SS78: What is Equity Multiple?

Equity multiple is one of the most popular metrics used when comparing commercial real estate deals. What does it mean? Why not just use internal rate of return? In this episode, Charles explains what equity multiple is and why it is important when reviewing different investment opportunities.

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Talking Points:

When reviewing different real estate syndication deals, you will notice the most common projection metrics used are IRR or internal rate of return and equity multiple. What is equity multiple?
The equity multiple is defined as the total cash distributions received from an investment; divided by the total equity invested. If you invested $100,000 into a deal and the total returns you received were $150,000; the equity multiple is 1.5x. If you doubled your money, it would be 2x and if you lost money; it would be less than 1x.
Equity multiple is an easy comparison tool because it provides a quick look into the total return that investors can expect to earn from a specific investment.
The drawback with the equity multiple is that it leaves out one important factor; time. Time is calculated in the IRR but not the equity multiple.
If you invested $100,000 into a property and the property sells in 5 years and you have received $200,000 in total returns; your equity multiple is 2x. It is the same equity multiple if the majority of the money was returned in year 2 or year 4; which is a little misleading but that is why you need to utilize the equity multiple AND IRR when reviewing different deals.
When I see a new deal, after reviewing the projected equity multiple and the time horizon. I am able to loosely estimate the IRR. If someone says the property will have an equity multiple of 1.75x in 3 years; I can divide that 75 by 3 and see that the IRR will be AROUND 25%. If the estimated IRR is lower than that; I know that the majority of the returns will be in the later years of the investment (in this example, most likely at the sale).
In most scenarios, rule of thumb, the IRR decreases as the length of the investment increases. If the business plan is to perform renovations and raise rents by $300 per month; you want to do it as quickly as possible. If it takes 5 years vs 3 years to reach the $300 rent increase; your IRR will be less; of course, this does not take into consideration cap rate movement, the financing environment, the market, etc. but it shows that the less time your money is invested; usually the higher the IRR.
Another problem with IRR and equity multiple is that they do not accurately assess the risk of an investment. The investor needs to take these 2 metrics into consideration but they also need to perform their own due diligence to evaluate the risk.
The equity multiple may be a better metric for real estate investors that are looking for a total return projection.
The IRR may be a better metric for real estate investors who are looking to see what type of annual return they can expect.

Transcript:

Charles:
Welcome to Strategy Saturday; I’m Charles Carillo and today we’re going to be discussing what is equity multiple when reviewing different real estate syndication deals, you will notice the most common projection metrics used are IRR or internal rate return and equity multiple. But what is equity? Multiple will. The equity multiple is defined as a total cash distributions received from an investment divided by the total equity investment. If you invested $100,000 into a deal, and the total returns you received were 150,000. The equity multiple is 1.5 X. If you doubled your money, it would be two X. And if you lost money, it would be less than one X equity. Multiple is an easy comparison tool because it provides a quick look into the total return that investors can expect to earn from a specific investment. The drawback with the equity multiple is that it leaves out one important factor.

Charles:
Time, time is calculating the IRR, but not in the equity. Multiple. If you invest it $100,000 into a property and the property sells in five years and you’ve received $200,000 in total returns, your equity multiple is two X is the same equity multiple. If the majority of the money was returned in year two or year four, which is a little misleading, that is why you need to utilize the equity multiple and the IRR when reviewing different deals. When I see a new deal after reviewing the projected equity multiple in the time horizon, I’m able to loosely estimate the IRR. If someone says the property will have an equity multiple of 1.7, five X in three years, I can divide that 75 by three and see that the IRR will be around 25%. If the estimate IRR is lower than that, I know that the majority of the returns will be in the later years of the investment.

Charles:
In this example, most likely at sale in most scenarios, rule of thumb, the IR decreases as a length of the investment increases. If the business plan is to perform renovations and raise rents $300 per month, you want to do it as quickly as possible. If it takes five years for three years to reach the $300 rent increase, your IRR will be less. Of course, this doesn’t take any consideration cap rate movement, the financing environment, the market, et cetera, but it shows that the less time your money is invested, usually the higher the IRR. Another problem with IRR and equity multiple is that they do not accurately assess the risk of the, of an investment. The investor needs to take these two metrics into consideration, but they also need to perform their own due diligence to evaluate the risk. The equity multiple may be a better metric for real estate investors that are looking for a total return projection. The IRR may be better metric for real estate investors who are looking to see what type of annual return they can expect. So thank you for listening. Please remember to rate, review, subscribe, submit comments, and potential show topics at global investors, podcast.com look forward to tumor episodes next week. See then

Announcer:
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure, subscription documentation, and are subject to all applicable laws. Please consult an appropriate tax legal, real estate, financial or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of Syndication Superstar, LLC, exclusively.