What is an Equity Multiple in Commercial Real Estate?
The equity multiple is one of the most important and effective financial metrics used in commercial real estate. An equity multiple is designed to compare the cash that an investor has put into an investment to the amount of cash that the investment has generated over a specific period of time.
How to Calculate the Equity Multiple for a Commercial Property
In order to calculate the equity multiple for a property, one can use the formula provided below:
Equity Multiple = Total Cash Distributions/Total Equity Invested
So, for example, if an investor bought a property for $4 million, and received net cash flows of $300,000 each year, and sold the property after 5 years for the same $4 million, they would have an equity multiple of 1.37, as evidenced by the calculation below:
$300,000 * 5 years + $4 million = $5.5 million/$4 million = 1.37
So, in essence, for every $1 the investor were to put into this property, they could expect to get $1.37 back (before taxes) at the end of the five years.
Equity Multiple vs. Cash on Cash Returns
When we look at a property's equity multiple, we're basically looking at the exact same thing as the property's cash on cash return. However, a cash on cash return is usually a percentage expressed on an annual basis, whereas an equity multiple is often calculated over a multi-year period, and often includes the sale of the property by the investor in the calculation. To determine cash on cash return, one can use the formula provided below:
Cash on Cash Return = Total Cash Distribution (NOI)/Total Cash Investment
So, if we were to use the example above to calculate cash on cash return for the property over a typical one year period, we would find:
$300,000/$4 million = 7.5% Cash on Cash Return
If we multiply that number by the five years the property was held in the earlier example, we can get:
7.5% * 5 years = 37%
Now, all we need to do is add 1 (for the sale of the property at the original price of $4 million), and we have 1.37, the equity multiple for the property.