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Equity Multiple in Commercial Real Estate
Use our calculator to find your equity multiple, comparing the cash an investor has put into an investment to the amount of cash the investment has generated over a specific period of time.
- What Is an Equity Multiple in Commercial Real Estate?
- How to Calculate the Equity Multiple for a Commercial Property
- Equity Multiple Calculator
- An Example of an Equity Multiple Calculation
- How to Interpret Your Equity Multiple
- What's a Good Equity Multiple?
- Equity Multiple vs. Cash on Cash Returns
- Cash-on-Cash Return Calculations
- Equity Multiple vs. IRR
- IRR Calculator
- How Commercial Real Estate Financing Affects Equity Multiple, IRR, and Cash Flow
- Related Questions
- Get Financing
What Is an Equity Multiple in Commercial Real Estate?
An equity multiple describes how much money a commercial real estate investor can earn compared to her or his initial investment. It utilizes two figures: total equity invested and total cash distributions over a specified period of time.
How to Calculate the Equity Multiple for a Commercial Property
In order to calculate the equity multiple for a property, you can simply use our calculator in the next section. To fully understand the calculation, see the formula below:
Equity Multiple Calculator
An Example of an Equity Multiple Calculation
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 five years for the same $4 million, they would have an equity multiple of 1.375, as evidenced by the calculation below:
$300,000 x 5 years + $4 million = $5.5 million
$5.5 million ÷ $4 million = 1.375 equity multiple
This means, that for every $1 the investor puts into this property, they could expect, in essence, to get $1.375 back (before taxes) at the end of the five years.
How to Interpret Your Equity Multiple
It's simple: Investments that have an equity multiple of less than 1 return less cash than than investors initially contributed.
Investments with an equity multiple of more than 1 return more cash than their initial investment.
What's a Good Equity Multiple?
A good equity multiple depends on a few factors — most importantly, the time window of the investment and the investment’s potential risks. To obtain a complete picture, investors should also compare a property’s equity multiple to other metrics, like a cash-on-cash returns and an internal rate of return (IRR).
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. An equity multiple also often includes the sale of the property by the investor in the calculation. To determine cash on cash return, use the calcuator below, or the formula further down.
Cash-on-Cash Return Calculations
Cash-on-Cash Return = Total Cash Distribution (NOI) ÷ Total Cash Investment
So, if we use the example above to calculate cash on cash return for the property over a typical one year period, we 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 get:
7.5% x 5 years = 37.5%
Now, add 1 (for the sale of the property at the original price of $4 million), and to get 1.375, the equity multiple for the property.
Equity Multiple vs. IRR
IRR, or internal rate of return, is another essential commercial real estate metric, which is often compared to a property’s equity multiple. Unlike equity multiple, IRR incorporates the concept of time value of money (TVM), which means that it adjusts returns based on the fact that money received today is more valuable than money received in the future. Therefore, while equity multiple measures cash return over the life on an investment, IRR measures the rate of return for the money invested for each period it is invested.
Projects with higher IRRs return more cash faster to investors, but they may not always return more cash overall. In general, IRR is a better metric for evaluating the potential investment returns of a project over a shorter time frame, while equity multiple is a superior way to examine the overall return of an investment over a longer time period.
When we look at Investment #1, we can see that, while it returns cash faster to investors (and hence has a higher IRR), it delivers less overall returns to investors so it has a lower equity multiple. In contrast, Investment #2 has a lower IRR, but it offers a higher overall return to investors, and consequently has a higher equity multiple.
IRR Calculator
Calculate your internal rate of return using our calculator below.
How Commercial Real Estate Financing Affects Equity Multiple, IRR, and Cash Flow
In the examples above, we have not incorporated or discussed the impact of commercial real estate loans on these investment metrics. All of these metrics can be calculated with debt (levered) or without debt (unlevered).
Since financing greatly increases leverage, naturally reducing the cash that must be invested in the beginning of a project, it will typically also increase equity multiples, IRRs, and cash on cash returns.
However, the extent to which it will do this depends on factors including interest rates, loan fees, and other expenses. If the levered equity multiple also includes reversion (for example, the sale of the investment), the duration of the holding period is also important, as amortizing loans begin by contributing a greater amount of the payment to interest, slowly increasing the principal contribution over the life of the loan.
Related Questions
What is an equity multiple in commercial real estate?
An equity multiple describes how much money a commercial real estate investor can earn compared to her or his initial investment. It utilizes two figures: total equity invested and total cash distributions over a specified period of time.
A good equity multiple depends on a few factors — most importantly, the time window of the investment and the investment’s potential risks. To obtain a complete picture, investors should also compare a property’s equity multiple to other metrics, like a cash-on-cash returns and an internal rate of return (IRR).
How is equity multiple calculated in commercial real estate?
Equity multiple in commercial real estate is calculated by taking the net cash flows of the property over a certain period of time, plus the sale price of the property, and dividing it by the purchase price of the property. 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 five years for the same $4 million, they would have an equity multiple of 1.375, as evidenced by the calculation below:
$300,000 x 5 years + $4 million = $5.5 million
$5.5 million ÷ $4 million = 1.375 equity multiple
This means, that for every $1 the investor puts into this property, they could expect, in essence, to get $1.375 back (before taxes) at the end of the five years.
What are the benefits of using equity multiple in commercial real estate?
The benefits of using equity multiple in commercial real estate are that it provides a comprehensive picture of an investment's performance. It takes into account both the total equity invested and the total cash distributions over a specified period of time. This allows investors to compare a property’s equity multiple to other metrics, like a cash-on-cash returns and an internal rate of return (IRR). This helps investors to make more informed decisions about their investments.
What are the risks associated with equity multiple in commercial real estate?
The risks associated with equity multiple in commercial real estate depend on the time window of the investment and the potential risks of the investment. Investors should also compare a property’s equity multiple to other metrics, like a cash-on-cash returns and an internal rate of return (IRR).
Risks associated with equity multiple include:
- Market volatility
- Interest rate fluctuations
- Inflation
- Unforeseen events
Source: www.commercialrealestate.loans/commercial-real-estate-glossary/equity-multiple
What are the best practices for using equity multiple in commercial real estate?
The best practices for using equity multiple in commercial real estate include comparing it to other metrics, such as cash-on-cash returns and internal rate of return (IRR). Additionally, investors should consider the time window of the investment and the potential risks associated with it.
For example, if the investment has a short time window, a higher equity multiple may be more desirable than a lower one. On the other hand, if the investment has a longer time window, a lower equity multiple may be more desirable.
It is also important to consider the potential risks associated with the investment. If the investment has a higher risk, a lower equity multiple may be more desirable.