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What Equity Multiple Means For Passive Investors
When you’re reviewing potential commercial real estate syndication investment options, you’ll likely come across the term “equity multiple.” It’s a term that you won’t see when you’re buying a primary home, or even when you invest in rental properties.
While real estate investing is an excellent way to diversify your fortfolio, minimize risk, and produce constant returns, in order to get the most out of it, investors must understand how to compare similar investments effectively. Unlike stocks and funds, commercial real estate is a private opportunity asset that does not usually provide the same level of insight into the qualitative factors.
Equity multiple, along with the Internal rate of return are two of the most effective calculations to compare the projected total profits of a commercial real estate syndication investment opportunity against the dollar invested.
In the video and blog post below, we’ll cover exactly what an equity multiple is, what you need to calculate equity multiple, and what it means for you as a passive investor.
It’s no secret that commercial real estate syndications have more complicated terminology, an entire list of (potentially confusing) metrics, and an entirely different cash flows procedure than other investments. We’re alongside you in the trenches and can’t let you stall out on your financial freedom journey just because you don’t understand how equity multiple works!
One of our investors shared with us that, after she had a grasp on what an equity multiple was, she was able to more confidently compare projected returns across potential investment opportunities and make wiser investment decisions.
So, here we are making sure that you have a solid resource for such information so that you too can make excellent, aligned investment decisions.
What Is Equity Multiple In Commercial Real Estate?
The term “equity multiple” is actually exactly what it sounds like. It’s the amount that your capital, or your equity, will be multiplied over the course of the projected hold time.
In commercial real estate syndications, the equity multiple is defined as the total cash distributions received from an investment, divided by the total equity invested.
Essentially, it is the amount of money that an investor may earn from their initial capital invested. An equity multiple less than 1.0x indicates that you are receiving back less cash than you put in. Conversely, an equity multiple more than 1.0x indicates that you are getting back more cash than you put in.
So, if a real estate syndication deal had an equity multiple of 2x over a projected hold time of 5 years, that means that you could expect to double your money during that 5 years.
The Equity Multiple Calculation
The equity multiple formula takes into account both the total cash flow distributions throughout the project, as well as the returns on the back end when the asset is sold.
For example, let’s go back to the deal with the 2x equity multiple. Let’s say you were to invest $100,000 into this deal. You want to know how much cash you might make compared to the capital (equity) invested.
Let’s say that this deal has a projected annual return of 8%. That means that you would get about $8,000 per year for 5 years. In other words, you would get about $40,000 in cash flow distributions over those 5 years.
Then, when the asset is sold, you would get your original $100,000 back, plus another, say, $60,000 in profit.
When you take the $40,000 from the cash flow distributions, plus the $60,000 from the sale, you get $100,000 in total returns. So you started with $100,000, and you end with $200,000.
Your calculation for equity multiples should look like this:
Total Cash Distribution / Total Equity Invested = Equity Multiple
or, when we insert the investment returns discussed in the example above, it looks like this:
(40,000 + 60,000) / 100,000 = 2
That’s what it means to have an equity multiple of 2x. You’ve increased your original investment by a factor of 2. In other words, you’ve doubled your money.
Why You Shouldn’t Rely Solely On Equity Multiple When Evaluating Private Investments
Equity multiple measures the total returns over the entire holding period in comparison to the cash you invested and has no measurement for time value or returns per year. This could mean that your returns on an annual basis will vary or that you may have a long period of time before the investment’s absolute return potential is reached.
Remember when I mentioned the Internal rate of return back there? Well, if you’re interested in consistent cash distributions over the holding period, and want the time value of money included in your calculations, then you’ll want to explore IRR in addition to equity multiple as part of your due diligence.
All of these metrics should be provided as part of the full investment underwriting process, and in addition to an equity multiple greater than 1.5x, you’ll want to carefully explore the tax benefits, illiquid period, the potential for cash calls, and other risks vs return details, especially on your initial investment.
How Goodegg Looks At Projected Investment Metrics
In the deals that we do, we typically aim for about a 2x equity multiple on your total equity invested over 5 years. This generally means that you can expect to double the cash value of your initial investment after a period of just 60 months.
Now, the sky’s the limit and higher equity multiples are possible, but those deals involve substantial risk. You generally won’t see us offering those as potential investments because risk mitigation and capital preservation are of extreme importance to us.
In other words, we won’t offer you a deal with a good equity multiple solely based on a metric that only measures the total cash distributions received. On deals with an equity multiple greater than 2.5x, it’s likely there are other risks involved with collecting those steep total cash distributions and our conservative underwriting process will come into play.
The important thing to keep in mind is that the calculated equity multiple, just like any projected returns, is projected. That means that the actual returns might not hit that, or they could far exceed that number.
In Preparation For Your Initial Investment In A Commercial Real Estate Syndication
So, now you know what it means for you as a passive real estate investor, how do you know how calculating equity multiple fits in with the rest of the projections you see in the investment summary for a potential real estate syndication deal?
For a walkthrough of a mock deal, be sure to check out our Anotamy of an investment Summary article. This will provide you a realistic look at a hypothetical investment and all its equity multiple vs internal rate of return details, and other important information you want to know prior to making your first investment in a real estate syndication.
Now that you’ve learned about equity multiple, why it matters to your investments, and how equity multiples are calculated, what will you do next? If you haven’t yet joined the onbridgecapital, what are you waiting for?
It’s free to join and inside you’ll gain access to our past and present portfolio items where you can see all the numbers for yourself!
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