What is an Equity Multiple?

What is an Equity Multiple?

An equity multiple is a tool used to measure the profitability/return on an investment. It is calculated through a formula that divides the total amount of money received (total distributions) by the total amount of money invested. It is a powerful measure in real estate as it is effective when comparing the attractiveness of different investments.

?Equity Multiple = Total distributions/Total capital invested

• Total distributions?comprise of distributions from the property sale (less any loan repayments), as well as the cumulative cash flow received during the hold period of the property.
• Total capital invested?is all the equity that was used to purchase the property and other capital costs such as refurb costs.

An equity multiple of less than 1.0x means that one would be getting back less cash than the amount that was invested throughout the hold period, ie the investment made a loss.?

Looking at an example, let’s assume we purchase a property for ￡10,000,000. Assume that ￡200,000 net operating income is received each year. An investor then sells the property for ￡22,000,000 after 5 years. In this case, the equity multiple calculation would be ￡23,000,000 ((￡200,000 x 5) + ￡22,000,000) divided by the initial purchase price of ￡10,000,000, which is equal to 2.30x. This means that for every ￡1 invested, you will receive ￡2.30 back at the end of 5 years.?

Looking at the same example above, but this time assuming the investor had a loan for ￡5,000,000 with annual interest payments of ￡150,000, the equity multiple would be 3.45x. In this case, leverage has helped improve returns, however it’s important to note that this won’t always be the case and it will depend how expensive the cost of debt is.?

While the equity multiple demonstrates the projected return on an investment and is a good comparison tool when analysing different properties, it ignores the crucial factor of time. If for example, the equity multiple is 2.00x, it doesn’t indicate whether this return is realised over 1 year, 5 years or 100 years! Therefore, in order to properly evaluate a potential investment, the equity multiple should be used alongside the Internal Rate of Return (IRR), as the IRR takes into account the time value of money. Refer to our previous blog on what an IRR is and how it is calculated?here.

It’s worth noting that neither the equity multiple nor IRR account for risk. Before acquiring a property, a thorough due diligence process must be undertaken in order to assess the risks inherent in a potential investment. The equity multiple could be very high, however the quality of the property could be low in terms of location etc and therefore all risk factors should also be considered alongside these two return metrics.?