Pro forma is a Latin term meaning “for the sake of form.” In real estate, pro formas often take on the “form” of an Excel spreadsheet. Pro formas are important documents for developers, investors, brokers, lenders and appraisers to know and understand. They are used to evaluate the viability of properties and projects by “taking a look at the numbers and assumptions.”
What is a Pro Forma in Real Estate?
Pro formas in real estate are created for all types of real estate properties including single-family, multi-family, condominiums, office, retail, mixed-use, medical, educational and industrial. They are used to make assessments about the financial return that a proposed property or project is likely to create.
The financial return analysis is the basic “go/no-go” information that real estate professionals use to decide whether to move forward with a project. Real estate proformas allow for the comparison of various types of real estate projects and properties from a financial return perspective.
Essentials of a Pro Forma
Fundamentally, real estate pro formas are “best estimates” or anticipations of expenses and revenues.
The types of expenses will vary depending on whether the project is an existing property, existing property needing renovation or new build. But generally, some of the expenses in each the various stages of development can include things such as:
- Pre-development costs – planning & initiation, land, design, feasibility, engineering, financing
- Construction costs – materials, labor, insurance, cost of financing
- Operations costs – management and operations, fees, repairs, maintenance, debt service, taxes, reserves, and uncollectables over one-year, three-year and five-year horizons of time.
Types of revenues for real estate pro formas may include such things as anticipated rents based on anticipated vacancy rate, late fees, sales revenues based on price and sales projections and phasing, parking and advertising revenue opportunities for the property, any licensing opportunities, mineral rights, etc.
Types of revenues are also anticipated over one-year, three-year and five-year horizons of time.
Pro Forma Analysis Considerations
It is common to see several different versions of pro forma analysis from different companies, real estate agents, buyers, sellers and brokers. Some are very simple, while others are extremely complex.
A key consideration when assessing a real estate property or project is to get to the “reality” about expenses and revenues. What is the truth? The first step to getting to “reality” or the real expenses and revenues of a property is to examine the intentions of the party responsible for the analysis. For example, sellers may want to inflate revenues and hide expenses. Same for brokers who want to “get a deal done.” They want to make the project as cash-flow positive as possible.
For example, are revenue projections too high? Pricing or rents too aggressive for the marketplace? Does it include discounts for tenant incentives? Vacancy loss? Are expenses accurate? Too low?
When using pro formas to assess real estate opportunities the analysis is only as good as the information used. For this reason all assumptions should be checked with experts in the type of real estate being considered and with local brokers.
When reviewing pro formas be aware of major pitfalls including underestimating costs, over estimating rents/sales absorption & pricing, underestimating operating expenses, omitting a reserve for replacement costs (rentals), underestimating repairs, overestimating sales/rental price escalation.
The real estate pro forma analysis is only as good as the information and assumptions that go into it. It is prudent to not assume that it is an accurate indication of expenses and revenues for cash flow potential. Ground the assumptions in your pro formas. Have experts. like the premier owner’s reps at DAE Group, fact-check your pro forma’s conclusions and assumptions