A real estate investment pro forma is a pretty important document in real estate investment that covers the expected cash flow of the subject property. Before you sit down and take a closer look at the pro forma for your next deal, here’s what you need to do—and what to avoid.
Do ask about the source
Sometimes, sellers or brokers will inflate the investment pro forma by estimating items based on something not yet proven. For example, a building may call for higher rent than what is currently being charged, so the broker goes ahead and makes the pro forma based on potential rent figures. However, in this case, the rent hasn’t been raised yet, and there’s no guarantee that higher rents won’t lead to a higher vacancy rate.
A pro forma based on real numbers is far better than one based on projections, so always ask for the data sources for all figures.
Don’t take the vacancy rate at face value
There are two things to watch out for when it comes to the vacancy rate: underestimating and overestimating. A statement with a vacancy rate of 2 percent, even if that is what the seller is currently experiencing, isn’t very conservative. To better prepare yourself for the variables, recalculate the figures using a vacancy rate between 7 and 10 percent.
An overestimated vacancy rate on a pro forma, on the other hand, is more of a red flag about the property, as it could mean the seller wasn’t able to attract or keep tenants. For a more realistic view of vacancies, ask the seller for rent records over the past five years.
Do get additional income detail
Your pro forma may have a listing for additional income, which is revenue generated by the property in ways other than rent. A complex that charges for parking, for example, has that extra income coming in. If additional income is listed, get documentation of its source. Extra revenue is good to have, but you need to evaluate the stability of that stream before you consider it.
Don’t take listed expenses as the final word
A pro forma may not include all the expenses that it should. It’s easy to forget occasional expenses, like snow removal fees in the winter, but these costs absolutely factor into the overall investment. There may be expenses associated with additional income items that are not factored in, too. Dig deeper around the property’s expenses and try to get as much information as possible from the seller.
While an investment pro forma is a good way to get a snapshot of the prospective properties you’re considering, don’t completely rely on it. Do your own research before buying your next property.
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