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Understanding the Equity Multiple: A Comprehensive Guide

CEO Khai Intela
How to Calculate Equity Multiple? The equity multiple is a crucial real estate returns metric that compares the total cash distributions received by an investor on a property investment to the total capital contribution. It...

Equity Multiple

How to Calculate Equity Multiple?

The equity multiple is a crucial real estate returns metric that compares the total cash distributions received by an investor on a property investment to the total capital contribution. It allows investors to gauge the return on their investment quickly.

To calculate the equity multiple, you need to follow these steps:

  1. Determine the Total Equity Contribution ("Initial Outlay").
  2. Calculate the Sum of Cash Distributions Earned on the Investment.
  3. Divide the Total Cash Distributions by the Total Equity Contribution.

Equity Multiple Formula

The equity multiple formula is straightforward as it is the ratio between the total cash distributions and the total equity invested. The equity multiple is expressed in absolute terms, so it's important to consider other metrics alongside it when making investment decisions.

Equity Multiple = Total Cash Distribution / Total Equity Contribution

Equity Multiple vs. IRR: What is the Difference?

While the equity multiple is a useful metric, it has its limitations. It neglects the time value of money, which is an essential aspect of investment analysis. To overcome this limitation, it's important to combine the equity multiple with another metric called the internal rate of return (IRR).

  • Equity Multiple: The equity multiple represents the number of times the initial investment is anticipated to be returned over the project ("turns").
  • Internal Rate of Return (IRR): Unlike the equity multiple, the IRR is an annualized rate of return that considers the time value of money.

By using both metrics together, investors can gain a better understanding of the profit potential and risks associated with a property investment.

What is a Good Equity Multiple?

The equity multiple measures the earnings retrieved by an investor relative to the initial investment on a per-dollar basis. Here are some guidelines for interpreting the equity multiple:

  • Equity Multiple = 1.0x: If the equity multiple equals 1.0x, the investor breaks even in terms of profitability. However, it's important to consider the opportunity cost of capital.
  • Equity Multiple < 1.0x: If the equity multiple is less than 1.0x, the investor has incurred a loss.
  • Equity Multiple > 1.0x: If the equity multiple exceeds 1.0x, the investor has recovered their original investment in full and is earning positive returns.

Equity Multiple vs. Cash on Cash Return: What is the Difference?

The cash-on-cash return and equity multiple are often confused as interchangeable metrics. However, they serve different purposes and offer unique insights.

  • Cash on Cash Return: The cash on cash return is the ratio between the annual pre-tax cash flow the investor earns on the property investment and the invested equity.
  • Equity Multiple: The equity multiple measures the total return on the investment and is calculated by dividing the total cash received by the total equity invested.

While the cash on cash return focuses on cash income generated by the property, the equity multiple considers the overall return relative to the equity invested.

Equity Multiple Calculation Example

Let's consider an example to understand how to calculate the equity multiple. Suppose an investor acquired a property for $2 million and received fixed net cash proceeds of $300k annually for five years. If the property is sold at the end of Year 5 for $2.5 million, what is the equity multiple?

The total cash distribution is the sum of the positive cash flows from Years 1 to 5, which amounts to $4 million. Dividing the total cash distribution by the initial outlay gives us an implied equity multiple of 2.0x.

Equity Multiple = Total Cash Distribution / Initial Outlay = $4 million ÷ $2 million = 2.0x

Equity Multiple Calculator

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