Introducing Weighted Equity Multiple: An Alternative for Dynamic CRE Investments

Across a 22+ year career in the industry, I’ve encountered a range of complex scenarios that traditional metrics sometimes struggle to accurately capture. A case in point that has been top of mind for me recently is a weakness in the Equity Multiple, a metric fundamental to our understanding of investment performance but often lacking in more complex situations.

Equity Multiple typically is calculated by dividing the sum of all capital inflows (capital distributions) by the sum of all capital outflows (capital contributions). However, when an investment includes a mid-hold capital event, like a partial sale, cash-out refinance or post-closing debt placement, the traditional Equity Multiple is ineffective or misleading.

This real-world conundrum has led me to share a variation on the traditional Equity Multiple metric: the Weighted Equity Multiple. This alternative refines the traditional formula by using a time-weighted average of capital invested, pre and post mid-hold capital event. This approach not only addresses the gap left by traditional methods but also aligns more closely with the nuanced realities of more dynamic commercial real estate investments.

Understanding Traditional Equity Multiple

Equity Multiple or EMx (often referred to in other areas of finance as Multiple on Invested Capital or MOIC) is a key return metric in real estate, showing how much an investor’s capital grows throughout the investment period. It’s generally calculated by dividing the total capital inflows by the total capital outflows. Although it doesn’t account for the time value of money, it effectively describes the total cash returned to the investor and is often used alongside the Internal Rate of Return for a comprehensive analysis. The Equity Multiple can be computed on both an unlevered and levered basis, and before or after taxes.

An alternative calculation method for traditional Equity Multiple is to add the total investment profit to peak capital invested and divide this by peak capital invested. This method generally produces the same resulting value as the total inflows divided by total outflows calculation, although for some is a more intuitive way of thinking.

One critical aspect of the Equity Multiple calculation is its inherent assumption that the invested equity remains constant throughout the investment period. However, this isn’t always the case in real-world scenarios.

For example, if an investor initially invests $1.00 and it grows to $1.50, the Equity Multiple would be 1.50x. But what if the investment amount changes mid-hold, say $0.50 is returned after 12 months in a 60-month hold period? Should the calculation be 1.50/1.00 or 1.50/0.50, or perhaps a weighted average of the two? This dilemma highlights the limitation of traditional Equity Multiple calculations in dynamic investment scenarios and the need for an alternative.

The Concept of Weighted Equity Multiple

To address the complexities in dynamically structured commercial real estate investments, allow me to share the concept of a Weighted Equity Multiple (wEMx). This alternative approach accounts for the time-weighted average of capital invested, both before and after mid-hold capital events. The formula is straightforward yet powerful:

Weighted Equity Multiple (wEMx) = (Total Project Profit + Weighted Capital Invested) ÷ Weighted Capital Invested

Where:

1. Total Project Profit = The sum of all net inflows and outflows throughout the investment’s life (i.e. sum of the net cash flow line) 
2. Weighted Capital Invested = Pre-Event Peak Capital × (Pre-Event Period ÷ Total Investment Period) + Post-Event Peak Capital × (Post-Event Period ÷ Total Investment Period)

This method not only acknowledges but quantifies the impact of changing capital structures over the hold period. It’s particularly useful in scenarios like mid-hold refinances or post-acquisition debt placements, where traditional metrics might not fully capture the nuanced performance of an investment.

By applying wEMx, investors and analysts can gain a more comprehensive understanding of an investment’s true return profile. This metric, when used alongside other established metrics like IRR and traditional Equity Multiple, enriches investment analysis, leading to more informed decision-making.

Two Examples of Weighted Equity Multiple

Let’s delve deeper into two real-world scenarios to illustrate the application and advantages of the Weighted Equity Multiple (wEMx) compared to the traditional Equity Multiple.

Scenario 1 – Post-Closing Debt

An investor purchases a property for $10,000,000 in cash. One year later, a $5,000,000 permanent loan is placed on the property. Over the total 60-month hold period, the project yields a profit of $5,000,000.

• Traditional Equity Multiple = (10,000,000 + 5,000,000) ÷ 10,000,000 = 1.50X
• Weighted Equity Multiple (wEMx) = 1.83X
  • Weighted Capital Invested = $10,000,000 x (12/60) + $5,000,000 x (48/60) = $6,000,000
    Weighted Equity Multiple = ($5,000,000 + $6,000,000) / $6,000,000 = 1.83x

The traditional Equity Multiple methodology in this case effectively calculates the unlevered Equity Multiple, without giving credit to the debt component that reduces the capital invested from $10,000,000 to $5,000,000 for the majority of the hold period. If an investor had simply looked at the traditional Equity Multiple, they might have passed on this investment.

Scenario 2 – Mid-Hold Cash-Out Refinance

In this scenario, an investor initially invests $5,000,000 into a property. After 36 months, a mid-hold refinance results in $3,000,000 being returned, leaving $2,000,000 invested. The property is held for a total of 120 months, eventually yielding a $5,000,000 profit.

• Traditional Equity Multiple = (5,000,000 + 5,000,000) ÷ 5,000,000 = 2.00X
• Weighted Equity Multiple (wEMx) = 2.72X
  • Weighted Capital Invested = $5,000,000 x (36/120) + $2,000,000 x (84/120) = $2,900,000
    Weighted Equity Multiple = ($5,000,000 + $2,900,000) / $2,900,000 = 2.72x

Again, the traditional Equity Multiple methodology in this case does not properly consider the effect of the mid-hold capital event on the total investment performance. However, the $3,000,000 returned would have certainly been invested elsewhere for the remaining 84 months and that fact is not represented well in the traditional method.

The wEMx captures this dynamic by adjusting the equity calculation, providing a more accurate reflection of the investor’s actual exposure and return on the remaining equity. This can lead to more strategic investment decisions, especially in long-term hold scenarios.

The Weighted Equity Multiple Explained Video

To help further understand how to use this metric, I’ve created a video on the Weighted Equity Multiple. This resource offers a clear explanation of the metric, addressing the shortcomings of traditional calculations in scenarios with mid-hold capital events. The video used the two examples above to illustrate the concept’s application in real estate analysis.

• Click here to download the file used in this video.

Closing Thoughts

The Weighted Equity Multiple is an important tool in analyzing CRE investments where the investment contemplates a change mid-hold in the capital structure. It supplements traditional Equity Multiple calculations, offering a nuanced view that aligns more closely with the real-world dynamics of real estate investments. If you have any thoughts on using this metric, or ideas for how you’ve handled this mid-hold capital event conundrum when calculating equity multiple, we’d love to hear them.