Pro Forma Statements in Commercial Real Estate
A pro forma financial statement, or simply ‘pro forma’, is a summary of key financial figures of an income-producing property. The pro forma can provide a forecast of a ‘best case scenario’ with respect to the financial viability of the property.
Pro formas are frequently used when dealing with the sale of multifamily properties. The pro forma can help a buyer understand the general financial operation of the property.
The pertinent financial information in the statement includes total income that the property produces and the total expenses that the property incurs during its operation. The difference between these values gives us the net operating income.
A sample pro forma is in the following format:
= Effective Gross Income(Gross Operating Income)
– Operating Expenses
– Non-Recoverable Operating costs on vacancy allowance
– Structural Reserve
= Net Operating Income(NOI)
• The NOI allows us to determine the property value from an income approach.
• It is important to know that the NOI can be affected by the items in the pro forma and therefore as mentioned, buyers need to be informed.
Although the pro forma is widely accepted and used, it is important to know that many of the items in the pro forma statement need to be understood with caution and buyers should always conduct their own due diligence. As mentioned above, pro formas provide the best case scenario to the buyer. The pro forma may provide vacancy rates and maintenance costs that are lower than what is actual, while rents provided may also be higher than actual.
As such, buyers may need to adjust each item line by line to numbers that they feel is a true reflection of how they would operate the property. It is imperative for buyers to do their own market research to have conversations with professional advisers including local appraisers, realtors, and property managers. They should also seek historical data and past financials from the sellers.
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