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
- This 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 means 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.
Equity Multiple Formula
- 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?
Step 1: To calculate equity multiple we need to know the money invested by the Investor. This is the initial investment.
Step 2: 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.
Step 3: 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:
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:
So Maxwell has earned a profit that is equal to 3.25 times his investment.
How does it works in Real-Estate?
This 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. This 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. This is the discount factor, 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
This is a common method by which the total return 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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