Pro Forma is a term that pops up in real estate investing and other business discussions. Regarding real estate, a Pro Forma is typically thought of as a forward-looking estimate of financial opportunity. As a result, many real estate investors review the Pro Forma documentation to analyze the value of a potential acquisition.
A Pro Forma should typically include these items:
- Rental income
- Vacancy
- Concessions
- Operating expenses
- Management fees
- Real estate taxes
- Debt expense
The information should include historical data and be viewed through a lens that provides for current market conditions and realistic growth assumptions. The Pro Forma will be included as a spreadsheet for many standard offering packages.
How important is the Pro Forma?
A Pro forma is a critical document that enables potential investors to accurately evaluate the potential value of a commercial real estate asset. The Pro Forma lets the investor model the future cash flow, which influences the current value estimate. Further, a Pro Forma may help the investor identify strategies they could employ to increase the potential cash flow.
Since the seller or broker creates the pro forma statement, a potential buyer should conduct their own due diligence by investigating the numbers presented for their consideration. For example, when reviewing the occupancy projections, a potential buyer may want to compare the anticipated rental rates and the vacancy forecast to ensure the projections are realistic and based on current rent information.
If the seller currently receives rental income of $10,000 monthly but believes that the property could bring in $12,000 and uses that number for the Pro Forma, it could be misleading. Similarly, suppose the seller expects operating expenses to drop for some reason and uses the anticipated lower number in calculating net operating income. In that case, the Pro Forma may be inflating the potential. The seller should justify any departures from actual income information used to project future results.
When is a Pro Forma statement appropriate?
The Pro Forma should be available for potential investors to consider any time an acquisition is offered. A Pro Forma used to evaluate the potential of real estate investments is likely to be more valuable and accurate if it incorporates current data. Therefore, the owner should create the document as close to the offering as feasible and consider updating it if the sale is delayed or conditions change.
Also, an interested investor may want to create their own Pro Forma during the evaluation process. This step might be wise if the investor thinks that the seller’s projections are too optimistic or have excluded some pertinent financial information.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
The income stream and depreciation schedule for any investment property may affect the property owner's income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
Programs that depend on tenants for their revenue may suffer adverse consequences because of any financial difficulties, bankruptcy or insolvency of their tenants.
