The Proforma Income Statement
The Proforma Income Statement is a proven method real estate investors use to evaluate a rental income property's future financial performance over time. This occurs because the proforma income statement is designed to display what the property's financial data (such as revenue and expenses) become during any specific year over the course of (say) the next ten years.
Based on revenue and operating expense projections, for instance, how much cash flow will the property be expected to generate at the end of the third year? What will be the cash-on-cash return after the fifth year? How much equity will the investor accumulate by the tenth year? And so on.
The type of data, of course, investors engaged in real estate investing rely upon to make prudent rental property investment decisions.
Pro Forma Structure
Simply put, proforma income statements apply a user-designated "variable" to one or all of the various rental property financial's listed below and then displays the outcome over subsequent years.
- Property value
- Rental income
- Vacancy allowance
- Operating expenses
For instance, for the items listed below an investor might expect property value to increase annually at 1% starting in the first year, rental income to increase 2% in both the fourth and seventh years, operating expenses to increase 3% in the fifth year and so on.
- Property value (1% annually starting in Year 1)
- Rental income (2% jump in Year 4 and Year 7)
- Operating expenses (3% jump in Year 5)
Let's say that you're looking at a 8-unit apartment building based upon the property's following current value and annual financial amounts:
- Property value = $480,000
- Rental income = $72,00
- Vacancy allowance = $3,600
- Laundry income = $1,440
- Operating expenses = $29,919
- Replacement reserves = $2,400
- Mortgage payment = $22,641
Next, you decide to apply the following variables in order to project both the cash flow and property value at the end of the third year:
- Rental income to increase 1.0% annually beginning in the third year
- Resale value to be determined by capitalizing next year's net operating income at 7.7%
- Rental income increased the specified 1.0% for the third year
- The sales value will be determined by capitalizing next year's net operating income (EOY4) at 7.7%
- Cash flow will be $16,284
- Sales value is $546,000 (42,016 ÷ .077, rounded to nearest thousand)
- The image above reflects the financial data for the three years sited in the example. The actual Proforma Income Statement would typically show the financial data for a full ten years.
Rule of Thumb
A Proforma Income Statement provides real estate investors with a reasonable way to evaluate a property's future financial performance. But it's based upon a series of assumptions. As such, do not rely solely upon a proforma to make your investment decision. Always consider all aspects of the property such as it's location, condition, price, and tenant appeal as well.