiple financing terms?
The most common equity multiple financing terms are loan-to-value (LTV) ratio, debt service coverage ratio (DSCR), and debt yield. LTV is the ratio of the loan amount to the value of the property, DSCR is the ratio of the net operating income to the debt service, and debt yield is the ratio of the net operating income to the loan amount. These metrics are used by lenders to determine the risk of a loan and the amount of leverage they are willing to provide. Additionally, the duration of the holding period is important, as amortizing loans begin by contributing a greater amount of the payment to interest, slowly increasing the principal contribution over the life of the loan.