Equity refers to the money which an investor invests in a particular transaction. Equity multiple, therefore, is your return on any investment. It shows the number of times your money has increased over a specific period.
The equity on any investment is usually twice the size of the investment. Therefore, if the multiple invested in a business is 3 times in 6 years, then the equity from another investor will increase double folds in six years. Therefore, Equity multiple is defined as the process involved in the total return on an equity investment. Most times such investment includes real estate.
Equity multiple helps to gauge the return on investment which an investor makes with the invested capital. Every type of investment has its way of measuring the returns to be gotten from such investments. For instance, Real Estate equity multiple is just that perfect measuring scale for measuring the rate of return on a real estate investment. It shows how often and in how many folds money invested in real estate has increased.
For instance, If you are getting a return of 200% on an investment of $200M, and you have an outstanding loan of about $400M, your folds or the return expected would be 200% of (400 + 200) = $1200M. Therefore 1200/200 = 6 is the number of folds or return expected.
How to Calculate Equity Multiple
You need to first understand that the instrument used in calculating the expected or total return on initial investment is known as equity multiple. This formula is calculated through any equity multiple formulae that divide the total returns of dollars received by the total invested.
The formula:
Equity Multiple, = Total distributions/ Total investment capital.
Example:
Assume that you invested $1,000,000 into a project as the total equity, and received $2,500,000 as total distributions from the project. To get the equity multiple, you need to divide $2,500,00 by $1000,000. Having done that, it gives you 2.5. Therefore, your equity is 2.5.
If your equity is below 1.0, it means that what you invested throughout this particular time frame is higher than the returns on the investment. In such a situation, you can be considered to have made a loss. However, if your equity is higher than 1.0, it means you are on a profit level and getting more returns than you invested which is why you invested in the first place.
Therefore, it here means that for every $1 which you invested into the project, you should be getting $2.50 as an investor which includes your initial investment amount.
Let’s consider another example below:
If an investor buys a property for $100,000 and the property pays $7,000 per year as its net income. That means in 6 years, the investor must have accumulated $42,000 from the property. If after six years, the investor decides to sell the property for the sum of $165,000 you may want to know if such sale was made at a profit.
To consider the equity multiple and decide if the investor is at a profit or loss, divide $207,000 by $100,000 which is the initial purchase price. This would leave the investor with an equity multiple of 2.07.
As a physician investor who wants to accumulate wealth and lay a strong financial foundation, your desire should be to drive yourself towards getting double the initial investment. So for every one dollar, an investor is supposed to get $2.19 if their initial investment of $1.
However, doubling your investment may not necessarily prove that you have made the right choice as a doctor. Using a single investment class to judge whether you have made the right investment choice or not may not give you an accurate answer. The value of a good equity multiple is usually calculated when compared to other types of investment.
It also ignores the value of time inequity multiple. It does not matter if the holding period is 1 year or 100 years.
How It Works in Real Estate Investing
Equity multiple is usually used in real estate. It is used to show the returns on investment. Buyers of real estate are usually shown various multiples of properties by real estate dealers.
It is seen as a tool that enables buyers of real estate to compare properties easily. It enables investors to know what amount of profit they could earn from a particular investment. However, equity multiple ignores one major factor when analyzing real estate which is time.
To use and calculate equity multiple equations in evaluating real estate, you need to know the following.
- To calculate equity multiple for real estate is; Total cash distribution/Total invested capital. However, this could also be calculated as Total realized profit + Equity invested / Equity invested.
- It is necessary to know the initial money invested by the investor to adequately calculate the initial investment.
- Always project the actual price of a property as it decreases or increases over time. Most times, the figures are usually projected as “BIG” to sell quickly.
- Divide the actual value of the property with the invested amount.
The Shortfalls in Real Estate Investment
- Avoid being misled by equity multiples that seem impressive without considering the time factor. Always consider better ways to invest the price over some time.
- When evaluating deals with high equity multiple, ensure there are certainties and not just projections.
How Physician Investors Can Take Advantage Of Equity Multiple
Real estate investment is revolving rapidly and with these changes and with these changes comes a need for physicians to start on a financial journey. Physicians and other medical professionals have now become increasingly interested in diversifying their portfolios with the advent of technology and regulatory changes. It has provided investment access with a universal array of assets in the markets.
Most physicians can take advantage of equity multiple by venturing into commercial real estate. Commercial real estate is any real estate that buys or develops lands to lease for commercial use. It usually comes in different forms. Some of the benefits involved in commercial real estate include:
- Appreciation in Equity: Commercial real estate has been discovered to appreciate over time. As a medical doctor, you can gradually accumulate wealth passively while still practicing medicine.
- There are many tax advantages attached to commercial real estate. As a commercial real estate property owner, you can write off depreciation on your property from the mortgage.
- Additional cash flow: through commercial real estate, physician investors can have a steady cash flow.
It provides access to an online platform for individual asset syndication. It also offers diversification to investors across the capital stack. However, this is dependent on your risk profile which can either be equity, preferred equity, or debt. The most exciting part is the fact that the equity multiple is partnered with Mission Capital which is a commercial asset sales as well as capital market group.
Conclusion
It is a method for calculating the total return from an investment. It is an indispensable tool for commercial real estate investors. To learn about other useful tools that will help you conquer the real estate world, click here.
Here at PhysicianEstate, we welcome all physician entrepreneurs to learn about commercial real estate investments, rental property investments, and wealth generation. We encourage all physicians to eventually become real estate physician investors. We know a great deal about Who – What – Why – How.
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