Simply put: A financial Pro Forma is a list of financial projections.
Projections based on a specific asset (in this case, we're talking about real estate), and based on certain numbers: expenses, rents, gross income.
A pro forma projects how an investment in that asset will perform.
You can have a financial projection for all kinds of assets:
- Businesses
- Real Estate
- Stocks/Funds (Wall Street)
A pro forma is a projection.
Are they important?
Yes. But they have to have a basis… and you have to know how to use it.
In real estate, it's really simple to understand a pro forma for a single-family house.
Other asset classes like commercial, multifamily, mobile home park self-storage…Those pro formas are much more complex.
When it comes to understanding pro formas, a single-family home is the easiest asset for investors to get started with.
Pro formas are produced by the seller of the property (but you can and should also produce your own).
You can look at the seller’s numbers (assumptions, really) based on their anticipated gross rents, income and expenses.
Be skeptical. Are these numbers realistic?
Have they projected expenses, turnover, vacancy, capital repairs or capital improvements?
Are the rents that they've listed market value rents? Have they factored for inflation? Do they anticipate rents going up year to year?
Don’t take the seller’s numbers for granted.
I'm a conservative investor… when I look at pro formas, I put my own numbers in and make my decision based on my numbers, not someone else's numbers.
Start with what something else gives you. Work them over for yourself. If you don’t know how to do it, get help from somebody who knows the market and the asset class.
Don’t move forward until you are rock solid in your understanding of the information included on the pro forma.
A pro forma is a projection… in essence, it’s an assumption.
No one's guaranteeing anything.
You've got to do your own due diligence to determine if this a good investment for you.
That’s the beauty of Real Estate.
Real Estate gives you control.
I believe control is good.
To your Freedom!
David
