Equity Multiples and What They Mean for Passive Investors
Any time a potential investor is reviewing real estate syndication investment opportunities, they’ll likely come across the term “equity multiple”. Even if they’ve purchased a primary home or a residential rental property before, it’s unlikely they’ve heard of equity multiples.
When it comes to passively investing in real estate syndications however, it’s an important phrase to know and understand.
What “Equity Multiple” Means for Investors Interested in Real Estate Syndications
As a new or seasoned real estate investor, it’s important to know what you’re getting yourself into. Part of that awareness comes from understanding the metrics presented in the investment summary prior to agreeing to the deal.
As passive investors review potential real estate syndication deals, the term “equity multiple” might seem confusing or even daunting if no one’s ever explained what exactly that means.
Alternately, our investors have shared with us that, after they grasp the concept of equity multiples, they are able to more confidently compare projected returns and make wiser investment decisions.
Defining “Equity Multiple”
The initial amount invested in a deal is an investor’s capital. That capital equals the amount of equity an investor has in the passive investment. Thus, the term Equity Multiple simply means the amount your capital (or equity) will be multiplied by the end of the deal.
If a real estate syndication deal has an equity multiple of 2x and a projected hold time of 5 years, that means investors can expect to double their capital (original investment) in that 5 year period.
The equity multiple is the total of the cash flow distributions plus the returns after the sale of the asset.
Have you seen the video series "Napkin Math," on our Youtube Channel? If breaks down terms quickly to prepare you for your next investment opportunity. Equity Multiple is laid out succinctly here:
A Little Math to Help Demonstrate
Let's explore an example deal with a 2x equity multiple?
The investment (capital, also referred to as equity) is $100,000 and this deal has a projected annual COC% (Cash on Cash) return of 8% with a 5 year hold period. This means the investor may receive about $8,000 per year for 5 years.
In other words, over a 5 year period, the investor will have received a total of $40,000 in cash flow distributions. Then, when the asset is sold, investors receive their initial $100,000 back, plus another, say, $60,000 in profit from the sale.
When the $40,000 in cash flow distributions and the $60,000 from the sale are added up, that’s $100,000 in total returns. The investor began with $100,000 and, not only got that back, but also earned an additional $100,000 cash.
In this example, the investor has doubled their money, which is what it means to have an equity multiple of 2x.
How Passive Investors Might Look at Equity Multiples
In real estate syndication deals, it’s actually quite reasonable to expect to double your investment over the course of 5 years, but that doesn’t mean these deals are easily found. Fortress Federation is always on the hunt for such deals, but as the market tightens, and cap rates compress, it may take 6 or 7 years to double one's money.
Remember, the equity multiple, just like any other projected return or rate, is projected. That means it’s estimated using formulas, algorithms, and expectations of the market, and it’s not guaranteed. The actual returns may be below the projections shown on the investment summary, or they may far exceed what was thought possible.
All in all, investors should be reviewing the details of any presented deal with a discerning eye and ask any and all questions that come to mind until they feel comfortable with the information presented and confident that they are ready to move forward.
Now that you fully understand equity multiples, you can approach the next deal with confidence around that term.