There is a language that is spoken in the world of multifamily real estate.
The more fluent you are in this language, the better able you will be to converse with brokers, property managers, and other investors. When you are well versed in the vocabulary, you will come off as a professional, rather than a novice and that means, you’ll be taken seriously.
Today, we’re sharing a term you need to add to your multifamily knowledge base, equity multiplier.
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Equity Multiplier for Passive Investors
What is the equity multiplier?
The equity multiplier measures how much of a company’s assets are financed by stockholder equity and how much by debt. It is found by dividing the company’s total asset value by its total shareholder’s equity.
This calculation is an indictor of risk that is used by investors to determine how leveraged a company is.
A company that is using a lot of debt to finance assets is considered to have a high equity multiplier, while a a company with less of a reliance debt, shows a low equity multiplier means that
It’s important to note, that the equity multiplier might also be perceived as high or low based on historical standards, averages for the industry, or related companies.
Understanding the equity multiplier is key to running a successful multifamily business.
You might be surprised to know, there is no ideal equity multiplier.
Average equity multipliers vary from industry to industry and by the sector an industry or company operates within. In general, however, investors look for companies with a low equity multiplier because this indicates the company is using more equity and less debt to finance the purchase of assets. A company that has a higher debt burden could signal a bigger financial risk.
A company's equity multiplier will also vary if the value of its assets changes. If assets increase while liabilities decrease, the equity multiplier will grow larger.
The bottom line is, equity multiplier is a financial ratio that measures how much of a company's assets are financed through stockholders' equity. Lower equity multipliers are likely better for investors, but this varies between industries and companies with particular industries.
In some cases, for instance, a low equity multiplier could indicate that the company cannot find willing lenders; or it could also signal that a company's growth prospects are low. On the other hand, a high equity multiplier is not always a sure sign of risk. High leverage can be part of an effective growth strategy, especially if the company is able to borrow more cheaply than its cost of equity.
Remember, the equity multiplier, just like any other projected return or rate, is projected. That means it’s estimated using formulas, so the results are fluid, not guaranteed. The actual returns may turn out to be below the projections shown on the investment summary, or they may far exceed them.
As a potential passive investor, you should review the details of any presented deal with a discerning eye and ask any questions that come to mind until you feel comfortable and confident that you ready to move forward.
Now that you fully understand the equity multiplier, you can approach the next deal with confidence around that term.