Cash Flow Guys Podcast 297 - What Is An Equity Multiple
The term equity multiple is used by syndicators/deal sponsors as a fancy way to discuss return on investment.
Google Definition: Equity multiple is a metric that calculates the expected or achieved total return on an initial investment. It’s calculated through an equity multiple formula that divides the total dollars received by the total dollars invested.
Equity Multiple = Total Distributions / Total Invested Capital
Example 1:
An investor purchases a property for $100,000;
The property is sold for $200,000.
The deal produces a 2x equity multiple.
If the investor only receives $150,000 back, the deal delivers a 1.5x equity multiple.
Example 2:
An investor purchases a property for $100,000;
The property pays $7,000 a year in net operating income;
The investor sells the property for $165,000 after six years
In this case, the equity multiple calculations would be $207,000 divided by the initial purchase price of $100,000, or a 2.07x equity multiple.
Example 3:
Leverage Example:
An investor purchases a property for $100,000
The investor used a loan for $50,000 and put $50k down
The property pays $7,000 a year in net operating income
The annual interest payments on the loan of $2,500
The investor sells the property for $165,000 after six years
In this case, the equity multiple would be 2.84x. While leverage can amplify returns because the cost of debt is cheaper than the cost of equity, it’s important to remember it can also destabilize a project and amplify losses.
Equity multiple is an easy comparison tool because it provides a quick glimpse into the total profit investors can expect to earn on a particular investment, provided its successful.
Keep in mind that it’s dangerous to put too much weight on this metric when deciding a go/no go decision because this metric does not factor time. Internal rate of return DOES consider time in the calculation yet like other metrics also has its shortfalls. True IRR cannot be considered unless the asset has already completed a given cycle of performance and has been exited.