What is a Multifamily Pro Forma

If you're just getting into the field of investment real estate, then you may have been recently presented with a multifamily pro forma regarding the value of the property you're interested in obtaining. A pro forma, which is essentially a form for the sake of having a form, is a method of showing what the cap value of a property may be, what the expected rate of return may be, and what the current owner believes an optimized version of the income will be.

The only problem with the multifamily pro forma document is this: it can be directly influenced by changes in numbers based on assumptions and expectations instead of facts alone. This gives the seller an advantage, but the buyer has a tremendous disadvantage.

Would You Pay For Something That Has Been Completed?

The issue with the typical pro forma is that it is based on a ratio that is expected after all improvements to a property have been made. When a multi-unit building is upgraded with modern fixtures, appliances, and other improvements, more rent can be charged for each unit that contains the upgrades. In the pro forma, the calculation of these upgrades are often not included in the final numbers, which pushes the cap ratio up by a full percentage point or more in some instances.

This can make a property look like it has over $1 million more in value than it actually does at that particular moment in time.

It's one thing to estimate what revenues would be after an improvement, but it's another to make that part of the value before the building has been upgraded. Would you pay for a contract in full before it has been completed? Most people would not, especially if they don't know who the other person in the agreement on a very personal level. That's exactly what the multifamily pro forma is wanting the average investor to do.

An Inflated Pro Forma Is As Bad as a Low Value One

Many of the loans that investors have access to for a multifamily unit are based on the figures that come from the pro forma document. High numbers make a property look great, but will cause the investor to potentially take out more in return. A poor pro forma that underestimates the value of a property is equally dangerous because it will fail to bring about the expected cash flow for the seller. It flips the dynamic: the buyer gets the advantage in this situation.

It is important to use a good template to make sure you get the pro forma correct. It can also be used to verify the information that has been included on a pro forma. Look at the income, expenses, and development costs in particular because these variables can dramatically impact the annual finances you may be expecting. This should be done over a relevant time period as well so that a true lifespan can be evaluated instead of a brief snapshot in time.

When done correctly, a multifamily pro forma can be a very helpful document. Use these tools to make sure the information on the document before you is correct.
Posted on Jul 25, 2014


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