What is Equity Multiple in Real Estate?
Equity Multiple is the process by which the total return on equity investment of a real estate is measured. So if this multiple on a particular investment is 2 times in 5 years, then it means that the equity that the person has invested will double in size in 5 years.
Explanation
- It helps to gauge the ROI made by your own money. If you have taken debt and it has helped to increase the return, then this multiple will increase. Every Industry has got a specific kind of measuring mechanism which helps them to portray the real return of investing in that industry. The most common measuring mechanism of return in the case of the real estate industry is equity multiple.
- Equity meansEquity MeansEquity refers to investor’s ownership of a company representing the amount they would receive after liquidating assets and paying off the liabilities and debts. It is the difference between the assets and liabilities shown on a company's balance sheet.read more the money invested from a pocket, or in other terms, the actual investor’s money that got invested. Multiple means folds. It shows how much fold your money has increased that you have invested in real estate. If the return on investment is 200% and you have only $200M, but you borrowed $400M more, so the total return will be 200% of (400 + 200) = $1200M. So this is coming out to be 1200/200 = 6 Times. Earlier the multiple without debt was 400/200 = 2 times. So leverage increases this multiple.
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For eg:
Source: Equity Multiple (wallstreetmojo.com)
Equity Multiple Formula
Equity Multiple = Present Value of the Investment / Amount of Money Invested
- Present value Of the Investment = This is the value of the property in present terms
- Amount of Money Invested = How much money is invested from the pocket of the investor
How to Calculate?
Below are the steps to calculate equity multiples.
- To calculate equity multiple, we need to know the money invested by the Investor. It is the initial investment.
- The next step is the projection or actual value of the property after a certain period.
This step is very important. In the case of property dealers, they will try to portray this figure BIG as they want to sell the property.
- Dividing the actual value of a property with the invested amount.
Examples
Example #1
David bought a property with $5M 10years ago. The present value of the property is $10M. Calculate the equity multiple of the property.
Solution:
Equity Multiple Formula = Present Value of the Property / Amount Invested
So David has earned a return that is equivalent to 2 times his investment in 2 years.
Example #2
Maxwell has bought a property for $8M 5 years back and is earning an income of $200,000 every year from the property. The current value of the property is $25M. Calculate his Equity multiple.
Solution:
Equity Multiple = (Present Value of Property + Income from Property) / Amount Invested
So Maxwell has earned a profit that is equal to 3.25 times his investment.
How does it work in Real-Estate?
It is used in real-estate to show the return from the investment. Real-Estate dealers show the projected multiple to buyers in order to sell properties. Investors find it easy to understand as the return is presented in multiple calculations. So an investor sees that if they invest money in real estate, then by how many folds will the money increase. So this method is quite popular in the real-estate world.
Equity Multiple vs. IRR
- IRR is the internal rate of return. It means what is the discount rate that is needed to make the future value of an investment equal to the present value of the investment now. It is the discount factorDiscount FactorDiscount Factor is a weighing factor most often used to find the present value of future cash flows, i.e., to calculate the Net Present Value (NPV). It is determined by, 1 / {1 * (1 + Discount Rate) Period Number}read more, so if the IRR is more than the interest rate that is prevailing in the market. Then it is logical to put the money in the investment and not invest it in market securities.
- It doesn’t compare the return with the return from the market. It shows how many folds your investment has gone up. So this return is more investor specific. It will change from investor to investor if an investor has invested a higher amount for a similar property than another investor. Then the equity multiple of the investor who has spent more will be less.
Advantages
- These are easy to calculate. There is no tough calculation involved in the calculation.
- It shows how much fold the investment will increase. Unlike other return calculations, where investors will have to calculate the future value by adding the returns year on year.
- It is inclusive of future value, income from investment as well as interest paid on capital. So this portrays the true picture considering all the factors.
Disadvantages
- It doesn’t consider the time factor. If the multiple throws a result of 2, it doesn’t specify whether the multiple 2 was reached within 1 year, 2 years, or 5 years.
- It doesn’t compare the interest rate that is prevailing in the market. It is more investor specific. If the initial investment changes, then equity multiple will also change.
Conclusion
It is a common method by which the total returnTotal ReturnThe term “Total Return” refers to the sum of the difference between the opening and closing value of all the assets over a particular period of time and the returns thereon. To put it simply, the changes in opening and closing values of assets plus the number of returns earned thereof is the Total Return of the entity over a period of time.read more from an investment is calculated. Property dealers often portray this multiple to sell properties. Investors should consider the time factor before considering the multiple. If there are two investments with equity multiple 2, then you should see the time frame. If the first investment has a time frame of 5 years and the second one with the time frame 10 years, then obviously you should consider the first investment.
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