There are several different return metrics to look at when analyzing a multifamily deal. ROI, IRR and Cash on Cash… just to name a few that we discussed in previous articles. There is one more that I really like and think rounds out the investment profile… the Equity Multiple.
Equity Multiple gives you an easy formula to understand what kind of return to expect on your investment.
What this formula shows is how many times over the investor makes on their original investment.
Let’s say you were to put $100,000 into an investment property that planned for a 5 year hold. If the property had an average annual cash flow of 8%, that would yield a return of $40,000 over the life of the project. Let’s also say there is $50,000 in sale proceeds at the end of the 5 years. This provides a total return of $90,000. Added together with your initial investment of $100,000 and you have a grand total of $190,000. This would create an equity multiple of 1.9. Basically, $100,000 X 1.9 = $190,000.
Pretty simple right?
Consider Equity Multiple as basically the “multi-year” version of Cash-on-Cash return I discussed in a previous article. If you don’t remember, Cash-on-Cash is the total cash flow you receive (profits) over ONE year divided by the total cash (equity) you invested in the deal.
The limitation of the Equity Multiple formula is that is does not “discount to present value”. In other words, it does not consider the time value of money. Going back to our example above… What if the operators had a 7 year hold instead of a 5 year, and still projected a 1.9 equity multiple? Would you still receive the same returns as the 5 year?? This is somewhat of a trick question. You would receive the exact same amount of cash overall on the deal (it’s still $90,000 of profit between cash flow and sale proceeds). However, you are receiving those returns over 7 years, rather than 5.
This is where IRR comes in to play (which would decrease in this example) and is why you have to take into account all of the return metrics, rather than any one in particular.
What’s the most important metric you look for when determining whether to invest in a deal? What kind of returns do you aim for?
