Understanding Pro Forma
How to analyze a Multifamily Property Offering
Content
• Some Definitions
• Important Metrics
• Relevant Documents
• Steps in Analyzing the Pro Forma Information
• Five Year Projection
Pro Forma Definition
• A financial projection based on assumptions.
• In a financial context, it is used to present data on an "as if" basis,
where one or more assumptions or hypothetical conditions are built
into the data.
The Pro Forma is used to compare the performance of
various investments.
Some Basic Financial Math
• Cash Flow = Income – Expenses
• Near term concern
• Increase Income
• Decrease Expenses
• Net Worth/Equity= Asset Value - Liabilities
• Longer term Concerns
• Increase Asset Value
• Decrease Liabilities
We go broke in the near term. - Unknown
In the long term, we’re all dead.- John Maynard Keynes
Important Metrics
• Cash on Cash Return
• Cap Rate
• Vacancy Rate
• Expense as a % of Income
• Debt Coverage Ratio
Documents That You Can/Will Use
MLS Listing Setup Sheet Pro Forma Prospective/Offering
Size
Property Description/Features
Photos
Income
Projected/Pro Forma Income
Expenses Summary
Basic Metrics (Cap Rate)
Unit Mix
Financing (Example)
Expense Details
Extended Metrics (IRR, NPV, etc.)
Demographics
Comps (Rent, Sales)
Exit Strategy
1-2 Pages
Minimal
Minimal
X
X
X
X
X
1 page
Minimal
Minimal
X
X
X
X
X
2-5 pages
Moderate
Moderate
X
X
X
X
X
X
10+ Pages
Extensive
Extensive
X
X
X
X
X
X
X
X
X
X
X
Steps in Validating a Pro Forma
• Collect the Actuals
• Current Rents
• Current Expenses
• Current Metrics (Cap Rate, Cash Flow, Cost/Unit, Cost/Sq. Ft. etc.)
• Compare to “Norm” for the Market
• Collect Pro Forma Data
• Income
• Expenses
• Market Potential
• Validate Pro Forma Data
• Compare to market
• Compare to your Plan
• Construct a Model That Reflects Your Plans and Condition
Overview of the Offering
How Credible/(Incredible) is the Offering?
The Offering Summary Provide an Overview of the
Investment
Offering Summary
Price
Down Payment (25%)
Loan Amount
Loan Type Proposed New
Interest Rate/Amortization/30 Years
Units
Price Per Unit
Rentable SF
Price Per SF
Year Built
Lot Size Sq Ft
Cap Rate - Current
Cap Rate - Pro Forma
GRM - Current
GRM - Pro Forma
Net Cash Flow After Debt Service - Current
Net Cash Flow After Debt Service - Pro Forma
Total Return - Current
Total Return - Pro Forma
$1,400,000
$350,000
$1,050,000
3.75%
9
$155,556
6,446
$217.19
1960
7,470
5.39%
6.76%
12.07
10.23
4.90%
10.35%
10.42%
15.87%
• Average Price/Sq. Ft = $175.87.
• Range $149-$199
Cap Rates are between 4.5%
and 6%
The Offering Income
Income
Gross Potential Rent
Other Income
Gross Potential Income
Less: Vacancy/Deductions (GPR) 3.0%
Effective Gross Income
Less: Expenses
Net Operating Income
Net Cash Flow Before Debt Service
Debt Service
Debt Coverage Ratio
Net Cash Flow After Debt Service
Principal Reduction
Total Return
•
•
•
•
Current
Pro Forma
$115,992
$136,800
$450
$3,600
$116,442
$140,400
$3,480
$4,104
$112,962
$136,296
$37,461
$41,721
$75,501
$94,575
$75,501
$94,575
$58,353
$58,353
1.29
1.62
4.9% / $17,149 10.3% / $36,222
$19,307
$19,307
10.4% / $36,456 15.9% / $55,530
Compare Vacancy Rate to 5%
Compare Debt Coverage Ratio to 1.25
Compare Net Cash Flow After Debt Service (Cash on Cash) to Other Investments
Compare Total Return to Desired Return in My Investment Plan (Need Double Digit)
Current Rents
# of Units
1
2
1
1
1
1
1
1
# OF BED
2
2
2
2
2
3
3
3
# OF BATHS ACTUAL RENT TOTAL RENT
1
855
855
2
950
1900
1
1050
1050
1
1100
1100
1
1166
1166
1
1100
1100
1
1195
1195
1
1300
1300
Additional Income Considerations
•
•
•
•
What is the Quality of the Rent?
How Seasoned is the Rent?
What is the source of the “Other Income” ?
