In this video I discuss the equity multiple and how to use it to evaluate deals.
I want to talk today about understanding the equity multiple. This is one of my favorite metrics when evaluating the investment. One of the other metrics that I’ve talked about in previous video is the cash on cash return. That’s how much cash your investment is generating every year, but the equity multiple is one of my favorite investments because it looks at the life of the investment and says, “Of the money I’m putting in, when it’s all said and done, and we sell this project, how much am I getting back and how much more am I getting back over my principal?”
Let’s say we invest one dollar in a project. We put it in there, one dollar. Over the course of a couple years, the multifamily operator or sponsor improves the property, they get expenses lower, they get income higher, all these things we can do to improve the value of the property and then let’s say three years down the road, we sell the property. All the proceeds to you as an investor are going to be cash flow, any refinance proceeds, any sale proceeds. You put all those proceeds together plus your return of original capital, let’s say that when it’s all said and done, what are you taking out of that deal?
Let’s say you take out two dollars after three years. You put in a dollar and you got out two, when the whole project is said and done between cash flow, refi proceeds, sale proceeds, all those things, the net to you as an investor is two dollars. What is the equity multiple? Well, this one is easy. You take the money that you made, divided by the money that you put in and your equity multiple is two. Now, that’s a good equity multiple because that means that you doubled your money on that investment. That’s very good.
Now, maybe you only got out a dollar 50 and your equity multiple will be 1.5, that’s great too, but this is a really quick gut check of an investment of all the variables that you can look at and evaluate. What’s the equity multiple? If it’s two over three, four, five years, you’re doubling your money in that time period. That’s really good and hopefully your sponsor or syndicator has underwritten a deal conservatively and taken into account a lot of things like overage on expenses, rehab cost going over, cap rates getting compressed at sale, all these different things, or cap rates expanding at sale rather. All these different things that can happen.
You want to make sure your sponsors underwrite it conservatively but the equity multiple is basically “how much am I getting out of the entire project when it’s concluded?” In this case, if I’m getting out two and I invested one, I’m doubling my money. Hopefully, that helps you understand equity multiple a little better. It’s a very quick metric that you can look at when evaluating project, what’s going to happen with this money over the life of the project? Is it going to be 1.5X? Am I going to get my money back plus half? That’s a great return. Am I going to double my money, et cetera? And that should be spelled out for you in the investment summary on any multi-family project that you’re looking at.
I hope that helps, thanks!