What does pro forma mean in real estate? Many real estate investors are not familiar with the term pro forma. It is a financial projection that assists you in deciding on what investment properties to buy. A pro forma can be for an individual or a group of potential investors in a project. It is one of the most important documents as a real estate investor, as it can be the difference between a profitable investment or a failed investment. 

The financials that go into the pro forma include estimated monthly expenses, projected cash flow, and return on investment. These all vary depending on where the property is located, its type, and how much it will cost to purchase or rehab.

Pro forma can be used for single properties or a group of properties. It is common in the real estate investing community to use pro forma to evaluate all properties simultaneously.

Pro Forma Explained

Pro forma documents are essentially financial documents. They estimate either current or future financial returns from a property. In other words, your pro forma will give you a projection for the cash flow of a potential investment. It can also give you a better idea about expenses and what your return on investment will be. 

Understanding Important Terminology

To understand what pro forma means in real estate investing, it is vital first to understand the definition of each term.

Pro forma: A financial statement that shows what a property is expected to produce. It is generally a one-year projection for a single property or multiple properties that have been grouped into an investment.

Income: This is the money that comes into the property that can be used for operation and maintenance. These are expenses such as mortgage, taxes, insurance, repairs, and vacancy. 

Cash Flow: The funds available after all expenses have been paid. It is the money left out of income.

Return on Investment: The amount it will cost to buy a property and the amount of money you can expect to be paid back. Return on investment could be annual, monthly, or even per week.

Basic Rental Income: This is the estimate of the rental income you will make. It provides an idea of what your tenants will pay based on current market rates.

Vacancy Loss: This is a very important piece of your pro forma. It tells you how much revenue you will lose in between tenants when there is a vacancy. This cost will be categorized in your pro forma as a loss rather than an expense.

Concessions: Concessions are things you offer to potential tenants to attract them to your property. Some investors may not need to do this, but it may help you get an edge on your competitors in a slow market. Many landlords offer specials like first or last month free. 

Credit Loss: As an investor, you need to anticipate bad debt within your business. Pro forma typically puts this at around 2% of your gross income, and it includes missed rent and other revenue that you are not paid. 

Expense Reimbursements: Depending on your lease agreements with your tenants, you will have certain expense reimbursements. These are things that your tenant covers instead of you. For example, you may cover water for the building and require your tenants to pay for electricity and gas. In this scenario, the expense reimbursements would be the electric and gas utilities. 

When do I use Pro Forma?

Pro forma can be used anytime you are evaluating potential acquisitions for your real estate investment portfolio. It is important to realize that there are properties that you will never buy or rehab for which you will not get any return on investment. Adverse properties typically have very high maintenance expenses, and there is a limited return on investment, so they are not attractive investments.

Pro forma can be used to evaluate commercial properties with the real estate statistics website, Zillow.com. You can use it as an asset diversification tool. For example, if you are looking at investing in apartment buildings or industrial properties, using pro forma will let you know the price of monthly rents you can expect to receive for each property.

Is Pro Forma Reliable?

In the Real Estate business, there is usually no documentation to verify that the expenses of a pro forma are reasonable. You are often basing your calculations on your experience, but in most cases, there is no experience to back it up, and you are going on what you think will happen in the future.

Each pro forma is different because each investor or developer will use a different formula. In many cases, the pro formas produced include disproportionate numbers that are not realistic. In such cases, it is best to analyze the pro forma on a case-by-case basis rather than try to stick with one number.

In some real estate forums online, such as Zillow or Trulia, you will find people arguing about when to use pro forma and which formula is correct. It is common for investors to use different pro formas for the same property. Everyone has their opinion on what is a good formula to use.

How and where do I get a Pro Forma?

There are several places online where you can download or buy pro forma templates. The information you can find is often fundamental and not much more than what you can find on Wikipedia or other websites.

A pro forma can be drafted by a real estate agent or a title company. The seller will probably have one or two draft templates that they would like you to follow. If you are buying a property from a wholesale company such as Wholesale Lots, LLC, you will receive pro formas, which usually match the terms of the end-user agreement.

How do I use pro forma?

When you open the pro forma for the first time, there are likely to be some questions or points you need to address. Let’s say you want to add a pool to your property. In the pro forma, you will probably find an estimate of how much it will cost and how much it will return. You may realize that the cost of adding a pool is higher than the money that it will return. You can then decide to add it or not based on your monthly cash flow.

You also have to make sure that the pro forma includes all expenses and does not leave out costs such as taxes or insurance. In addition, you should check to see if the pro forma has accounted for contingencies. Contingencies are extra expenses that can occur, such as a roof leak or someone tripping in the yard and getting injured. Most pro formas account for contingencies, but you may want to adjust or add a contingency if you are uncomfortable with the amount of money.

What is the difference between Income and Cash Flow?

Pro forma income and cash flow are often used interchangeably in the real estate business. However, they mean different things. Income is an estimate of all the money coming in for each month or year of operation. Cash flow is an estimate of how much money the transaction will make. The difference between income and cash flow is that cash flow includes a contingency or a contingency plus value, while income does not.

When assessing the pro forma, you will need to determine the return it offers compared to other investments. It is important to note that if you are using a pro forma for buying an investment property, it is expected that the return on investment will be lower than buying and rehabbing a property.

If you buy an investment property with a pro forma, you will need to analyze what return you will get from the pro forma. The return is usually expressed monthly. If your real estate agent or broker gives you a different rate of return per year, they want to have it coincide with the closing period of the property. In fact, most real estate agents will not give you that information for free, and they may charge between $200 and $1,000 for this service.

To use a pro forma, you will need to make sure that the return is advertised in the pro forma. If the return is not advertised, then there is a possibility that it does not exist. This can usually be verified through a simple call to the lending institution or the escrow company. To be safe, it would be best to ask for proof of income during one of your meetings with the seller or agent.

The return on investment is expressed as a monthly rate to ensure that all investors have the same expectations. The property owner will often advertise a rate per month, but you must do it yourself if he does not do this.

If you are buying with a pro forma and are under contract, it will take another meeting with your agent or broker to ensure no other undisclosed contingencies that your lender did not include in the pro forma.

You can also verify the return by going to the escrow company and asking for a copy of the pro forma. The escrow company will only keep a copy of the pro forma for a short time, which will limit your ability to use it later when you are buying with a cash buyer.

The last way you can verify the return from buying with a pro forma is to ask for proof that you have done business with each of the officers and owners of the property. This is only very useful if you are buying the property through a broker or outside investor. In this case, you can ask for documentation from each of them that they own a percentage of the property. This can be verified through a simple call to the loan company and verifying that each person has a loan on file.

Conclusions About Buying With A Pro Forma

The bottom line is that when you buy with a pro forma, there are no surprises later in the process. Suppose the pro forma is complete and accurate. In that case, you will have a perfect sense of precisely what your return on investment will be when you buy with a pro forma—because of this, buying with a pro forma is an excellent way to start your real estate investing career.

This does not mean that picking up a deal with a pro forma can be done quickly or easily. If it were simple, everyone would do it. If you’ve read through this article, you probably realize that it is a lot of work and requires a lot of time to do it right. It is much more likely that a pro forma deal will be on the back burner, waiting for the right time to execute. Keep in mind that a good pro forma deal will pay off many times over later deals if appropriately executed.

For more help in real estate investing, sign up to get one-on-one coaching to ensure you make all of the best decisions for your career in real estate.