Why Hasn’t Current Owner Achieved the Pro Forma
Rents?
Expenses
EXPENSES
Real Estate Taxes
Insurance
Gas
Water
Repairs & Maintenance
Sewer
Trash
Off Site Management
Electricity
Reserves & Replacements
Gardener
Total Expenses
Expenses per Unit
Expenses per SF
% of EGI
Current
$17,222
3,022
1,307
2,529
4,115
553
456
4,876
741
1,800
840
$37,461
$4,162
$5.81
33.20%
Pro Forma
$17,222
2,799
1,307
2,529
6,840
553
456
6,634
741
1,800
840
$41,721
$4,636
$6.47
30.60%
In any transaction, the seller knows more about the property than
the buyer
Are All Expense Categories Covered?
• M(aintenance)
• I(nsurance)
• T(axes)
• U(tilities)
• M(anagement)
The building you are buying is getting older. Therefore expenses will increase
Cash Flow Calculation
Cash Flow Calculations Current State
Net Cash Flow Before Debt Service
Debt Service
Debt Coverage Ratio
Net Cash Flow After Debt Service 4.9%
Principal Reduction
Total Return 10.4%
Current
$75,501
$58,353
1.29
$17,149
$19,307
$36,456
Future State
Use Pro Forma Data to calculate Future State
Can the Market Support a Rent Increase?
# of Units
1
2
1
1
1
1
1
1
# OF BED
2
2
2
2
2
3
3
3
# OF BATHS PRO FORMA
1
1250
2
1250
1
1250
1
1250
1
1250
1
1450
1
1450
1
1450
• Average Rents for 2 Bed is around $1200
• Average Rents for 3 Bed is around $1500
• 77% of Units in the area are rentals
Does the Household Income Support Rent
Increase?
Average Household Income is $39,000
What Happens to Income When Rents are
Raised?
Income
Gross Potential Rent
Other Income
Gross Potential Income
Less: Vacancy/Deductions (GPR) 3.0%
Effective Gross Income
Current
$115,992
$450
$116,442
$3,480
$112,962
Pro Forma My Calculations
$136,800
$126,396
$3,600
$3,600
$140,400
$129,996
$4,104
$6,320
$136,296
$123,676
• Assume it takes 6 months to get Rents to projected levels
• Assume vacancy rates go to 5%
Revised Expenses to Accommodate New Rents
EXPENSES
Real Estate Taxes
Insurance
Gas
Water
Repairs & Maintenance
Sewer
Trash
Off Site Management
Electricity
Reserves & Replacements
Gardener
Total Expenses
Expenses per Unit
Expenses per SF
% of EGI
Current
$17,222
3,022
1,307
2,529
4,115
553
456
4,876
741
1,800
840
$37,461
$4,162.33
$5.81
33.20%
Pro Forma
My Calculations
$17,222
$17,222
2,799
3,022
1,307
1,307
2,529
2,529
6,840
15,840
553
553
456
456
6,634
6,634
741
741
1,800
2400
840
840
$41,721
$51,544
$4,635.67
$5,727.11
$6.47
$8.00
30.60%
41.68%
• Move Insurance back to
original
• Add $1000/Unit for
rehab to increase rents
• Increase Reserves by
50% because of
Building’s age
Five Year Projection
Returns Year By Year
• Assumptions
•
•
•
•
•
35.00%
30.00%
Invest in Year 1 to achieve rent increases
Use 5% vacancy
Rents and Expenses increase 2% per years
Loan Interest rate is 5% for 25 Years
Provide 35% Down
Effective Gross Income
Expenses
NOI
Expense as Percent of Income
Debt Service
Cash Flow
Cash on Cash Return
Equity Increase/Debt Reduction
Total Return
Year 1
$123,676
$51,544
$72,132
41.7%
$63,837
$8,295
1.69%
$18,763
5.52%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
Year 2
$136,980
$42,544
$94,436
31.1%
$63,837
$30,599
6.24%
$38,487
14.10%
Year 1
Year 2
Year 3
Cash on Cash Return
Year 3
$139,720
$43,395
$96,325
31.1%
$63,837
$32,487
6.63%
$59,219
18.72%
Year 4
$142,514
$44,263
$98,251
31.1%
$63,837
$34,414
7.02%
$81,012
23.56%
Year 4
Total Return
Year 5
$145,364
$45,148
$100,216
31.1%
$63,837
$36,379
7.42%
$103,920
28.63%
Year 5
Summary
• Know Your Market/Submarket
• Verify Data in Pro Forma
• Compare Pro Forma Data to Market/Submarket
• Test Data Against Your Individual Plan
• Focus on Cash Flow