In commercial real estate, several concepts and calculations evaluate the performance of investments. The equity multiple calculates projected profits as well as reviews past performance. In this article, we discuss using and calculating the equity multiple. The formula uses basic variables common to any multi-family real estate syndication.
Why does the Equity Multiple matter?
In its simplest form, the equity multiple helps you get an idea of how much income generates in a particular investment opportunity. For example, an equity multiple of 2 indicates that the investment doubles, creating additional income in the same amount as the original investment. “Income” includes both the income gained during the investment period and at the sale. In other words, the equity multiple is the amount that the investment will multiply, during the life cycle of the investment deal.
So, in other words, if you invest $100,000 in a deal with an expected equity multiple of 2, the total income expected from the deal equals $200,000 or twice the initial investment. Alternatively, you could see it as receiving your initial investment back, as well as an additional $100,000. That income comes in the form of cash flow during the investment holding period as well as the lump sum achieved at the sale of the property.
How is it calculated?
Let’s use the expected annual rate of return to calculate the equity multiple of an example investment. If you are considering a $100,000 investment into a 5-year agreement with an expected 8% annual rate of return, it would give you approximately $40,000 in passive income during the 5 year holding period of the investment:
$100,000 initial investment x .08 = $5,000 per year x 5 years = $40,000 of passive income
Upon the sale of the property, your initial $100,000 would be returned plus $60K in additional gains from the profit of the sale. So, at this point, you’ve taken a $100,000 investment and across 5 years, turned it into $200,000.
The formula for equity multiple:
Equity Multiple = Total income distributed / total equity invested
So, plugging in our numbers, we see that:
EM = (passive income + sale profit + returned initial investment) / (Initial Investment)
EM = ($40,000 + $60,000 + $100,000) / $100,000
EM = $200,000 / $100,000
EM = 2
In conclusion, the equity multiple can help you use one number to compare several investment opportunities. EM can also be used to review the performance of a completed syndication.