Equity Multiple Real Estate Dallas, Texas
Equity multiple is a performance metric that is commonly used in commercial real estate. It is what investors use to measure the performance of real estate opportunities.
It is a metric that is used to calculate the expected or achieved total return on an initial investment.
Equity multiple is the total cash distribution received from an investment divided by the total equity invested.
For example, if the total cash distribution received from a project is $2,000,000 and the total equity invested in the project is $1,000,000, the equity multiple will $2,000,000 divided by $1,000,000 which is $2x.
When an equity multiple is less than 1.0x, this means that you are getting less cash than you invested as an investor. When an equity multiple is more than 1x, it means that you are getting more cash than you invested.
From the example cited above, it means that an investor is expected to get $2 for every $1 invested. The $2 includes the $1 initial investment.
Equity multiple doesn’t put time into account. It ignores the time value of the money. This means it is much better if the holding period is 1 year rather than 10 years. This is why an investor needs to consider the equity multiple of an investment against similar investments.
Equity multiple is often reported along the Internal Rate of return (IRR).
What is the Internal Rate of Return?
Internal Rate of Return (IRR) measures the percentage rate earned on each dollar invested for the period it was invested while equity multiple measures how much cash an investor will get from an investment.
IRR and equity multiple are usually reported together because they complement each other. The difference between them is that they measure two different things.
IRR takes into account the time value of money but equity multiple does not take the time value of money into the account.
Equity multiple is a performance metric that puts IRR into perspective by summing up the return on investment in absolute terms. It does this by describing the amount of cash investment that will yield over the entire holding period.
Accessing risk in real estate investments
Neither equity multiple nor IRR adequately account for risk. Investors should pay adequate attention to the risks inherent in a project as part of the due diligence process.
This is very important especially if high equity multiple opportunities are projected for low-quality properties or if the financing is inherently risky. Investors owe it to themselves to adequately consider all the risks involved before acquiring an investment even if the deals are particularly attractive with upside potentials.
It is important for investors to be skeptical of deals advertised, particularly with high equity multiples. This is because most metrics in real estate are projections, not certainties. Investors should adequately examine which key assumptions drive a deal with high equity multiple.
Investors should keep in mind that the metrics do not consider all factors and should be analyzed as part of the due diligence process.
Equity multiple is a very important tool for real estate investors. It is recommended that you pair equity multiple with IRR when evaluating a potential real estate investment and appropriately analyze the risk in order to identify the investment that best meets your investment criteria.