Equity Multiple vs IRR
As an investor, it’s important that you constantly evaluate the overall viability of your investments to ensure that your money is still working for you. While some investment classes, such as stocks traded on the New York Stock Exchange are easy to evaluate as you can simply look at their performance over a given period, other investment classes often require a bit more work. One such example is real estate investing.
For instance, the success of a real estate investment can rarely be determined simply by looking at the financial reports of a given period. That’s why industry experts have created metrics that can be used to better determine the success or failure of many real estate investments. Understanding how to utilize these tools is an important part of achieving optimal success as you continue to evaluate your real estate investments.
Within the world of real estate investing, there are several options available to investors. One such example is crowdfunded real estate investing. The success of a crowdfunded real estate investment is often determined through the use of one or two metrics: IRR and equity multiple. Let’s take a look at these two metrics, how they work, and the benefits of using each one.
What is IRR?
IRR is short for “internal rate of return.” This metric, which includes an incredibly complex mathematical formula, is an annual return metric. Obviously, if you’re participating in a crowdfunded real estate investment, you’re probably going to be involved for at least 12 months. Since IRR relies on annual return data, it is a great tool for this type of investment.
One of the best features of the internal rate of return metric is found in the fact that it considers the time value of money, which is represented as TVM while the equity multiple metric does not. Since money’s value is impacted by ever-changing factors such as inflation, it’s a good idea to consider it when determining the status of your investment. If you’re not a mathematician, don’t be alarmed about the complexity of calculating IRR. There are dozens of IRR calculators online that allow you to simply plug your data into the labeled fields. Additionally, you can access an IRR calculator in Excel.
What is Equity Multiple?
The equity multiple approach to investment evaluation is a bit more straightforward. Equity multiple measures all of the cash distributions that stem from an investment. This includes regular cash flow, the return that was generated by any initial funds, and more. Since equity multiple compares the amount of money invested to the cash distributions generated by the investment, the final solution to the equation is presented in the form of a ratio.
Similar to IRR in one aspect, equity multiple is best used when evaluating a long-term investment that you plan on holding for multiple years, which is why it’s such a popular tool in the world of real estate crowdfunding. If you’ve ever used the cash-on-cash return metric, you probably have a working knowledge of equity multiple. However, while CoC return is presented as a percentage, equity multiple is a ratio. The formula for determining an investment’s equity multiple ratio is a more straightforward process than the complex IRR formula. You simply divide the total cash distributions of a property by the total equity that has been invested.
Both of these metrics provide their own benefits and can be a useful tool for investors, which is why they are often presented side by side on an asset report that is presented to investors. The two are also presented in unison because each of them provides some pieces of information that the other doesn’t. IRR is useful because it reports the percentage rate earned on every dollar that you’ve invested in a property while equity multiple gives a forecast of how much money you can expect to earn over the life of an investment. Understanding how, when, and why to use each of these metrics is paramount. Doing so ensures that you’ve got your finger on the pulse of your investments and are receiving the best return on your money.