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What is Pro Forma in Real Estate?

Are you planning on doing some real estate investing? Maybe you want to start big with commercial real estate investing right away.

Investing in real estate is a sound financial move. However, investing in real estate is not as simple as one may think, and for those who are just starting out, it can be confusing.

There are so many things to learn. For example, you should be familiar with pro forma real estate. Below, we'll have an insight into what this is and its uses when real estate investing.

What is Pro Forma in Real Estate?

Pro forma is a Latin term that means "for the sake of form" but that original meaning has little to do with its real estate context.

In the real estate industry, it refers to a method of calculating the financial flow of a property to determine possible income in the future. So, in simple terms, pro forma is the cash flow projections.

You should see by now why pro forma is so crucial to real estate investors like yourself. It can help you have a ballpark idea of how much your real estate investment can make.

Assumptions in Pro Forma

Some of the assumptions that can be included in a pro forma include:

  • Rent
  • Number of units
  • Floor area
  • Fees, taxes, and other expenses
  • Cost of financing
  • Inflation
  • Capital expenditures

The assumptions should not be limited to those on the list. There are others that are just as crucial. Real estate pro forma is important to investors because it helps them to come up with calculations that can predict the amount of money they can make from a property.

The knowledge that can be derived from the pro forma can also be very useful during a negotiation. So, just think about this, if you have an inaccurate idea as to the cash flow of a property, do you think you'll get the most out of it?

Therefore, buyers and sellers must know the cash flow of the property they are dealing with.

Uses of Pro Forma in Real Estate

You have an idea now of what pro forma is and why it's beneficial. The next thing to cover is its uses in real estate. Pro forma is more commonly used in commercial real estate investing, it is used when a commercial property gets onto the market for sale and gets into a listing.

Pro forma can also be used when developers are seeking financing to develop a property. Now, before the investors look at the title, they would first be interested in a property or home inspection or an appraisal and then review the pro forma.

Moreover, pro forma is used to set the cap rate and ultimately determine the price of the property.

Are You Selling a Property?

Are you selling a commercial property? If you are, then the realtor or agent will use the pro forma to analyze the property's performance compared to the standards in the market.

The property will be listed by a broker based on the information found on the pro forma.

How to Create a Pro Forma

Obviously, pro forma is somewhat complicated to create. You need to list down all of the following items:

  • Income 
  • Operating costs
  • Net operating income

You can get the net operating income by subtracting the operating costs from the total income. 

Remember that there is a fine line in pro forma— it is not the actual profit, but the possible income that can be generated by the property. The projection can be very different from the actual income that will be generated by the property.

Pro Forma - What to Keep in Mind

Sometimes, the pro forma can be misleading too. For example, the income generated by a property can be greatly exaggerated to make it seem that the property is making more money than it is actually generating. The vacancy rate on a commercial property can also be hidden.

There are also instances when a multi-year pro forma will assume that the income of the property will go up over the years. You have to be careful with those because you are not getting the real amount that you can potentially get.

Learn More About Pro Forma Before Making an Investment in Real Estate

Now you know about pro forma real estate.  It's still a long way off before you can create one on your own.

To get help on how to create a pro forma for real estate investing or commercial real estate investing, visit our website now and learn how you can make the most out of your investment.

You may also fill out our online form or contact us at 949-881-7128 at Saint Investment Group today!

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